Innovative investment strategies can help deal with low interest rates
Low interest rates remain a challenge for insurers—but some have innovated in an attempt to overcome this, as Chip Clark of New England Asset Management tells PCI Today.
“More insurers are investing in floating rate structures as a hedge against an interest rate increase.”
Low interest rates remain one of the biggest challenge facing insurers on the investment side of the business as they struggle to achieve adequate investment yields while also grappling with soft rates and anaemic organic growth on the liability side of the business. Some have adjusted their strategies because of this, but higher interest rates remains the panacea they hope for.
That is how Chip Clark, president, New England Asset Management (NEAM), characterises the investment environment facing insurers and reinsurers in the US. He said that, while interest rates have started to increase gradually, many challenges remain.
“The search for yield continues and there are no easy answers for insurers,” Clark said. “Rates are higher here in the US but they are still low relative to historic levels and they are lower in other areas of the world such as the EU where negative rates still exist.
“Book yields and net investment income remain under pressure.”
Clark argued that most insurers have been forced to adjust to one of the longest periods of low interest rates ever seen. He noted that, as well as tweaking their investment strategies, many companies have also tightened their expense base, cutting unnecessary costs.
“Some have reduced headcount while others have cut back on operating expenses in this difficult business environment” he said.
But despite this adjustment, he acknowledges that insurers are still hoping for rate rises. “They are still hoping it will happen and provide higher levels of investment income to augment their business,” he said.
Alternative strategies
In terms of the way insurers have reacted to the investment environment, Clark said some players have adopted strategies that involve more risk and/or alternative investment strategies.
“But this has not been a wholesale change, it is more on the margins of their portfolios,” he said.
“Some have extended the duration of their investments, taking more interest rate risk, others have been willing to move down the credit spectrum and take more credit risk.
“We have also seen some increased interest in areas such as non-traditional structured securities, high yield bonds and bank loans. But these investment allocations have been at the margins of their overall high grade core portfolios; they have not risked a large portion of their portfolios.”
Such strategies have been broadly successful for those that have done this, Clark said, meaning it is likely some will maintain those investments even if interest rates do increase.
The exploration of investing in non-core asset classes has also opened the door to more insurers outsourcing elements of their investment portfolios; some seek expertise, while others are looking to reduce their costs.
The soft market on the liability side of the balance sheet has been an important factor in all of this, Clark said, as it has put additional pressure on the asset side of the balance sheet.
Several other factors have been influencing insurers’ investment strategies, he noted. One has been the first cut in corporation tax in the US in almost 30 years.
“This has forced insurers to examine the mixture of taxable versus tax-exempt investments they have in their portfolios,” he said.
A second trend he noted is that, as the fed starts to increase interest rates, more insurers are investing in floating rate structures as a hedge against an interest rate increase
“Collateralised loan obligations have become a very popular sector for insurers looking to add floating rate assets with attractive spreads over LIBOR,” Clark said.
Chip Clark is President of New England Asset Management (NEAM). He can be contacted at: chip.clark@neamgroup.com
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