Plummeting Investment Income Pushes Insurers to Diversify

(January 24, 2014) – The traditional treasury-bill heavy insurance portfolio won’t last in a persistent low-rate environment, according to a BlackRock industry outlook report. 

“Risks in traditional markets will prompt firms to increase exposure to more alternative sources of income like collateralized bank loans and infrastructure debt, as well as real estate debt and mezzanine debt instruments,” the authors predicted. “Insurers will have to embrace less liquid and alternative investment strategies that offer attractive risk-adjusted returns.” 

In 2013, investment income as a portion of insurers’ overall profits plummeted to nearly half its historical average level, the report noted.  

With few predicting a dramatic uptick in core interest rates to arrive any time soon, insurers and analysts alike have said the industry’s investment practices will have to adapt to the new reality.  

More than three-quarters (81%) of 307 insurance executives surveyed by State Street in April 2013 said they were considering increasing their allocation to alternative investment strategies, in the short or long term. Nearly half (49%) said they were evaluating for action within the next 12 months.

According to BlackRock, insurance firms have already begun to carry out those plans and branch out into nontraditional asset classes. In the last three years, the volume of alternative fixed-income assets it manages for insurers has increased fivefold.  

“Insurers are looking for uncorrelated returns in diversifying assets and are interested in harvesting proceeds from investing in less liquid asset classes,” said David Lomas, head of the asset managers’ financial institutions group. “Being generally flush with liquidity, they are willing to take more illiquidity risk to get the returns they need.” 

However, harvesting liquidity premia cannot restore corporate balance sheets alone. To boost income while complying with tighter regulation—Europe’s Solvency II and the Own Risk and Solvency Assessment in the US—BlackRock stressed that efficient use of the capital will be paramount. 

“Ultimately, if insurers’ profit margins dwindle and the costs of doing business keep going up, then those players that do not fully exploit the return potential of their assets will have to stop offering some lines of less profitable business,” Lomas concluded.   

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