Insurance companies are actively planning for interest rate changes that will significantly impact the management of investment portfolios, Cerulli Associates finds in a new survey.
The Cerulli research discusses management of insurance investment portfolios in the United States, as well as insurance companies’ “increasing interest in outsourcing investment functions supporting their general accounts.”
According to Alexi Maravel, associate director at Cerulli, the way a particular insurance company is reacting to a likely interest rate hike depends on its business line: “Life insurance companies, which control the largest amount of insurance general account assets and have to match long-duration liabilities with long-duration assets, are making investment adjustments to their surplus assets, while, on the other end of the spectrum, we find health insurers are raising liquidity.”
Asset managers and retirement plan advisers alike say it’s still hard to pin down exactly when the Federal Reserve will raise the Federal Funds Rate from its current target of 0 to 25 basis points. Resurgent market volatility in the last week of August led some observers to question whether the Federal Reserve should raise rates after nearly seven years of easy credit policy. Now many in the market are planning for a hike in December, but as the last few years have proved, this is far from certain.
Maravel says it should benefit long-term investors, including both defined benefit and defined contribution plan participants, when interest rates start ticking up, but some distressing short-term circumstances could coincide with a rate hike for those unprepared.
“While falling interest rates benefit fixed-income investments from a total return standpoint, as bonds mature or are called by the issuer, insurers have to reinvest in even lower-yielding securities,” Maravel explains. Depending on the type and duration of the insurer’s liabilities, this reinvestment risk can be detrimental to the short-term financial performance of the company. A similar lesson can be applied to retirement investment portfolios.
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Cerulli explains that the interest rate situation since the financial crisis “has pushed institutional fixed-income investors of all stripes to reach for yield to meet investment goals.”
For insurers in particular this is a challenging position, Cerulli says. “Insurers are caught between a rock and a hard place: they are under pressure to meet investment goals, yet they operate within strict regulatory capital constraints. Hence, even if they have an incentive to target higher-yielding, more risky securities, the capital charges may be too onerous and the investments might raise concerns with the rating agencies.”
Therefore, Cerulli says, within the context of high-quality fixed-income portfolios, insurers will “generally try to add credit risk on the margin, taking advantage of an individual credit falling a notch or two either within the investment-grade universe, or into the upper reaches of high-yield/non-investment-grade spectrum.”
Cerulli’s survey found nearly seven in 10 insurance asset managers and consultants “expect their insurance clients to increase their allocations to private fixed income,” while a little more than half said they expect insurers to add to allocations in either floating-rate debt (bank loans) or emerging markets debt.
Information about obtaining Cerulli research, including “Insurance Asset Pools 2015: Emerging Addressable Opportunities for Asset Management,” is here.