How carriers make their profits depends on multiple factors, and there are any number of sweet spots to be found for different market conditions (hard and soft, for instance) and interest rates. It is possible (though not automatically desirable) for carriers to operate without positive combined ratios, deriving their profits exclusively from the interest accrued on their investment pools. So, despite being an invisible function little beloved of industry pundits and would-be disruptors, investment management remains every bit as much the lifeblood of insurance as underwriting.
Two of the principal challenges facing investment managers within carriers are low interest rates and regulation. Low interest rates have persisted on a global scale since the financial crash of 2007/8 and show no immediate signs of going away. This naturally diminishes the yields carriers can make on their investments, which have historically been a palliative or even an incentive for marginal underwriting.
As though low yields weren’t bad enough, carriers’ scope to invest is also constrained by regulation, which may subject them to strict capital requirements (as is the case with the E.U.’s Solvency II, effective since the start of 2016) or otherwise limit the range of products carriers can invest in.
“Solvency II regulation is good, but in the kind of environment where we have low interest rates, it makes it much harder for insurers to find opportunities to make money.” — Spiros Margaris, VC (InsureScan.net, moneymeets and kapilendo)
This investments downturn is largely confirmed by our statistics: We asked carriers whether their investment returns had risen or fallen year on year, and 78% globally indicated that these had indeed fallen.
With the money under their management throwing off less profit, carriers worldwide are being forced to shore up their primary business – underwriting – and to generate their profit there instead, through the good old combined ratio and in spite of generally soft market conditions.
This is not to say that investment management ever stops being an important part of the insurance life-cycle; it is just that it is subject to periodic shifts. The pivot we are currently witnessing, away from investments and back toward the core business, is reflected in the universally low priority we saw allocated to investment management in our post on insurer priorities, with carriers around the world ranking it lowest out of our shortlist of 15.
Similarly, we saw in our earlier post on services, investments and job roles that Investment Management was the only service area in which carriers were on balance reducing their investment.
— Insurance Nexus (@InsuranceNexus) July 26, 2017
Today’s low interest rates certainly make life harder for investment managers, but the show must go on – and there is no reason why carriers can’t make the best of a bad situation by pursuing investment strategies tailored to the present adverse environment. One approach is portfolio diversification, which, as we see in the doughnut above, is being pursued by around three quarters of carriers worldwide.
See also: The Future of Asset Management
Regulation cropped up as a key challenge for investment managers, and we further explore this topic, the scope of which certainly extends far beyond investments alone, in our next post. Of course, if you’d like to read ahead straight away, and access the entirety of the Trend Map, then simply download it here free of charge.