Rating agency Moody’s Investors Service has commented on regulator EIOPA’s findings that insurers and reinsurers are searching for yield in their investment portfolios, but notes that this increases the risk to credit quality.
A survey by the European Insurance and Occupational Pensions Authority (EIOPA) found that in recent years re/insurers have been shifting their investment portfolios into a range of assets designed to deliver higher yields.
This is a direct response to the low yield environment created by central banks, but also likely to the softened and less profitable state of the re/insurance market as well, which has further exacerbated re/insurers ability to make adequate returns for their shareholders.
Any increase in investment yield can help to boost overall return and as a result re/insurers have been transitioning into illiquid investments, including non-listed equities and non-traditional asset classes such as infrastructure, mortgages, loans and real estate.
EIOPA warned that these investment shifts can, “impact the risk profile of undertakings and the sector as a whole” saying that they require close supervision.
Gabriel Bernardino, Chairman of EIOPA, commented, “The survey points to a search-for-yield investment behaviour of insurers which is a natural reaction to the low interest rate environment. The increased exposure to more illiquid investments and to non-traditional asset classes, such as infrastructure, improves asset diversification but also demands new risk management capabilities from insurers and closer supervisory attention. At the same time, in line with our expectations, the first observations from the impact of Solvency II point to an increase in long-term investment and a stable allocation to equity. EIOPA will continue to closely monitor the investment behaviour of insurers to ensure that it continues to remain in line with their risk bearing capacity.”
Moody’s Investors Service agrees, saying that this view is consistent with its views.
“Most insurers have been looking to increase investments in illiquid assets. While some of these illiquid assets can represent a good match for insurers’ liabilities, many groups do not have any expertise in these asset classes and we see a risk that the credit quality of insurers’ assets will deteriorate,” Benjamin Serra, Vice President and Senior Credit Officer at Moody’s Investors Service, commented.
“Changes to the asset mix of the European industry as a whole have been limited in the last five years,” Serra continued. “This is partly because insurers struggle to find enough good quality illiquid assets to invest in, and demand is much higher than the supply. However, if interest rates remain very low, we expect that insurers will accelerate changes in their asset allocation, potentially by investing in lower quality assets.”
But Serra warned that regulators and supervisors need to keep a close check on the rules surrounding illiquid assets to ensure that the search for yield does not accelerate.
“EIOPA and the European Commission are reviewing capital charges that apply to illiquid assets under Solvency II. A reduction in those capital charges could also support faster changes in asset mix,” he said.
Aligning investments with the risk portfolio remains a key feature of the re/insurance industry and even the largest companies need to ensure their asset portfolio is well-suited to match their underwriting business and contains the liquidity required.