Asset Management
Building Assets

• Best’s Review Staff
• March 2020
• 

Insurers are experiencing a range of influences that are raising the profile of illiquid assets in their balance sheets. In this context, AM Best conducted a survey of Europe-based insurers managing in the region of €4 trillion of financial investments, loans and real estate (€3 trillion, excluding assets held for unit-linked liabilities), according to a Best's Special Report European Insurers and Illiquid Assets—an Upwards Trajectory. The survey, conducted in 2019, focused on identifying what changes are ahead in the next five years and the current rationales for those changes. Anthony Silverman, associate director, analytics, AM Best, said insurers have been long-time investors in less-liquid assets such as commercial real estate, and are exploring other similar investment sectors. Silverman spoke with ^AMBestTV about the report's findings at AM Best's Insurance Market Briefing—Europe, held in London.

Following is an edited version of the interview.

The report refers to evidence of increases in insurance holdings of illiquid assets. What's been driving that trend?

There are some quite strong drivers which have got us into this position post the 2008 financial crisis, which had a lot of liquidity issues in there. Insurers are now looking to hold more illiquid assets than ever before. There are low interest rates, a defining influence.

It can't just be that it's low interest rates because there are a variety of responses to that. There has to be an attraction in the illiquid assets space for insurers to react as they have been. There are various strands to that. I'll mention just a few.

There is an acceptance of the argument that, because the universe of investors is far more limited for illiquid assets, insurers can expect to get paid extra for holding them. That has begun to be recognized in financial reporting as well.

If you consider in Solvency II, for example, the matching adjustments and, to a degree, the volatility adjustment and the discount rates that one might expect to see under International Financial Reporting Standard 17, these are all in excess of risk-free rates. Insurers' CFOs could reasonably ask, “How does what we're going to get, how does that compare to the return assumptions in the financial reporting?”

There's a collection of other reasons as well. There was an expectation that underwriting profit would react directly to low interest rates, but it's been squeezed. It moves around a bit and it may be moving around. It may be looking better going forward now, but it's failed to react directly to low interest rates.

Then there's the question that a lot of assets have moved from the public-listed markets that migrated to private markets. If you don't follow them, then the nature of the assets you hold changes, by default.

Finally, insurers have been involved with illiquid type assets, for example, commercial property, for a long time. They have skill sets there. The question is trying to maximize or monetize, optimize the use of those skill sets. That's something that this exercise also involved.

We've got a good idea and a good picture of where we are at the moment. How's this going to play out over the next five years?

We were very interested in that. We have surveyed our clients. We got an excellent response. This is the survey of European-based insurers. The survey referenced over €3 trillion of assets, excluding unit-linked. The answer was quite clear.

I'll put it this way, 50% of insurers, representing over 90% of the assets of the sector, are looking to increase their holdings of illiquid assets as a percentage of their total funds, excluding unit-linked. Twenty-five percent of those, representing 65% of the industry's assets, are looking to increase the allocation to illiquids by between 5% and 15%.

We're looking at a highly visible change, which will change the complexion of the investment process for the sector if it plays out as we're expecting.

As you say, that's a very large increase. How are insurers going to drive this? Are they going to do it themselves? Will they have to get a specialist in or use third parties?

Yes, we asked this question. This sort of change presents an implementation challenge on all sorts of levels. The responses, as you might expect, did vary between the unweighted sample—that's just one insurer, one vote—and the weighted sample, weighted by investment assets.

Whereas 50% of insurers said that they would expect the majority of their assets to be managed and sourced internally, the weighted sample was over 90% direct. That varies between segments. If you look at the different asset categories, then for the unweighted sample, they're mostly indirect across the categories.

That's infrastructure and commercial property, equity and debt-related for those two categories, equity-released mortgages, private debt, private equity. There is a single exception to that, which is commercial property equity, where the weighted sample was looking to manage that directly for the most part.

If you look at the weighted sample, weighted by investment assets, then it's all the other way around, certainly for the infrastructure and the commercial property categories. They're heavily represented by direct management. The larger insurers are looking to do that directly.

This does raise the question of whether an industrywide move to allocate a bit more, 5% to 15% more to illiquid assets, amounts to a challenge and a competitive disadvantage for smaller insurers.

I'll finally say that one interesting thing is that if you look at the weighted sample for the final three categories—private market debt, private equity and debtor assets, and equity-released mortgages, which is a specialist thing—then the weighted sample looks much more similar to the unweighted.

In fact, even for the weighted sample, in those categories, insurers are looking to do more in the indirect, third-party managed space than managing directly. It appears to be that, for those categories, it's really hard to replicate the expertise and the accumulated history of the third-party managers.

It also means that in those segments the smaller insurers would not be at any disadvantage compared to the major insurers. It may be that private market debt is something that smaller insurers [do], perhaps it's surprising they're not doing more of that. The implementation does vary across segments, with the larger insurers looking to do it directly.