Too much capital, too little return
Finding attractive investment opportunities is a familiar challenge in a world of low to negative yields, tight spreads and high equity prices. In this year’s Goldman Sachs Asset Management (GSAM) insurance industry survey, insurers demonstrated the greatest pessimism since the study was first conducted four years ago.
Capitalisation levels remain strong, as 91 percent of insurers believe the industry is over or adequately capitalised, with more than 60 percent of Bermuda-based insurers indicating they believe their peer group is over-capitalised (Figure 1).
With ample capital to put to work, insurers are finding it difficult to find attractive investment opportunities. The majority believe investment opportunities are getting worse (63 percent), while only 9 percent believe opportunities are improving (Figure 2).
Despite the bearish sentiment on the investment environment, one-third (33 percent) of insurers globally are looking to increase overall portfolio risk. Insurers located in Europe, the Middle East or Africa (EMEA) and pan-Asian insurers demonstrated strong risk appetite this year (Figure 3).
The majority of Americas-based insurers intend to maintain their overall risk level. EMEA-based insurers have increased their risk appetite over the years and are looking to take more liquidity risk, while pan-Asian insurers are looking to increase both credit and equity risk.
Bermuda-based insurers are looking to take equity risk (35 percent) and liquidity risk (26 percent) (Figure 3).
Macroeconomic risks
Insurers consider slow economic growth in the US to be the greatest macroeconomic risk (23 percent), followed by credit and equity market volatility (19 percent) and deflation (17 percent). Insurers are also concerned about the unknown impact China and Russia can have on global financial markets.
Despite years of unprecedented global monetary easing, insurers are more concerned about deflation due to slow global growth and lower commodity prices, while inflation concerns have been pushed out.
Insurers are not expecting a meaningful increase in oil prices this year, and they expect commodities to be among the lowest returning asset classes. The last time insurers indicated this level of concern around deflation was in 2012 when they were concerned about the European debt crisis.
Higher rates are vital for insurers to improve returns, but after yields moved lower in 2014, contrary to expectations, and central banks expanded their quantitative easing programmes, insurers are not anticipating a meaningful increase in rates this year.
The majority (52 percent) believe the 10-year US Treasury yield will be between 2.0 and 2.5 percent at year-end, while 31 percent believe it will be 2.5 to 3.0 percent.
Most insurers are not anticipating a significant move in credit spreads, which highlights the difficulty of finding attractive investment opportunities.
The majority of insurers believe we are in the middle of the credit cycle (62 percent), yet one-third believe we have entered the late stage of the credit cycle with deteriorating credit quality conditions (33 percent). Almost half of Bermuda-based insurers (48 percent) believe we are in the late stage of the credit cycle.
Asset class return expectations
Similar to last year, insurers expect equities to outperform fixed income, with the highest return expectations for private equity, US equities and European equities. Insurers globally have the lowest return expectations for cash/short-term instruments and government and agency debt, and intend to decrease allocations accordingly (Figure 5).
Asset allocation
Insurers are looking to less liquid, private asset classes to bolster returns, and intend to increase allocations to commercial mortgage loans (35 percent), infrastructure debt (30 percent), middle market loans (29 percent), private equity (29 percent) and real estate equity (25 percent).
Bermuda-based insurers plan to increase allocations to middle market loans (35 percent), US securitised credit (30 percent), private equity (26 percent), real estate equity (26 percent) and commercial mortgage loans (22 percent) (Figure 6).
Negative sovereign yields are leading EMEA and pan-Asian companies to diversify into US investment grade corporates, an asset class insurers have not demonstrated strong incremental demand for since 2012.
Outsourcing
The demand for outsourcing to third party asset managers remains strong, as insurers globally intend to outsource more of their portfolio (22 percent) or the same amount (58 percent). Bermuda-based insurers have historically demonstrated strong interest in outsourcing, and 74 percent indicated they will continue to outsource the same amount of their investment portfolio this year.
Given the need for significant infrastructure and resources, insurers intend to outsource investments in alternatives such as hedge funds and private equity and niche strategies such as emerging market equities.
Bermuda-based insurers also plan to outsource investments in high yield, emerging market corporate debt and mezzanine debt (Figure 7).
Conclusions
As easy global monetary policies have pushed sovereign yields to low or negative levels, insurers are finding it difficult to find attractive investment opportunities. Despite this pessimistic view, approximately one-third of insurers globally intend to increase overall portfolio risk.
Insurers are concerned about the growth trajectory of the largest economies, particularly the US, and are concerned about higher levels of volatility and deflation. Insurers believe equities will outperform fixed income and are looking to increase allocations to less liquid, private asset classes.
Overall, the industry is well-capitalised and insurers are generally comfortable with the level of risk their peers are taking.
Survey information as of February 25, 2015. Email gsam-insurance@gs.com to request a copy of the report.
