Insurance Asset Management: a new paradigm
by Claire Bourgeois, ALM Invesments Director, and Alexandre Piazza, Head of ALM Investments, for third party clients at Groupama Asset Management
The environment for investors in the insurance sector, including mutual healthcare insurance providers and welfare and pension funds, is becoming increasingly complex. First, the low interest rates of the last few years have prompted investors, in their quest for returns, to diversify portfolios towards previously unexplored, higher-risk asset classes, to the detriment of liquidity. “Carry trade, which is traditionally the main source of yield on sovereign bond markets, has declined significantly over less than a decade. At the end of 2007, the yield of the 10-year German Bund (4.30%) was sufficient to offset an increase in interest rates of 54 basis points per year. At the end of November 2016, yield level is down to 0.30% and can no longer offset a rate hike any higher than 3 basis points,” explains Claire Bourgeois, Director ALM (Asset Liability Management) at Groupama AM.
Optimization of the solvency margin is becoming a major goal
Second, the implementation of the Solvency 2 directive now obliges insurers to take into account the market value of their regulatory capital requirement, which corresponds to the difference between the market value of their assets and the market value of their technical provisions, the “best estimate”. In other words, they must now take their liabilities into account. “However, valuation of assets and liabilities at market value introduces volatility into the prudential balance sheets of insurers. For insurers, the challenge is to actively manage the volatility of the solvency margin, which until now received scant attention,” adds Claire Bourgeois.
Under these conditions, the absolute goal of institutional investors is no longer to obtain high yield but rather to optimize their solvency margin, in other words the market value of their regulatory capital. These challenges call for dynamic management of the insurer’s balance sheet. “It’s a change of paradigm for investors. The asset class approach, in other words asset allocation defined with the aim of generating investment income to cover the liabilities of the institution, is no longer operative. Instead, by defining market value optimization as the aim, bond management is having to move away from ‘buy‑and‑hold’ strategies towards a market value approach,” says Alexandre Piazza, Head of Investments ALM, External Clients.
Insurance asset management becoming more “tactical”
The team at Groupama AM has identified two types of strategy to maximize the market value of a company’s regulatory capital. One strategy, which has become attractive today, is optimized carry, based on the active management of bond positions. “To a certain extent, this is a kind of new‑generation ‘buy and hold’, always on the lookout for new opportunities and founded on actively searching for natural imperfections intrinsic to bond markets, an approach that combines the identification of windows for buying and selling with sectoral arbitrage, per issuer or per country,” he adds.
Another strategy is to establish profit “traps” by means of controlled diversification of the portfolio. The appropriate diversification mix is established via dedicated funds with detachment option. “This strategy is characterized by the benefits of decorrelation, by risk hedging and by active balance sheet management, from earning potential to actual investment income”.
These strategies are reflected in a slightly more tactical approach than in the past for portfolios managed under insurance market constraints. “The governance structures of insurance companies will gradually adapt to these very concrete changes in asset management. Over the next few years, we may witness a redefinition of the mandates entrusted to asset managers, towards a framework that allows for a little more agility,” concludes Alexandre Piazza.