How Low Interest Rates Challenge Insurer CFOs, Affect Pricing

September 19, 2012

Property/casualty insurers say that principal preservation and total return are the most important objectives of their companies’ portfolio management, yet when asked about their satisfaction level with these two investment goals, their responses diverge. In a survey of P/C carriers’ chief financial officers by Towers Watson, three-quarters said principal preservation is the most important objective for their companies, and equal percentages are very satisfied with the outcome. Total return is ranked most important by 69 percent of the CFOs; however, only 23 percent are very satisfied with it.

The survey found that liquidity and the ability to pay claims registered third among CFOs’ overall objectives, with a 63 percent response rate — and scored high in satisfaction, as 85 percent are very satisfied with how their companies met this objective.

“CFOs with P/C insurers are facing current investment challenges, which are inherent to their dual requirements of ensuring that their companies withstand today’s adverse market conditions while still meeting the expectations of rating agencies and regulators. The responses from our survey illustrate that capital appreciation and investment income aren’t sufficiently contributing to P/C insurance company returns levels needed to adequately please their investors,” said Stuart Hayes, senior consultant, Towers Watson.

The survey results are in sync with reports out of the Reinsurance Rendezvous in Monte Carlo on insurer and reinsurer concerns over the continuing low interest rate environment.

According to the Towers Watson survey, almost one-third of respondents (31 percent) expect their companies’ investment strategies to become slightly more aggressive in the coming year, yet none say they anticipate taking on a significantly more aggressive investment posture.

“The more assertive investment posture reflects a low interest rate environment that necessitates slightly more risk taking to improve portfolio returns,” Hayes said.

CFOs expressed satisfaction with their companies’ approach to investment policies. Over three-quarters (78 percent) said they are very satisfied with their companies’ investment management governance. Similarly, CFOs conveyed that adequate risk controls such as asset/liability management and liquidity are in place, with 75 percent revealing they are very satisfied.

“With the confluence of the financial crisis and the resulting investment environment combined with the push on ERM – risk controls and policies will continue to be important as companies effectively manage risk in the future.” said Hayes.

Asset/Liability Matching

Participants were asked how closely matched their companies’ assets and liabilities are, and only one-third said their companies’ assets and liabilities are matched within one year of each other. In fact, 19 percent disclosed their portfolios are shorter on assets by more than two years, and another 19 percent indicated their portfolios are longer on assets by more than two years.

“The current yield-curve structure appears to be leading different companies in different directions,” said Karen Wells, senior investment consultant, Towers Watson. “On one hand, the steep yield curve and the Fed’s indication it will not raise interest rates in the near term have led some P/C insurers to extend out the yield curve to pick up incremental return. Other companies have positioned their duration short, waiting for yields to rise while avoid locking their assets into today’s relatively low yield.”

When respondents were questioned as to what degree their investment management was outsourced for each of its general account invested assets, CFOs revealed it largely depended on the difficulty of managing particular asset classes. For example, five out of six respondents that listed hedge fund assets as an investment also outsourced that part of their portfolios. However, for core fixed-income investments, only 63 percent of CFOs said their companies completely outsourced the responsibility for managing that sector of their portfolios.

CFO Concerns

Over the next three years, all respondents expect low interest rates to be their companies’ biggest challenge. Paradoxically, half of the CFOs expect the risk of rapidly rising rates will also be their biggest challenge.

“This dual interest rate risk reflects two extreme cases: historically low yields and the potential for rapid rate increases if the Fed and fiscal policymakers don’t steer the economy carefully,” said Wells.

Half of the CFOs surveyed also indicated that market volatility remains a top concern.

“This reflects the continuing financial crisis, which promises to remain a part of the investment landscape due to financial weakness in the European Union and the possibility that the global economy could face a new recession,” said Wells.

To round out the results, CFOs described how their companies’ investment risk profile compares to its stated investment risk tolerance limit. While no respondents are over their limit, 53 percent expressed that their companies are at, or near, their risk tolerance limit, and only 47 percent are significantly under their stated risk tolerance. “The fact that just over half of our survey participants said their companies were near or at the limit reflects just how challenging it is to generate respectable returns and still stay within guidelines acceptable to stockholders and rating agencies,” said Wells.

Thirty-two CFOs from P&C insurance companies participated in the Towers Watson survey, which was conducted between mid-May and mid-June 2012. CFOs represented local and regional carriers, along with national carriers and multinationals.

Source: Towers Watson

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