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Pressure points

The investment challenges facing insurers

Low interest rates, regulation and ESG risks are not new considerations for insurers’ investment strategies. However, the long-term fallout from COVID-19 is adding a layer of complexity they will need to adjust to.

Last winter’s snowstorm in Texas froze the state in more ways than one. Homes that were not built for such low temperatures quickly got cold. Energy infrastructure that did not link with other states couldn’t meet the spike in demand. Uninsulated water pipes burst. And people who did not own adequate clothing had to queue for blankets.

Similarly, in 2020 COVID-19 created a perfect storm for insurers. Spikes in health and business claims combined with a work-from-home order, requiring fast adaptation and causing a huge shock to the economy and financial markets. Few saw the pandemic coming, and insurers, like everyone else, were not immune to the fallout.

Fortunately, they were well capitalised and able to absorb the shock, and many adapted incredibly quickly. Such characteristics will stand them in good stead in the months and years ahead as they face transformative pressures on their businesses; from the rise of technology to ageing populations, together with ongoing uncertainty and challenges that require solutions in the near term.1

The economic legacy of COVID-19

Even as vaccines are rolled out around the world, the economic effects of the pandemic will linger for some time – possibly years. Interest rates are likely to remain low, impacting income streams in life and annuity products and creating difficulties for asset and liability management.

COVID-19 has shone a light on the likelihood of future pandemics

According to a recent McKinsey report, equity market volatility, low interest rates and the repricing of assets exposed to climate risk are all putting pressure on insurers’ balance sheets, product profitability in life insurance, and investment management fees for savings products. Insurers will need a stronger focus on risk and should review their investment strategies using robust economic scenario analysis and clear assessments of risk appetite in the changing environment.2

COVID-19 has also shone a light on the likelihood of future pandemics, which had been largely ignored despite the alarms of previous viruses and the fact they regularly featured in reports on global risks. The crisis has also highlighted the urgent need for climate action and to support the most vulnerable members of society.

“Clearly, COVID-19 has profound policy implications,” says Ashish Dafria, chief investment officer, Aviva. “The size of fiscal stimulus around the world is unprecedented; the amount of debt being issued is almost inconceivable. The second implication, into which we are putting a lot of thought, is the acceleration in structural shifts that we were seeing in the economy already.”

In terms of business impact, insurers will need to take pandemic risk into account, prepare for potential legal challenges to policy wording and factor in climate risk to their models, all of which will drive solvency risk. On the investment side, they will continue to face mounting pressure to incorporate environmental, social and governance (ESG) factors, and need to review their risk and regulatory capital allocation models to assess, for instance, whether downgraded credit ratings reflect a temporary or a more fundamental shift.3

In this context, ongoing low rates, continued regulatory changes and increasing pressure to integrate ESG are likely to be the key investment considerations for insurers in 2021 and beyond.

Low interest rates: Impact on investments and business models

For insurers with large life and annuities books, low rates combined with increasing lifespans will impact business models, pushing companies to offer products for different life stages and non-monetary benefits and health services.4 This will allow them to maintain attractiveness when competing with asset managers, particularly as life and health coverage converge. Pressure will continue to mount on guaranteed products, which may shift from offering guaranteed returns to upside potential with downside protection.5

Many insurers are selling their annuities books as well, where the mix of capital intensity, lower profitability and administrative constraints makes them unattractive to retain. Rationalising costs, considering improvements, and entering structuring partnerships with potential buyers all represent efforts to limit the risk of undervaluation.6

However, insurers that remain active in this segment see opportunities in buying annuities books, from both competitors and corporate pension schemes. The latter is a significant trend in the UK, where bulk-purchase annuity supply exceeded £40 billion in 2020 and is projected to grow over the next five years. Commercially, it is a good opportunity for life insurers, but it raises the question of where to invest the assets once they land on the balance sheet.7

“Insurers buying bulk annuities face a number of challenges,” says Moiz Khan, head of insurance solutions at Aviva Investors. “Very low interest rates have made it expensive to price and hold capital for this business. While some of this can be addressed by investing in sufficiently long-dated and higher-yielding assets that generate cashflows, finding such assets that also comply with Solvency II matching adjustment regulations is a challenge in itself. Despite origination and deployment challenges, insurers operating in this space need to invest in real assets to be able to offer competitive pricing.

“Another significant challenge for insurers in the bulk annuity market remains longevity risk capital. In particular, the risk margin is disproportionately high given the level of interest rates, and it adds balance sheet volatility given the mechanics of its calculation. Insurers operating in this market have to look at a multiple array of solutions, including effective investment, hedging and reinsurance strategies,” he adds.

Figure 1: UK projected bulk annuity supply (in £bn)
UK projected bulk annuity supply
Source: Hymans Robertson, as of April 13, 2021

For some time, low to negative interest rates have weakened the ability of fixed income allocations to provide consistent and regular cashflows to cover liabilities. Two steps insurers have taken to position themselves for this new reality have been increased allocations to real assets (real estate and infrastructure) and the use of smart solutions to improve returns at the liquid end of their portfolios, such as cash holdings.

“It is geographically dependent,” says Gareth Mee, partner Europe, Middle East, India and Africa, in the insurance practice at EY. “In continental Europe, particularly in the south, more credit risk is being taken to achieve higher nominal rates of return and the return on capital people expect. There is a bit less of that in the UK. In US markets, rather than a move down the credit curve, there has been more of a move into structured finance, private credit and alternative assets.”

One of most noticeable initial impacts of the pandemic was insurers de-risking allocations and building cash reserves in the second quarter of 2020. They mainly reduced their exposure to equities, but also to some parts of the credit market.8 This has driven interest in smart solutions for holdings in cash and cash equivalents, as insurers looked for ways to work their cash harder without increasing their overall risk exposure.

“Because they can't just leave all of their surplus assets sitting in cash or government bonds, insurers have got to be a bit cleverer about what they do with liquid assets,” says Mee. “In some cases, that's asking asset managers to come up with solutions to generate cash ‘plus’ returns from liquid strategies. But it has also meant considering areas such as trade finance to pick up additional returns, as well as simply taking more risk with liquid assets to hit return targets.”

For long-term allocations, the findings of Aviva Investors’ 2020 Real Assets Study highlight the trend towards private markets, with 49 per cent of the 532 insurers surveyed expecting to increase their allocation to real assets. Real assets typically offer an illiquidity premium over fixed income and are a good fit for insurers’ cashflow matching needs, time horizons and risk appetite. Perhaps unsurprisingly in such a challenging environment, real estate long income, which can offer relatively stable cashflows at a premium to government bonds, came out as one of insurers’ favoured asset classes, alongside debt-based strategies in infrastructure, real estate and private corporate debt.9

“Insurers are increasingly looking to private assets to provide higher yields than liquid alternatives of broadly similar credit quality, to provide diversification, relative value opportunities and to enhance downside protection,” says Alex Wharton, head of insurance relationships at Aviva Investors. “Our insurance clients look to private assets to meet their specific requirements, including sourcing eligible assets for liability matching purposes. They are also acutely focused on managing risk – in debt transactions, they require robust deal structures where manager expertise in valuation, risk and credit analysis is critical.”

Figure 2: Asset classes insurers stated they were more likely to invest in after COVID-19 (per cent)
Asset classes insurers stated they were more likely to invest in after COVID-19
Source: Aviva Investors, as of October 30, 2020

European and North American real asset markets are the most developed, but Asia is catching up. The continent has a huge need for both infrastructure investments and long-term life and retirement solutions, creating a powerful driver for the market to develop quickly. Until recently, private equity and hedge fund investments were the preference of many Asian insurers, but interest has been growing for the more sustainable returns offered by top-tier real estate and infrastructure projects.10

Accessing prime real assets projects is essential for efficient deployment of capital

Investing in real assets presents challenges, however. Firstly, the devil is in the detail, and the risk of anything other than top-tier projects can be too high for insurers’ appetite. Accessing prime projects is essential for efficient deployment of capital, as is an ability to perform robust due diligence.

Secondly, returns from illiquid assets are not always smooth; they can create a cash drag and make it more difficult for insurers to match the cashflows they receive and the ones they distribute. Diversification and stress testing the liquidity of investments are essential.

Larger insurers have typically grown their real assets teams in recent years, while smaller firms increasingly rely on asset managers with strong specialist capabilities for research and pooled investments.

The impact on credit

Mee also sees challenges in another asset class – credit – where spreads do not reflect the level of economic uncertainty brought on by the COVID-19 pandemic.

“There is potentially more of a negative outlook currently than there has been at any other time in the last ten years, yet credit spreads are incredibly low,” he says. “A lot of sectors have had a tough year, and some people assume those companies will bounce back. I worry there is a risk of a second set of challenges for many of these companies over the next couple of years. Some of these companies are leveraged and can't withstand another hit.”

Central banks are increasing the price of liquid credit assets

Mee believes spreads are compressed in part due to the short duration of the credit cycle, but also liquidity factors. Through their purchases of corporate bonds, central banks are increasing the price of liquid credit assets, as well as making it more difficult to assess whether the less liquid ones are reasonably priced.

“You've also got a lot of money chasing some new issuances, so the credit markets are very challenged on the public side,” says Mee. “Insurance companies, as long-term holders and the biggest investors in credit globally, are uniquely exposed to the challenge of investing in assets that don't provide sufficient value for the amount of credit risk they are taking on.”

Ongoing regulatory changes mean these issues are unlikely to go away as insurers struggle to optimise the trade-off between solvency capital requirements and investment returns.


Risk-based capital (RBC) regulation is progressively being adopted around the world, adding to the pressure of low rates on profits. The result has been sweeping changes in capital allocations and more onerous reporting requirements. Regular reviews are necessary to iron out the wrinkles of initial obligations and adapt to the evolving risk environment.

Risk-based capital regulation is progressively being adopted around the world

In the US, the National Association of Insurance Commissioners’ (NAIC) capital adequacy taskforce reviews the formulas annually. Other upcoming regulation may also impact the calculations or reporting standards. For instance, the NAIC’s financial stability taskforce has been working on liquidity risk and capital stress testing, which may impact the requirements laid out in the RBC regulation. However, this is not yet reflected in allocations.11, 12

“In the US, significant modification to regulation has driven a change in asset allocation, but competition has arguably ended up being a bigger driver,” says Mee. “Therefore, we haven't seen the wave of change the advent of Solvency II caused. Where we do see innovation and changes in asset strategy is in specific markets; for example, those focused on pensions risk transfer or other annuity-type markets in the US, which are very competitive. Interestingly, we are yet to see change from long-duration targeted improvements or IFRS-type standards, which will potentially have a longer-term impact.”

In Canada, the Office of the Superintendent of Financial Institutions (OSFI) published an update to its guidelines for the Life Insurance Capital Adequacy Test (LICAT) in November 2020, mainly aiming to smooth the calculation of interest-rate risk requirements.13

In the EU, the European Insurance and Occupational Pensions Authority (EIOPA) proposed wide-ranging changes on Solvency II regulation in December 2020 (Figure 3).14 These could have significant effects on balance sheets, be potentially positive for risk margin and volatility adjustment changes, and possibly negative for the risk-free rate and standard formula interest-rate risk changes.15

In the UK, 2021 will be a key year for the post-Brexit regulatory landscape, with insurers keeping a keen eye on the government and the Prudential Regulation Authority’s (PRA) stance. While the PRA seems willing to deviate from EU rules, designing and implementing changes will take time. In the meantime, insurers will most likely abide by current Solvency II rules – which have been enshrined into UK law.

Solvency II has brought many benefits but there might be an opportunity to revisit certain areas

“Solvency II has brought many benefits, and I don't think anyone is expecting the UK to do away with it and have something completely different,” says Dafria. “However, there might be an opportunity to revisit certain areas. Risk margin has been a topic of debate for some time, and regulators may also look again at infrastructure investments, especially in a climate context and how the rules support that. But what we are looking at is the potential for incremental changes rather than something more substantive.”

Khan agrees. “In the UK, insurers are keenly watching this space and have fed their answers to the Treasury’s consultation on Solvency II,” he says. “The consolidated response from the Association of British Insurers proposes amending a number of areas. These include potentially reforming the calculation of risk margin, broadening the types of long-term assets that could be eligible for the matching adjustment, and simplifying the matching adjustment approval, asset eligibility and reporting processes.16

“This is likely to improve investment in long-term assets, particularly those that play a positive role in tackling climate change, as well as the social and infrastructure development needs of the country,” he adds.

However, any changes will have to find a balance between competitiveness and safe levels of capital, and the outcome is yet to be determined.

“The UK regulator and Treasury are both dissatisfied with some aspects of Solvency II, and they are probably going to pull in different directions,” says Mee. “The Treasury is really keen that we become more competitive. The PRA is obviously keen on us retaining the level of capital, so it depends who wins that tug of war. The uncertainty is probably the main risk.”

ORSA and RBC rules will remain at the forefront of insurers’ minds

In Asia, Own Risk and Solvency Assessment (ORSA) and RBC rules will also remain at the forefront of insurers’ minds. While ORSA requirements already exist in several jurisdictions such as Taiwan, Singapore and Australia, they come into force in 2021 in Hong Kong, imposing more onerous risk assessments and reporting that will be hard for smaller insurers to manage.17

The progressive tightening of RBC requirements in the region will also drive investment decisions; although the further development of local bond and real asset markets will be crucial in enabling insurers to balance long-term liabilities with robust portfolios. Some insurers will rely on asset managers to find diversified opportunities, as there are big differences in terms of assets and regulatory constraints from one country to the next.18

“A number of Asian countries are going through an RBC revolution, such as Hong Kong, Korea and Singapore. In countries where firms have historically taken more risk, notably the likes of Taiwan, that becomes much harder in an RBC regime given the additional capital required,” says Mee. “It also encourages closer matching, which means there is a need to find assets that have a similar duration to liabilities, and this tends to be less common in some Asian countries.

“Some Asian markets are opening up to investment in foreign assets and foreign investors in local assets, including China, which is a huge and growing market. A number of Asian markets are going through a similar revolution to what we saw with Solvency II in Europe a few years ago – where the investment philosophy is changing from the idea of a local market to a global one, and RBC is changing the way firms invest,” he adds.

The International Association of Insurance Supervisors is developing a risk-based global insurance capital standard

For international insurers, further complications lie ahead. In late 2019, the International Association of Insurance Supervisors adopted a ‘Common Framework for the Supervision of Internationally Active Insurance Groups’, in which it is developing a risk-based global insurance capital standard. Capital requirements may be affected when it enters its second phase, which aims to implement the international capital standard as a group-wide prescribed capital requirement.19

Ahead of COP26 in November (presuming the event still goes ahead), countries and regions are also stepping up their climate transition pledges, which should involve new regulations on sustainability. While this could add to insurers’ burden, it may also translate into favourable capital requirements for green investments.

Figure 3: Key features of EIOPA’s advice

1. Long-term guarantee measures and equity risk

  • Change the method of extrapolating risk-free interest rates to better reflect market rates.
  • Volatility adjustment: better align the design of the adjustment to its objectives, in particular reward insurers for holding illiquid liabilities.
  • Risk margin: recognise diversification over time thereby reducing size and volatility of the margin, especially for long-term liabilities.
  • Equity risk: revise the criteria for the ability to hold equity long-term, by making a link with longterm illiquid liabilities.

2. Solvency capital requirements

  • Increase the capital requirement for the interest rate to reflect the steep fall of interest rates experienced during the last years and the existence of negative interest rates.

3. Proportionality

  • Increase proportionality across the three pillars of Solvency II, especially regarding low risk undertakings.
  • Introduce a new process for applying and supervising the principle of proportionality characterised by clarity, predictability, risk sensitiveness, supervisory dialogue and reversal of the burden of proof.
  • Increase the effectiveness of proportionality embedded in the supervisory review process.
  • Increase the transparency on the use of proportionality measures across the three pillars of Solvency II.

4. Macroprudential policy

  • Supplement the current microprudential framework with a macroprudential perspective.
  • Introduce tools and measures to equip national supervisory authorities with sufficient powers to address all sources of systemic risk.

5. Recovery and resolution

  • Develop a minimum harmonised and comprehensive recovery and resolution framework for (re) insurers to deliver increased policyholder protection and financial stability in the European Union.

6. Insurance guarantee schemes

  • Introduce a European network of national insurance guarantee schemes or alternative mechanisms that should meet a minimum set of harmonised features for the benefit of policyholders and financial stability.

Source: EIOPA, December 17, 2020

Navigating ESG and real assets

Spurred by increasingly frequent natural hazards, regulators have been working on risk assessments and disclosures for several years, including insurers’ investments, particularly those with long time horizons.20 EIOPA published an opinion on sustainability within Solvency II in September 2019, the Australian Prudential Regulation Authority outlined plans for climate risk prudential guidance and vulnerability assessment in February 2020 – including plans to update its guidance on investment governance and ESG – and the NAIC announced the development of a climate and resiliency taskforce in July 2020.21, 22, 23

“2020 has seen an increasing number of insurance companies set net-zero targets, typically with a 2050 target, aligned with the Paris Agreement,” says Wharton. “On March 1, 2021, Aviva became the first major global insurance company to target net-zero carbon by 2040. This commitment included a net-zero pathway to cut 25 per cent in the carbon intensity of its investments by 2025 and 60 per cent by 2030. It also committed to net-zero carbon emissions on its own operations and supply chain by 2030.

“This industry-wide trend is leading to a seismic shift in asset strategy, with climate transition becoming a core focus for investment teams and boardrooms alike. As part of our 2040 net-zero pathway for real assets, we committed to originate £1 billion of climate transition-focused loans by 2025, reflecting demand by insurers and other investors to finance projects that drive positive change. This asset transition mirrors the change being driven by many insurers on the liability side of the balance sheet,” he adds.

Dafria remains conscious of the risks this presents for insurers; such as having to balance long-term risks and short-term returns, communicating to clients, and adapting as regulation becomes more punitive for ‘brown’ investments.

“Another key issue is whether there is enough supply,” he says. “Green bonds and other sustainable investments typically come at a premium. There is a risk of investors crowding in to buy the same narrow set of investments, which further reduces their returns and distorts the reality. But if we look at the substance and seek progress, not perfection, it is fantastic that we and our peers are on this journey.”

Investing responsibly will be good from a return perspective

Mee agrees. “For core assets – notably fixed income, equities – I think we're going to end up with a massive drive, with companies without green credentials being penalised and green companies being incentivised. So, investing responsibly will be good from a return perspective,” he says. “Peer pressure, investor pressure, and regulatory pressure will all be pulling in the right direction and will be positive for returns in the long run.

“Where there is more competition is in green bonds and impact investments, which everybody currently seems to want. There are some concerns for these investments that regulation is not yet at a stage where all companies can be held to account,” he adds.

Social investments

In addition to environmental and governance elements, which have been material considerations for some time, insurers are focusing on the positive impacts of their investments on local communities and wider society.24

This is particularly relevant for investments in real assets and reflected in insurers’ positive views on allocations to social infrastructure, such as healthcare and social housing. In Aviva Investors’ 2020 Real Assets Study, 55 per cent of insurers considered investing in the former was important, and 51 per cent for the latter.25

Figure 4: Social infrastructure assets insurers think are most important to include in their portfolios (per cent)
Social infrastructure assets insurers think are most important to include in their portfolios
Source: Aviva Investors, as of October 30, 2020

One of the primary drivers of increased interest and allocations to ESG-positive real assets is the recognition these will sit on the balance sheet for a long time, sometimes decades. Moving well beyond the impact on portfolios today, attention shifts to how they will play out over the full lifetime of the investment. 

For example, investing in a motorway would have a positive social impact and a negative environmental one, but it also raises the question of future driving habits. If people increasingly favour train journeys or online meetings over driving, it could pose a risk for future revenue streams, as well as reducing the positive social impact of the investment over its lifetime.

Insurers need to find investable projects and manage potential allocations based on their overall ESG impact

Not only do insurers need to find investable projects, they also have to dedicate resources or work with specialist asset managers to assess – and manage – potential allocations based on their overall ESG impact.

Pressures are mounting on insurers from all sides. To face them down, strong investment thinking and execution are required, particularly since increased real asset allocations present deployment challenges. Asset managers can help insurers invest dry powder efficiently until a long-term opportunity arises, but only if the conversation focuses on overall investment outcomes and partnerships instead of siloed asset classes.


  1. ‘The future of insurance’, Aviva Investors, May 17, 2019
  2. Kevin Buehler, et al., ‘A unique time for chief risk officers in insurance’, McKinsey & Company, December 17, 2020
  3. ‘CRO Discussion: Regulatory requirements and a rapidly changing world – the CRO’s strategic response’, Insurance Asset Risk and InsuranceERM, January 19, 2021
  4. ‘The future of retirement’, Aviva Investors, February 28, 2019
  5. Pierre-Ignace Bernard, et al., ‘The future of life insurance: Reimagining the industry for the decade ahead’, McKinsey & Company, September 29, 2020
  6. Pierre-Ignace Bernard, et al., ‘The future of life insurance: Reimagining the industry for the decade ahead’, McKinsey & Company, September 29, 2020
  7. ‘Future demand outlook for the bulk annuity market’, Hymans Robertson, April 23, 2020
  8. Pamela Kokoszka, ‘Intelligence: Impact of COVID-19 on insurance investments’, Insurance Post, December 21, 2020
  9. ‘Real Assets Study 2020’, Aviva Investors, October 30, 2020
  10. ‘Asian insurers’ appetite for illiquids’, Insurance Asset Risk and InsuranceERM, February 9, 2021
  11. ‘Capital Adequacy (E) Task Force’, NAIC, 2021
  12. ‘Macroprudential initiative (MPI)’, NAIC, October 19, 2020
  13. ‘Life Insurance Capital Adequacy Test (LICAT) advisory’, Office of the Superintendent of Financial Institutions, November 27, 2020
  14. ‘Opinion on the 2020 review of Solvency II’, EIOPA, December 17, 2020
  15. ‘Regulatory outlook for 2021’, Hymans Robertson, January 28, 2021
  16. ‘Review of Solvency II: Call for evidence’, HM Treasury, February 24, 2021
  17. ‘CRO Discussion: Regulatory requirements and a rapidly changing world – the CRO’s strategic response’, Insurance Asset Risk and InsuranceERM, January 19, 2021
  18. ‘Asian insurers’ appetite for illiquids’, Insurance Asset Risk and InsuranceERM, February 9, 2021
  19. ‘Insurance capital standard’, The Center for Insurance Policy and Research, NAIC, February 17, 2021
  20. ‘Nature and neglect: The era of ecological disasters’, Aviva Investors, July 21, 2020
  21. ‘Opinion on sustainability within Solvency II’, EIOPA, September 30, 2019
  22. ‘Press release: APRA outlines plans for climate risk prudential guidance and vulnerability assessment’, APRA, February 24, 2020
  23. ‘Press release: NAIC levels up on climate & resiliency’, NAIC, July 17, 2020
  24. ‘New GFIA paper examines insurers’ role as investors in sustainable finance’, Global Federation of Insurance Associations, December 2020
  25. ‘Real Assets Study 2020’, Aviva Investors, October 30, 2020

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