Insurers, still desperate for yield, are partnering with external asset managers in innovative ways.
- Jeff Roberts
- September 2018
- Collaboration: Insurers and asset managers are partnering, seeking mutual growth.
- Hunt for Yield: Despite two rate hikes in 2018 and seven since 2015, insurers will continue to feel the sting of the prolonged low rate environment.
- Outsourcing: The insurance industry’s assets under management grew 5%, according to The Boston Consulting Group report, even as its global AUM market share shrank by 1%.
The hunt continues.
Even as interest rates rise, the U.S. economy hums and many insurers report healthy profits, sluggish yields continue to plague their portfolios.
Systematic challenges such as the prolonged low rate environment, tight credit spreads, market volatility and regulatory pressure persist, squeezing investment earnings.
So some insurers are closely collaborating in innovative ways with external and captive asset managers searching for mutual growth, according to The Boston Consulting Group, a global management giant.
“If you look from an insurance perspective, we're still on the downslope,” said GB Taglioni, senior partner and North America regional leader for the firm's insurance practice. “Low rates and low spreads mean the return on insurance assets have been very low.
“So the headline is searching for more yield, searching for additional return.”
Hence, close collaboration between insurers—specifically life insurers—and asset managers is on the rise in the United States and Europe, according to the firm's 16th annual report, Global Asset Management 2018: The Digital Metamorphosis, released in July.
The partnerships between insurers and asset managers seek to develop new, differentiated investment capabilities that capitalize on insurers balance sheets, design new retail investment products and create third-party asset allocation solutions.
“Partnerships between asset managers and insurance companies [are developing] new sources of yield and new expertise, especially in real assets—whether it's private debt, infrastructure, real estate, private equity,” said Benoît Macé, partner and managing director, The Boston Consulting Group. “The whole idea is asset managers that partner with insurers can share a long-term view of what insurers need in terms of capabilities.
“Asset managers will invest in those capabilities, obviously to serve the insurance company, but also to develop an expertise that they can market outside of the insurance company. And the credibility that the insurance company provides can be quite critical and differentiating in pushing this new expertise to third-party investors.”
For insurers, the quasi-partnerships present privileged access to new sources of yield, release capital from their legacy books and concentrate new business toward capital-light products such as retail savings and wealth, defined contribution pensions and protection.
For asset managers, there is an opportunity to grow and diversify their sources of revenue among insurers beyond the traditional fixed-income product range. To do so, they are developing expertise in Schedule BA alternative and emerging asset classes, while also trying to build their offerings to attract those third-party investors that have become their primary source of new money flows.
GB Taglioni, The Boston Consulting Group
“The headline is searching for more yield, searching for additional return.”
Life insurers, with their large mandates and asset holdings, can “provide critical size to the new investment solutions that [money managers] are developing,” Macé said.
Insurers also tend to stay with external managers once they outsource a portion of their portfolios.
“We increasingly see asset managers getting closer to insurers' marketing departments and possibly even distribution channels to develop tailored retail solutions,” Macé said. “Another one is a big push among big asset managers to commercialize the capabilities that they develop to serve some of those big insurance companies. This is all the more relevant as regulations—think Solvency II in Europe, for instance—are becoming increasingly more complex to navigate for insurers.
“And so insurance companies, rather than managing their assets along the constraints that are defined by those regulations, are turning to asset managers who are doing it for bigger insurance companies and look for packaged allocation solutions.”
Insurers outsourced $2.2 trillion of the $23 trillion in industry assets on their balance sheets at the end of 2017, according to research by the Insurance Asset Outsourcing Exchange.
BlackRock ($281.3 billion in insurer assets), Goldman Sachs Asset Management ($192.1 billion) and Amundi ($180.8 billion) lead the competitive landscape. Blackstone entered the market in late 2017, while others have increased their commitment to the insurance space.
The market for externally managed assets grew 16.9% globally in 2017, according to the Insurance Asset Outsourcing Exchange.
But Taglioni recently has witnessed outsource growth from insurers slow, as they manage more of their assets internally compared to other institutional investors.
The insurance industry's assets under management grew 5%, according to The Boston Consulting Group report, based on an analysis of 165 firms managing $48 trillion—more than 65% of the global asset management industry's assets. However, insurers' global AUM share shrank by 1%—the weakest institutional performance, according to the study.
Cost pressure, insurers' development of internal mortgage origination teams and their concentration on employing external guidance specifically to manage asset classes outside their capabilities drove the slower outsourcing growth.
But that hardly means insurers are not relying on external managers.
“The insurance sector grew nicely,” Taglioni said. “The share that has been given to third-party money managers just has not grown as much as others.”
Assets under management for the entire global asset management industry grew 12% in 2017 to $79.2 trillion, according to The Boston Consulting Group. It attracted record net inflows and profits in the strongest annual performance since the financial crisis.
Bull markets fueled the growth, following a decline in 2016 of revenues and profits for the first time since the crisis.
Benoît Macé, The Boston Consulting Group
"Partnerships between asset managers and insurance companies [are developing] new sources of yield and new expertise, especially in real assets—whether it’s private debt, infrastructure, real estate, private equity."
Search for Yield
But insurers, who operate with conservative risk appetites and invest largely through fixed income instruments, have been forced to look for creative solutions to find yield.
After the financial crisis, they de-risked their balance sheets. They wanted to increase stability in earnings and investment returns.
But as the low rate environment has dragged on and the yield curve flattens, insurers have intensified their search by pushing further out in duration and further into illiquid investments.
They also continue to drop down in bond credit quality—although they remain focused on investment-grade assets—given the long-running positive credit cycle. Credit losses in BBB and BB have been “very modest in recent years, far below historical averages,” Taglioni said.
And while “there is a declining appetite for alternatives among many insurance companies, there's still an appetite,” Taglioni added. They continue taking incremental risks in nontraditional asset classes such as Schedule BA assets.
Demand has increased recently for mortgage securities—particularly commercial mortgage-backed securities—private placements, bank loans, real estate debt, infrastructure debt and emerging market debt.
Many outsource to external managers for expertise in those specialized areas.
“They can help you invest in asset classes or in securities you wouldn't be able to, especially if it's a small part of their portfolio,” Taglioni said. “Maybe you don't have high yield expertise internally and decide to use a third-party expert. It could be emerging market debt. Structured credit. Bank loans. Asset classes that are specialized, and therefore insurers use experts.”
Still More Pressure
But external money managers offer more than specialized expertise in investing, according to Macé.
They also lend help with the sector's complex accounting considerations and capital implications due to regulation.
“Obviously insurers rely on asset managers to develop new investment allocation solutions to relieve capital from legacy books, which can be quite significant on the balance sheet,” he said. “They're also looking—especially in the context of low yields, low interest rates—for asset managers to create new solutions that will deliver more yield. Think about real assets, for instance. And obviously those asset managers that they partner with provide privileged access to such solutions.
“And for their retail offering, they're looking to asset managers to provide capital-light solutions. It can be in [defined contribution] pensions, retail wealth and protection in some cases where there's an investment component.”
Despite rising interest rates of late—the Federal Reserve has raised rates twice this year, seven times since 2015 and has signaled it could raise rates four times overall in 2018—insurers will continue to feel the blunt impact of the prolonged low rates.
“Even though the rates have started going up, which is obviously great news for insurance companies, they are still suffering from the low rates of the last few years,” Taglioni said. “The yield of new assets is lower than the average portfolio yield. The portfolio takes a while to turn over. The investment yield that they get from the bonds they buy today is still lower than the average yield on every asset in their portfolio, which are assets bought 10 years ago, 15 years ago, five years ago.”
So they look to external managers for help.