Insurers increasing their appetite for risk when markets climb pose challenges when markets begin to experience corrections. Behavioral finance lessons apply now more than ever as markets continue to climb and risk appetite increases by investors and institutions.
Individuals behave in ways that often run counter to their self-interest—something that sophisticated life insurers would never succumb to. As some companies turn their backs on well-planned risk management strategies to manage product volatility, the question arises whether some life insurers are also acting against their better nature.
Like individual investors who have lost sight of their goals only to return to a prudent investment strategy after a financial crisis, some life insurers, which were exposed to the effects of the 2007-2008 recession, returned to the risk management fold at the bottom of the recession, often redoubling their risk management programs at a hefty price just after the tail event.
In this article, Milliman’s Ghalid Bagus and Suzanne Norman explore the drivers of this behavior and the impact it had during the last crisis.
Milliman Chairman Ken Mungan is moderating the discussion “Chief Investment Officer Panel – Searching for Yield” at the ReFocus Conference 2017 on Monday, March 6. Panel participants will address the challenges of investing in a low interest rate environment and offer their perspective on strategies that can be employed.
ReFocus 2017 is a global conference for senior-level life insurance and reinsurance executives. It is sponsored by the American Council of Life Insurers and the Society of Actuaries. Milliman is also a sponsor of this year’s conference. ReFocus 2017 is scheduled from March 5-8 at The Cosmopolitan of Las Vegas. To view the entire conference agenda, click here.
The Solvency II requirements, combined with the low interest rate environment, have resulted in a trend toward insurers seeking innovative product structures to improve customer return, while minimising capital requirements. In Germany, a number of large insurers have effectively stopped marketing their traditional insurance products to focus on more innovative products, including Constant Proportion Portfolio Insurance (CPPI), index-linked products, static and dynamic hybrids, variable annuities, etc. However, there is often a balancing act between increasing customer return, through the inclusion of investment guarantees, and minimising capital requirements for market risk.
My colleagues in Germany recently published a research report analysing three products in the German market from a capital efficiency perspective. The products include Allianz’s “Perspektive” and “Index Select” and Zurich’s “VorsorgeInvest Premium.” Each product offers attractive investment guarantees to policyholders, with the type of guarantee varying by product. However, the guarantees are structured in such a way as to reduce market risk, compared with traditional insurance products in the German market, resulting in improved capital efficiency.
Asset management techniques need to be considered to fund the investment guarantees offered by these products. In a low interest rate environment with high volatility, the costs associated with hedging investment guarantees can be very high. However, volatility control techniques have emerged as a way to reduce the costs of hedging investment guarantees. Using such techniques, a dynamic investment strategy can be adopted to invest heavily in equities to maximise return when markets are relatively stable, but limit equity exposure during periods of high volatility. The Milliman Managed Risk Strategy (MMRS) is an example of such an investment strategy. The research report discusses this in more detail and compares MMRS to a CPPI investment strategy in terms of policyholder return and capital efficiency.
For more information on this topic, please see the Capital Efficient Products in the European Life Insurance Market research report, authored by Marco Ehlscheid and Dr. Matthias Wolf.
This blog post is part of an ongoing series of blog posts on capital efficiency. To see past posts in this series, please click here.
The search for investment yields is a constant challenge faced by U.S. life insurers because of persistent low interest rates. This Milliman report features an analysis of life insurers’ asset portfolios and investment strategies as they focus on generating higher returns while managing risks in a low interest rate environment.
Individual investors at or near retirement may have to reconsider their risk tolerances because of a low interest rate environment and increased longevity. This IO&C article quotes Milliman’s Wade Matterson discussing an alternative portfolio risk management approach featuring an insurance scheme.
Here’s an excerpt:
According to Matterson, building insurance into retail investment products can be achieved with minimal cost using derivatives “in some form or another”.
“These strategies are not unfamiliar at the institutional level but retail investors may not have had much exposure to them,” he said.
Matterson said the products essentially aim to keep investors exposed to at least some market growth while putting a floor on downside risks.
“The reality is there is an insurance cost associated with getting protection,” he said. “And that cost might see investment returns lag as the market rises – it’s an opportunity cost – that will be somewhat proportional to how far markets are up.”
Traditional allocation approaches assume that investing in a wider range of assets or asset classes will lead to a lower risk portfolio. It was also believed that the correlation between asset classes was relatively stable. But recent experience has found a number of issues with this approach. Instead of constructing portfolios using the traditional asset class approach, risk factor portfolio construction can lead to a better understanding of portfolio risk exposures. Milliman consultants Fred Vosvenieks and Stuart Reynolds offer some perspective in this research report.