Insurers should move from listed to private markets within an asset class to keep the overall level of market risk the same, Mercer has said.
Mercer insurance investment team partner Ravi Rastogi said many insurers have moved to higher risk strategies due to a need for sustained investment returns in a low yield environment and “though these strategies may have met investment goals, they will also have led to increased mark-to-market volatility and capital requirements”.
However, Rastogi said the move from listed to private markets “offers a material illiquidity premium to insurers, to increase returns without necessarily increasing market risk”.
“Though insurers do need to be comfortable supporting the lower level of liquidity in such investments, these kinds of strategies can provide a very real boost to return expectations, without the increase in market risk that might be required from public markets.”
Furthermore, expectations are that developed economies, and the US in particular, are approaching the later stage of the credit cycle.
“In the late cycle, risk premia typically compress, and there is a danger that aggregate risk appetite becomes excessive. Associated economic pressures cause central banks to tighten monetary policy, causing risk premia to expand and risk appetite to fall,” Rastogi stated.
“Given the extremely accommodative monetary policy that has been prevalent in recent years, there is a chance that the late cycle this time around will be more dramatic than usual. Insurers should, therefore, ensure that their portfolios are prepared for the potential widening in credit spreads and an increase from the low current level of defaults.”
Insurers have also been urged to investigate asset class risk premia developments.
“There may be further benefit from alternative risk premia within more traditional asset classes. However, while many of the more esoteric risk premia strategies may offer attractive financial benefits, there also needs to be consideration of the transparency offered, as well as the reporting and capital requirements,” Rastogi concluded.