Insurers are likely to re-examine their allocations to fixed income assets in 2013 as continued low interest rates challenge business models and profitability, Blackrock warns.
The firm’s global insurance industry outlook, 2013: The Year Ahead, says insurers will be forced to embrace new ways of achieving profitability in order to meet the increasingly complex challenges thrown up by both the current investment environment and post-crisis regulatory regime.
The report analyses the key drivers that Blackrock believes will shape the insurance industry, including the sector’s income prospects, profitability targets and capital allocation techniques and provides insight into the evolving regulatory landscape.
David Lomas, head of the Financial Institutions Group within Blackrock’s institutional business, said: “Not only is profitability being squeezed, but the investment returns insurers generate from traditional fixed-income assets – to match their underwriting liabilities – are now harder to access at attractive risk-to-reward levels.
“Central bank purchases of quality fixed income assets, coupled with a global thirst for yield and safety, has created an environment where newer bonds are being issued with lower interest rates, but longer maturities. As a result, interest rate risk is increasing significantly. Faced with the dilemma of needing predictable cash-flows to pay client claims and policy guarantees, insurers will need to be more selective and opportunistic with their fixed income allocations than ever before.”
As ongoing market volatility, regulatory changes and increases in capital are forcing banks to deleverage by exiting businesses, selling assets and transferring risks, Blackrock believes larger insurers will help to fill the void as they seek higher yields, inflation protection and superior risk-adjusted returns.
“We expect that some insurance companies will take advantage of the situation and increase their exposure to illiquid assets, particularly those assets with predictable cash flow, such as infrastructure project finance,” said. Lomas.
BlackRock, which last year set up a European infrastructure debt investment team in Europe to meet demand from insurers seeking long-dated and predictable income at attractive levels, also expects increased inflows into areas such as opportunistic credit, real estate debt (both senior and mezzanine), social housing, high-yielding bank loans and equity dividend strategies. Insurers are also expected to begin to look beyond high yield bonds and find attractive opportunities in leveraged loans and collateralised loan obligations.
In addition to emerging market sovereign hard currency debt, Blackrock expects demand for emerging market corporate debt and local currency denominated debt to increase. It also predicts insurers will increasingly implement their investment strategies through exchange-traded funds (ETFs).
Assets in fixed-income exchange traded products currently stand at $339bn, just 0.3% of the overall $98trn global bond market.
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