Virtual conference, 7 October 2021
The Zero Bound: Tackling key challenges for insurers in today’s normal
Nearly two years on, the COVID-19 pandemic has yet to dissipate, though there is light at the end of the tunnel thanks to the rapid development and rollout of vaccines. The Geneva Association’s 2021 Chief Investment Officers Conference, co-hosted by Allianz and held virtually, looked forward to the key challenges for insurers in the new normal, notably climate change and negative real rates, convening CIOs from our member organisations, leading thinkers and experts to consider how insurers can plan for and navigate this environment.
The Zero Bound
As countries prepare to return to normal and economies bounce back, there are new challenges on the horizon, notably concerns about inflation and economic fragility.
For insurers, these risks are accentuated by the continued suppression of real yields in the face of ongoing stimulus and a clear indication from central banks that rates will remain low as they prioritise support of economic growth. The zero bound for rates (and indeed, negative in real terms) that insurers have lived with for the last decade continues to haunt them. In this environment and given the paucity of compelling opportunities in traditional areas to deploy capital, insurers have had to think more than ever about how to make their balance sheets work harder and deliver shareholder returns.
Alongside, a new zero bound is emerging. Concerns over climate change have acquired critical mass, with both policy and regulation moving towards greater scrutiny and activism. COP26 was not as ground-breaking as many had hoped, given sovereign disagreements over areas such as coal. A heartening development was the enthusiastic response from investors to tackle the problem tangibly within their portfolios. Many signed up to pledges, most notably the Net-Zero Asset Owner Alliance, which seeks to transition investment portfolios to net-zero emissions by 2050.
For insurers, integrating these pledges meaningfully into the portfolio will be critical to achieving actual success past just words and meeting stakeholder expectations towards an industry that manages more than USD 30 trillion in assets.
Fireside chat: Transitioning the Real Economy
Francesco Starace, CEO, Enel
Insurers are first and foremost investors, yet change has to begin first with the real economy. This is also critical as, fundamentally, the investments that might be deployed within portfolios are determined by the changing needs and demands of corporates.
Francesco Starace, CEO of Enel, offered insight into Enel’s journey to net zero and the implications for the company’s own financing needs as well as the role of investors.
The electricity sector was the first to deal with energy transformation. Technology drove and continues to drive a revolutionary change across all aspects of the supply chain. Going forward, the focus is on continued decarbonisation of generation and increased investment into distribution networks to make them larger, denser and more resilient to extreme events.
There are bottlenecks, however. Governments are much more aligned with a net-zero view of the world and are much clearer about the scale of their ambition. Nevertheless, work remains to be done on the detail, given the legacy of governance tools, policies and regulations. Project approvals, for example, require endorsement from many different constituents and stakeholders, representing a disconnect between government policies and the ambition demanded by society, the pace of technological development and the quanta of capital available from investors. Removing those bottlenecks and untangling the web of regulatory frameworks will be key to accelerating change.
Capital is not in short supply, with insurers and many other institutions eager to get involved. However, further development is needed. Sustainable development goal (SDG)-linked issuance at the corporate level was highlighted as one area of focus, and it was suggested that long-term investors could begin to own, rather than simply finance, new infrastructure. Beyond being a powerful way of helping the transformation, the long duration of these assets also aligns well with insurance cashflow needs.
Panel 1 – Net zero: Moving the needle?
(Top) Nathan Fabian, Chief Responsible Investment Officer, UN Principles for Responsible Investment (UNPRI); Line Hestvik, Group Chief Sustainability Officer, Allianz. (Bottom) Bob Swarup, Director, Chief Investment Officer Network, The Geneva Association; Carsten Quitter, Group CIO, Allianz.
Achieving net zero is a sizeable ambition, and so it comes with significant implications. For insurers, there are considerable strategic challenges.
Insurers help customers to build resilience against tail risks and extreme events. That creates a natural interest in climate change and a need to evolve both product suites and business models. However, while society at large has accepted that we are facing a climate crisis, the sense of urgency among organisations is perhaps lacking. Under the best-case scenario of 1.5°C warming, we will experience many more climate disasters. More realistically and absent significant change, we are looking at a warming of 2.7°C. If warming is of the order of 3–5°C, then fundamentally there are no longer any insurable assets.
Insurers have an important role to play in fostering solutions, given the assets and long-term capital at their disposal. Allocating capital towards future investments is critical but it is also clear that collaboration is key. The Net-Zero Asset Owner Alliance, which a number of Geneva Association members have joined, sets interim fixed-year targets, with the first ones due by 2025. These are ambitious, with portfolio carbon-reduction targets between 16% and 20%.
Nevertheless, a gap remains. Notwithstanding investor appetite and portfolio targets, there is a significant undersupply of low-carbon assets and business models, leading to bottlenecks in deployment and accentuating the levels of transition required over time.
Two clear areas of focus emerge for the insurance industry: stewardship, namely active ownership of companies and investments so that the right transition paths can be progressed, and concerted policy engagement. Currently, government policies are not coming through quickly enough; if the economy is to transition and investment flow to where it is needed, investors need to make more explicit demands on policy to tackle the undersupply of investment opportunities and ensure that those that do emerge are aligned with their needs and portfolios.
Panel 2 – What goes around: The impact of COVID-19 on the credit cycle
(Top) Bob Swarup, Director, Chief Investment Officer Network, The Geneva Association; Carsten Quitter, Group CIO, Allianz. (Bottom) David Marsh, Chairman, Official Monetary and Financial Institutions Forum (OMFIF), Jim Cielinski, Global Head of Fixed Income, Janus Henderson Investors.
The quantum of stimulus over the last two years has been remarkable, but we are also now entering uncharted territory (again). Despite the socioeconomic effects of the pandemic, the impact on insurance portfolios has been muted. Spreads went out and came back in. Defaults never really happened. The system didn’t break. But fragility has certainly been reinforced and there is plenty to worry insurers.
Inflation is a key emerging concern, given the rapid rise around the world as supply chains remain under pressure, wages pick up and demand returns. This also provides problems for policymakers, who are under pressure to tighten policy at a time when support remains uppermost in their minds. The argument was made that central banks are claiming inflation is transient, largely because they are trying to control a difficult situation.
However, there is also a growing sense that this battle may be harder than previous ones, with a consensus emerging that inflation – though perhaps not reaching the double digits of the 1970s – would be well above the 2% target of most central banks in the coming years.
There is certainly some decoupling underway. The Fed is getting ready to scale back asset purchases and begin tapering. Central and Eastern European central banks have started tightening already, with Poland and the Czech Republic recently raising rates. There are also tensions emerging between the European Central Bank (ECB) and hawkish factions within Europe, which may be exacerbated by recent political change within Germany.
In this environment, markets are sensitised. The fact that central banks and policymakers do not have models that can predict what will happen when you pump trillions of dollars of liquidity into a system that is then disrupted through an exogenous shock like the pandemic means that this is now a game of confidence. Should markets begin to worry about the capacity of central banks to control inflation, they will vote for themselves.
For insurers, credit fundamentals are less important now than liquidity and, critically, the path of liquidity. Though there is a lot of debt, access to capital is still easy for borrowers, rates are low and there has been no shock to the financing system. Arguably, central banks are now underwriting the debt markets to some extent, with default cycles getting lower and lower.
Our fate rests more than ever in the hands of central banks. The challenge is that the pressure to tighten is rising; managing that path in the coming years against a backdrop of rising inflationary pressures and nervous markets will be a careful balancing act.
Panel 3 – Guess the price, whack the mole and other parlour games
(Top) Bob Swarup, Director, Chief Investment Officer Network, The Geneva Association; Carsten Quitter, Group CIO, Allianz. (Bottom) Randy Brown, CIO, Sun Life Financial; William Nicoll, Head of Private Investments, M&G.
Private markets have continued to grow in importance and size within insurance portfolios. However, as insurers have expanded into new areas and deployed capital at scale, the need has also grown for them to think carefully about how they might create more resilient and diversified private asset portfolios in today’s fragile environment.
For many insurers, private assets have become a natural evolution of portfolio strategy as real rates stay persistently negative. However, as their allocations grow, challenges have also emerged and there is increasing debate about what to do with this growing segment of the book.
It is clear that private assets are now a structural part of the portfolio for longer duration insurers, with the lines blurring between traditional core public fixed income and private assets of investment-grade quality, such as senior secured lending, core infrastructure and various forms of real estate debt. Around that, niche areas are stepping in to provide diversification and yield enhancement as smaller satellite allocations, albeit moving further down the risk curve or taking on increased complexity risk.
What does a mature private assets portfolio look like for insurers? Diversification is an all-encompassing word, but it also needs to reflect insurer needs and fit within the business model. There are also resourcing implications, given the diversity of portfolios and the need for fundamental analysis, particularly in the absence of easily available external markers such as credit ratings.
Other critical areas of importance are origination (given the need to source deals in scale), ongoing monitoring and workouts, as inevitably some loans will become delinquent or even default over time. Capacity remains a bottleneck, echoing the point raised in earlier discussions that insurers may well have to engage more deeply with policymakers and companies to create the supply they are asking for. Integrating ESG criteria into the private asset portfolio and aligning them with broader strategic objectives, such as net-zero targets, is another key challenge.
Understanding the impact of all this is critical for insurers, as they build out these portfolios and make pragmatic, real-world decisions.
CIOs Conference 2022
Participation in The Geneva Association’s Chief Investment Officers Conference is by invitation only. To inquire about the 2022 conference and to share thoughts on topics for discussion at the event, please contact Bob Swarup, Director of the CIO Network, The Geneva Association, at email@example.com.