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Pessimistic re/insurers struggle on low investment returns: Goldman Sachs


Insurance and reinsurance companies are at their most pessimistic on the prospects for the industry, according to the results of a survey undertaken by Goldman Sachs Asset Management, as low investment returns take their toll.

Finding attractive investment opportunities remains a key concern for insurance and reinsurance firms, according to the survey by GSAM. In an investment climate characterised by zero to negative yields on safe assets, low returns across much of the yield curve, expensive equities with markets at highs, and tight spreads, re/insurers are struggling to put money to work effectively.

The fourth edition of GSAM’s survey, titled this year ‘Too Much Capital, Too Little Return’, saw insurers and reinsurers respond the greatest amount of pessimism since the first edition of the survey.

“Insurers are concentrating on finding new investment opportunities which are sparse because yields still remain at low levels, and insurers are not anticipating a meaningful increase in rates this year,” commented Michael Siegel, GSAM’s Global Head of Insurance Asset Management. “Nonetheless, one-third of insurers globally intend to increase overall portfolio risk. Insurers believe equity asset classes will outperform credit assets and they are looking to increase allocations to less liquid, private asset classes.”

The result of this pessimism over the investment climate, at a time when both insurers and reinsurers are facing high levels of competition within the industry and from new third-party capital exploring insurance-linked returns, is an increase in risk appetite.

Many insurers and reinsurers are looking to increase the risk they take on in their investment portfolios, with allocations to alternative asset classes and riskier fixed income likely. This will also result in greater allocations to less liquid, privately sourced assets, such as commercial mortgages, infrastructure, private equity and middle market loans, according to GSAM.

Interestingly, this could result in a greater use of third-party asset managers, according to GSAM, as insurers and reinsurers look to tap into more specialist asset classes, using third-party managers.

Hedge funds stand to benefit, with 26% of respondents suggesting they will outsource to hedge fund managers, while 23% indicated emerging market equities as a target asset class, 23% U.S. investment grade corporates and 22% private equity.

Of course it’s not only the poor investment climate that drives this pessimism amongst insurance and reinsurance firms. The competitive environment, inflows of more efficient ILS and alternative capital, as well as the threat posed by disintermediation and disruptive business models, all threaten re/insurer returns on equity (ROE’s), making investment returns more important than ever.

In a softened reinsurance market and with insurance price rises decelerating across much of the property and commercial insurance world, the need to focus on the return these companies make to investors is clear.

Re/insurers have achieved this through returning capital, share buybacks, one-offs and dividend hikes, all designed to keep shareholders happy while reducing the drag caused by excess capital. At the same time a renewed focus on efficiency is a consistent theme, as the expense ratio presents a target for combined ratio reduction.

Hence also a focus on adding a few extra points of return on the investment side of the business. Insurers and reinsurers have such large asset pools to put to work that adding a percent or two on the portfolio return can make a significant difference to overall performance.

GSAM’s survey identifies a trend that has been ongoing for the last two years or more, a gradual reallocation of assets in search of return, including more of a focus on alternatives. As this continues, the differences between traditional insurers or reinsurers and the hedge fund or investment oriented re/insurer model narrows.

Hedge fund backed reinsurance firms have long sought out the total return, across underwriting performance and asset returns with a close eye on matching liabilities to asset duration in order to keep capital available for claims payments.

It seems that more of the world’s traditional re/insurance companies are taking steps in this direction, which could also result in more emulation of the Warren Buffett and Berkshire Hathaway business model.

With industry losses from catastrophes and other major events remaining low, as they have been for a few years now, insurers and reinsurers have found their results masked by excess capital. This has perhaps, for some companies, made results look better than they should have, but increasingly as reserve releases begin to slow for some this masking effect may evaporate.

Should we see a significant catastrophe loss event some insurers and perhaps reinsurers could very quickly see their ROE’s turn negative. With competition high and more alternative capital on the sidelines, the expectation is that post-loss rate rises will be muted. That means re/insurers may not get the payback they have historically been used to.

All of the above makes the asset return of the re/insurance business more important than perhaps ever before. No longer is an ultra safe and conservative ~3% return possible to achieve easily and more importantly it may not be sufficient for re/insurers to maintain returns to shareholders in the current pricing environment.

Finally, the interest being shown in the insurance and reinsurance sector by large institutional investors who seek a lower total return than equity investors perhaps hints at the future ROE targets for the industry.

When money that is happy operating an insurer or reinsurer for an annual total return (over the long-term horizon) of 8% enters the sector en mass (perhaps look at the example of Exor), the shareholders seeking ROE’s of 13%+ may no longer be seen as the most attractive capital providers.

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