BlackRock: Insurers Face Fixed Income Dilemma

David Lomas, Head of the Financial Institutions Group within BlackRock’s Institutional business, said, “This is a crucial time for insurers as persistently low interest rates will challenge their income prospects and stress their business models. We expect them to embrace new ways of achieving profitability to meet the increasingly complex challenges of the global investment environment and the post-crisis regulatory regime.”

The Year Ahead analyzes 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.

Mr. Lomas added: “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.”

The current market volatility, regulatory changes, and increases in capital are forcing banks to deleverage by exiting businesses, selling assets and transferring risks. Mr. Lomas predicts larger insurers will help to fill the void as they seek higher yields, some 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 Mr. Lomas.

BlackRock recently established a European Infrastructure Debt investment team in Europe to meet demand from insurers seeking long-dated and predictable income at attractive levels. In addition, BlackRock also expects increased inflows into areas such as opportunistic credit, real estate debt (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 collaterized loan obligations.

“Insurers may look to growth and higher investment returns in emerging markets in order to increase and diversify revenue,” said Mr. Lomas. In addition to emerging market sovereign hard currency debt, BlackRock expects demand for emerging market corporate debt and local currency denominated debt to increase.

BlackRock also expects insurers to increasingly implement their investment strategies through exchange traded funds (ETFs). For example, Mr. Lomas believes insurers in the developed world, seeking to diversify away from the historically low levels of domestic sovereign fixed income, will look to deploy assets in flexible credit oriented ETFs.

Mr. Lomas added: “The firm’s success has always focused on having both the foresight to anticipate its clients’ changing needs and developing innovative product solutions to meet them. ETFs provide an efficient and effective manner for insurers to deploy cash or tactically allocate assets. For example, the inventory of emerging market fixed income is limited – which may reduce the effectiveness of investing through traditional means. ETFs can make this process more efficient. We’re eager to work with our clients to show them how to more strategically implement ETFs to their investment portfolios, and we’ll look to further innovate products that meet their unique investment and regulatory needs.”

Assets in fixed-income exchange traded products currently stand at $339bn, just 0.3% of the overall $98 trillion global bond market [1].

“The outlook we are releasing today reflects BlackRock’s insight into the management of insurance assets globally and the firm’s commitment to supporting insurers that are seeking independent advice and solutions in the current low yield environment,” added Mr. Lomas.