1 OECD Journal: Financial Market TrendsVolume 2016 Issue 1 OECD 20161 The evolution of insurer portfolioinvestment strategiesfor long-term investingbyHelmut Gr ndl, Ming (Ivy) Dong, Jens Gal*The recent global financial crisis, combined with regulatory changes in financial industries,has altered the financial landscape in terms of how financing can be achieved and thepotential role of institutional investors. The potential role that insurers, particularly lifeinsurers and pension funds, can play as long-term institutional investors has become acentral topic of discussion in various fora. How this role develops will, in the long run, affecthow firms obtain financing for their investments and ultimately lead to growth of the realeconomy.
2 This article provides an overview of the evolving investment strategies of insurersand identifies the opportunities and constraints they may face with respect to long-terminvestment activity. The report investigates the extent to which changes in macroeconomicconditions, market developments and insurance regulation may affect the role of insurers inlong-term investment financing. It concludes that regulation should neither unduly favournor hinder long-term investment as such, but place priority on incentivising prudent asset-and-liability management with mechanisms that allow for a true and fair view ofinsurers risk exposures. In risk-based solvency regulation, an asset s risk relative toliabilities is reflected in the capital classification: G22, E22, F21, O16,Keywords: insurance, long-term investment , asset-liability management, risk-based capital* Prof.
3 Dr. Helmut Gr ndl is Managing Director of the International Center for Insurance Regulation(ICIR) and Professor for Insurance and Regulation at Goethe University Frankfurt, Germany. At timeof writing, Dr. Ming (Ivy) Dong worked as a research assistant at the ICIR and at Goethe University sresearch center Sustainable Architecture for Finance in Europe (SAFE). She now works at DWSH olding & Service GmbH. Prof. Dr. Jens Gal is Professor at the Institute for Insurance Law at GoetheUniversity Frankfurt and the ICIR. This report, revised from an earlier version, was presented anddiscussed at the June 2016 meetings of the OECD Insurance and Private Pensions Committee (IPPC).It has benefitted from comments by delegates and data from (re)insurers on their investmentscompiled in the OECD Large insurer Survey.
4 The authors are solely responsible for any remainingerrors. This work is published on the responsibility of the Secretary-General of the OECD. Theopinions expressed and arguments employed herein do not necessarily reflect the official views ofthe OECD or of the governments of its member countries or those of the European Union. Thisdocument and any map included herein are without prejudice to the status of or sovereignty overany territory, to the delimitation of international frontiers and boundaries and to the name of anyterritory, city or evolution OF insurer portfolio investment strategies FOR LONG-TERM INVESTINGOECD JOURNAL: FINANCIAL MARKET TRENDS OECD 20162 Executive SummaryThe recent global financial crisis, combined with regulatory changes in financialindustries, has altered the financial landscape in terms of how financing can be achievedand the potential role of institutional investors.
5 Before the crisis, banks and capitalmarkets were significant sources for project financing. However, increases in the cost ofinterbank lending and the expectation of tighter regulations have constrained the ability ofbanks and equity markets to provide long-term financing. The potential role that insurers,particularly life insurers and pension funds, can play as long-term institutional investorshas become a central topic of discussion in various fora. How this role develops will, in thelong run, affect how firms obtain financing for their investments and ultimately lead togrowth of the real the current low interest rate environment, financing long-term investment can bebeneficial forinter alialife insurers (as well as pension funds) looking to match their long-term liabilities with long duration assets, and having a steady investment income streamfrom these investments.
6 On the other hand, the risks associated with such assets and theirregulatory treatment may inhibit insurance company objective of this report is to provide an overview of the evolving investmentstrategies of insurers and to identify the opportunities and constraints insurers may facewith respect to long-term investment activity. The report investigates the extent to whichchanges in macroeconomic conditions, market developments and insurance regulationmay affect the role of insurers in long-term investment financing. To complement theanalysis, the OECD carried out the OECD Large insurer Survey on investment betweenFebruary and June 2015 to collect information from insurers on investment decisionsaround the world with a view of better understanding changes in their long-terminvestment activity across time, particularly for infrastructure response to the recent financial crisis and the current macroeconomic conditions,the risk appetites of insurers and pension funds are diversifying.
7 In searching for higheryields, some fund managers have opted for re-risking strategies by investing inalternative assets (illiquid assets) or in emerging markets. Others have chosen de-risking strategies by investing in shorter-term assets so as to cope with changing , since fixed income instruments are presently the predominant asset class of lifeinsurers, low interest rates have led to lower investment income and earnings might beinsufficient to cover investment guarantees that often constitute an important productfeature of life insurance asset and liability management (ALM) strategies of insurers vary depending on thecompany s lines of business. Non-life insurers primarily use stochastic models such asdynamic financial analysis (DFA) to cope with their liquidity risks.
8 Life insurers generallyengage in immunisation strategies , optimisation strategies , and scenario analyses, wherestochastic modelling is extensively used in economic scenario generators (ESG) forTHE evolution OF insurer portfolio investment strategies FOR LONG-TERM INVESTINGOECD JOURNAL: FINANCIAL MARKET TRENDS OECD 20163valuation and risk modelling purposes. Derivatives are considered a valuable instrumentfor the ALM of insurance companies and pension funds, and a liquid derivatives exchangemarket with a sufficiently long time horizon is important for this purpose. ALM theoriessuggest that direct long-term investments are, in principle, a suitable asset class for lifeinsurers, and less so for non-life insurers due to the illiquidity of life insurers liabilityportfolio and as surrender payments and unexpected benefit payments are a lessimportant feature of life insurers portfolios.
9 However, some lines of non-life business havelong-term payout patterns, such as liability insurance, with the possibility of investing inlong-term duration insurers hold relatively more diversified insurance and investment products,which give large insurers greater latitude to invest in assets or underwrite obligationswhich could otherwise be considered risky on a stand-alone basis. Generally speaking,risk-taking by insurers may become excessive if the risk of an insurer s liabilities increaseswithout the insurer charging sufficient premiums or if the insurer has an imprudentunderwriting policy. Insurers can change their asset allocation toward a riskier investmentportfolio after collecting premiums from policyholders or reduce their equity capitalendowment to the minimum regulatory capital required, leading to a higher probability ofinsolvency.
10 Otherwise, an insurer may fail to sufficiently manage risks through considerations to insurers long-term investment include the continuedslow growth of major economies coupled with an aging population in certain developedmarkets may negatively impact the insurance industry s growth in some to the default risk of sovereign bonds of certain countries and bonds of otherfinancial institutions remains a concern in many countries (particularly some Europeancountries); although this largely depends on the extent to which insurers are themselvesinvested in such assets or are invested in companies that are invested in such , emerging risks such as cyber risks and world/regional health risks (forexample, EBOLA) are important emerging issues for countries have implemented or are planning to implement a risk-basedsolvency regime.