The insurance industry is embracing greater complexity amid low asset yields, uncertain economic conditions, and evolving trends such as manager/insurer tie-ups and impact investing. The desire to diversify sources of income and enhance yields through nontraditional assets has led to increased consolidation and a proliferation of private equity (PE) and other asset management firms acquiring or partnering with insurers. Insurers and other asset owners are also watching the evolving regulatory landscape and heightened focus globally on ESG issues. These key trends are expected to continue into 2022 amid a very dynamic economic, regulatory, and geopolitical environment.
To combat concerns about rising inflation, higher interest rates, and pandemic/policy-related shocks, insurers are adding real assets, floating-rate products, and semi-liquid strategies. Within real assets, real estate investments backed by suburban offices and industrial/logistic properties have performed well recently, reflecting the dramatically changing demand from businesses and consumers due to the pandemic. Insurers are finding that floating-rate assets such as direct lending, commercial mortgage loans (CMLs), and collateralized loan obligations (CLOs) are well positioned in a rising rate environment. Alternatives are also popular given their potential for higher and uncorrelated returns. Semi-liquid products that invest in a mixture of liquid public securities and private assets may also help insurers meet both yield and liquidity needs in volatile times.
Tight asset yields are driving insurers to diversify income sources via strategic partnerships or mergers and acquisitions (M&A) between insurers and investment managers. These partnerships can come in several forms. Many PE firms have pursued partnerships via partial or full ownership of insurance companies, particularly annuity writers. For PE managers, the attraction is the long-term stable capital that comes with affiliated insurance assets. According to the Capital Markets Bureau of the National Association of Insurance Commissioners (NAIC), 177 US insurers were owned or controlled by private equity firms with total cash and invested assets of approximately $487 billion in 2020. That was up by about 200% from 89 insurers and 42% from $344 billion in 2019.1 The proliferation of the PE activity has caught the NAIC’s attention regarding its potential impact on the industry.
Insurers are often drawn to asset managers to supplement their in-house investment capabilities. Asset managers can offer value-added expertise in managing and originating nontraditional assets with attractive illiquidity premiums (direct lending, real estate, and alternatives), better geographical diversification (emerging market securities), and greater complexity premiums (structured securities). In addition, managers with deep roots in insurance asset management can help structure insurance-friendly solutions to maximize capital-adjusted returns within insurers’ asset liability management (ALM) constraints. And capital management is increasingly complex, as many insurers must model and optimize across multiple capital regimes, including statutory, AM Best, S&P, and others.
The NAIC is also reviewing its definition of a bond, in part due to complexities related to securities with equity-like characteristics being filed as bonds. The NAIC has indicated that changes related to bond definitions likely won’t go into effect until January 2024 at the earliest. Separately, the NAIC is looking into private letter ratings and their rating accuracy.2 These changes may affect a security’s eligibility for filing exemption designation, the use of credit ratings, and the statutory capital charges. To further complicate things, it’s quite possible that certain investments will not be grandfathered, or that a transition framework may be created.
Going forward, capital efficiency will become more important than ever. This year’s newly approved bond factors are expected to increase statutory risk-based capital requirements for life, property and casualty (PC), and health insurers broadly starting in 2022.3 That may lead insurers to increasingly rely on asset managers that can offer capital-friendly solutions and expertise in efficient funding sources such as Federal Home Loan Bank (FHLB) lending.
Climate change has long been central to PC (re)insurers due to their underwriting exposure to natural catastrophes (e.g., hurricanes and wildfires) and social risks (e.g., the US opioid epidemic). But besides that, as asset owners, insurers are increasingly integrating holistic ESG considerations into their investment decisions and regulatory disclosures, and they’re joining the growing ranks of investors who are requiring their asset managers to report portfolio data related to carbon emissions.
Regulators have been gradually requesting more ESG reporting and testing, and we expect that trend to continue. For example, the UK Prudential Regulation Authority has requested UK insurers to stress-test investment portfolios for climate risk. In 2021, the UK central bank issued a Climate Biennial Exploratory Scenario (CBES) survey to analyze the climate risk of financial exposures, covering both assets and liabilities, of the country’s largest banks and insurers.4
In the US, ESG disclosures and testing vary by state. For example, New York and California have been particularly active in this area. NY has issued proposed guidance for its insurers regarding governance structure, financial risks, scenario analysis, and disclosures related to climate change.5 6 To help track insurance climate risk exposures, the NAIC adopted an Insurer Climate Risk Disclosure Survey in 2010 and a Taskforce on Climate-Related Financial Disclosures (TCFD) report in 2017.7 8
Looking ahead to 2022, PineBridge expects insurers to continue diligently expanding into new and more diversified sources of income and return, and to pursue these strategies in structures that best fit their ALM and regulatory needs. Insurers are increasingly subject to greater ESG reporting requirements. Finding the right strategies, structures, and investment partners that cover all these fronts will remain essential to competing in this increasingly complex marketplace.
For more economic and asset class insights, see our full 2022 Investment Outlook: Opportunities in a Climate of Change.
1 Source: NAIC Capital Markets Special Report as of year-end 2020.
2 Source: PineBridge Investments, “Investment Implications of NAIC Revisions to SSAP No. 43R and Bespoke Securities,” October 2020.
3 Source: PineBridge Investments, “What New Risk-Based Capital Bond Factors Could Mean for Life Insurers, June 2021.
4 Source: https://www.bankofengland.co.uk/stress-testing/2021/key-elements-2021-biennial-exploratory-scenario-financial-risks-climate-change, June 2021.
5 Source: Proposed Guidance for NY Domestic Insurers on Managing the Financial Risks from Climate Change, March 2021.
6 Source: NYSDFS: An Analysis of New York Domestic Insurers’ Exposure to Transition Risks and Opportunities from Climate Change, June 2021.
7 Source: Assessment of and Insights from NAIC Climate Risk and Disclosure Data, November 2020.
8 Source: Task Force on Climate-related Financial Disclosures, October 2020.
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