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  • Insurance
  • Real Assets

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.

COVID-19 created a perfect storm for insurers. 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

Even as vaccines are rolled out around the world, the economic effects of the pandemic will linger for some time – possibly years.

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.2

“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.”

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.3

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.4 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.5

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

Two steps insurers have taken to position themselves for low rates 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.

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.6

“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 Gareth Mee, partner Europe, Middle East, India and Africa, in the insurance practice at EY.

For longer-term allocations, real estate long income, which can offer relatively stable cashflows at a premium to government bonds, is one of insurers’ favoured asset classes. Others are debt-based strategies in infrastructure, real estate and private corporate debt.7

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

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.


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.

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.”

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 progressive tightening of RBC requirements in Asia 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.8

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.9

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.10

“2020 has seen an increasing number of insurance companies set net-zero targets, typically with a 2050 target, aligned with the Paris Agreement,” says Alex Wharton, head of insurance relationships at Aviva Investors. “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,” 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.”

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.11

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.12

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. 

Figure 3: 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

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.

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