Europe’s Insurers Are Walking a Fixed-Income Tightrope

March 18, 2022 — London

New options are being explored in response to the challenges posed by inflation and low yields

Insurers’ move away from traditional assets represents an opportunity for asset managers with specialist private-market expertise and strength in actively managed fixed income, according to the latest issue of The Cerulli Edge―Europe Edition.

The European insurance industry has also seen premium income decline and liabilities increase, the latter due largely to costs related to climate change and the coronavirus pandemic, notes Cerulli.

“The effects of the COVID-19 crisis and the war in Ukraine on prices, supply, and demand mean that insurance companies—heavily dependent on bonds to offset liabilities—must navigate a combination of rising inflation and low yields,” says André Schnurrenberger, managing director, Europe, at Cerulli.

The prospect of yields remaining low while inflation rises is posing challenges in terms of asset allocation, profitability, and solvency. As insurers’ approaches continue to evolve, more are outsourcing their asset management. Some are doing so entirely; others are keeping core asset management in-house but outsourcing specific mandates in areas such as alternatives.

Higher inflation would usually be accompanied by higher yields, but there is currently no such compensation and returns are falling well short of prices. The inflation outlook compounds the low-yield environment, given that insurance companies will try to maintain shorter-duration portfolios to minimize the impact of rising rates. The expectation is that many insurers will cut their fixed-income allocations and increase their exposure to less traditional and more specialized assets.

The options for insurers are shaped to a significant degree by Solvency II, EU rules that impose greater costs on insurers to invest in higher risk assets. The market impact of the pandemic and the low-yield environment have added to the pressure on insurers’ solvency ratios, although the effects vary by insurance sector, risk profile, and capital position, among other factors.

A conventional response to inflation typically involves greater exposure to inflation-linked bonds, although the increase in flows to such funds remains relatively moderate.

Insurers are also seeking to limit the duration of their fixed-income holdings, reducing their exposure to long-dated bonds in favor of more short- and medium-dated bonds. This, however, has the unfortunate consequence of further reducing yields, with knock-on effects. In the struggle to deliver acceptable returns, bond managers have increasingly responded to lower yields by moving further down the credit quality ladder, which brings its own risks, notes Cerulli.

Insurers are increasingly turning to real assets and alternatives. Many had previously kept their exposure to these relatively opaque and specialist assets to a minimum but are now obliged to increase their allocations to them in order to counter the effects of inflation.1

“Although the shift from core fixed income to alternative assets was underway before 2020, current conditions will accelerate the transition,” says Schnurrenberger. “Nevertheless, bonds will continue to attract the bulk of insurers’ investments, given Solvency II restrictions and the sheer volume that would need to move for alternatives to make up a large percentage of overall holdings. Asset managers with a strong track record in actively managed fixed-income and private-market strategies are well placed to help insurers adjust to changing conditions.”

1 Source: Refinitiv

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Note to editors

These findings and more are from The Cerulli Edge—Europe Edition, 1Q 2022 Issue.

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