Beyond cash
and Treasuries

Read this article to understand:

• Asian insurers’ evolving investment challenges amid a complex market environment and rapidly changing regulatory standards
• Insurers’ dilemma and unintended liquidity risks 
• Our approach to enhancing portfolio resilience for better overall outcomes

Insurers have long navigated a distinctive set of investment challenges. From the prolonged low-yield environment following the Global Financial Crisis to today’s volatile government yields and historically tight credit spreads, the landscape has shifted repeatedly and often abruptly.

In Asia, the complexity of this market context has been compounded by the implementation and further development of risk-based capital (RBC) regimes.¹ Not only have insurers had to adapt to a rapidly changing investment environment; they have simultaneously had to integrate new regulatory considerations into portfolio construction.

Within this multi-dimensional context, the need to access yield efficiently has remained a constant.

A world of persistent shocks

The past four years have delivered six major supply-led disruptions:

Figure 1 shows how short-term rates have repriced higher since 2021.

Changing regulatory standards

While the headline for many insurers has been the adoption, or enhancement, of RBC frameworks for Asian insurers, liquidity risk has also been a pressing issue. Whether from a lapse risk perspective, or as a function of increasing allocations to less liquid assets, liquidity risk is, and remains, a regulatory priority.²

The combination of liquidity risk on both the liability side (lapse) and the asset side (illiquid, typically private assets) creates a risk management challenge, with the need for sophisticated liquidity risk modelling.

Stresses can be severe. The European Insurance and Occupational Pensions Authority (EIOPA) for example, requires a base case mass lapse event of 40 per cent of a portfolio.³ This is anchored in the well-flagged examples of such events having happened in the recent past. In Italy for example, policyholders surrendered policies in favour of banking products as interest rates rose. When combined with potential, uneven cashflows from illiquid assets and challenges in liquidating such exposures in a timely manner, the task is considerable.

As a consequence, insurers globally, as much as in Asia, are forced to not only triangulate their asset allocations between the needs of their liabilities, the regulatory capital effectiveness of those assets and their yield targets, but also to factor in the overall liquidity needed by the business in ongoing and stressed scenarios.

There is evidence of change in Singapore for example: cash exposures at life insurers have fallen steadily post RBC2 implementation, while equity exposures have risen. Debt exposures have remained broadly stable (see Figure 2).

In our view, this means Singaporean insurers are likely placing increased reliance on secondary market transactions to realise liquidity. For example, through holdings in Treasuries or potentially short-dated high grade credit. At a high level, these offer the attractive combination of increased yields and capital efficiency through the combination of high credit quality and short maturity.

The insurer’s dilemma

For insurers, the immediate challenge is less about how to add yield and more about how to preserve usable liquidity without importing avoidable balance-sheet volatility. Cash provides certainty but it can weigh on return on capital.

Treasuries offer depth and regulatory familiarity, but recent yield volatility has shown that even high quality government bonds can introduce meaningful mark-to-market noise at precisely the point when liquidity may be needed. Short-dated credit can appear to solve the income problem, but tight spreads leave limited compensation for liquidity, downgrade and spread-widening risk.

This creates a more acute liquidity dilemma. Insurers need assets that can be monetised confidently through stressed markets, but the traditional options each carry hidden costs.

• Holding Treasuries preserves liquidity, but duration and yield curve volatility can turn a supposedly defensive asset into a source of surplus volatility and realised loss, if assets must be sold during a rate shock.
• Moving into short-term credit can lift yields, but at today’s compressed spreads it may offer too little reward for the risk of impaired liquidity, spread widening or ratings migration in a downturn. Seeking liquidity from these holdings if spreads have widened, particularly following a sudden shock, and amid broader liquidity pressures such as margin calls or policyholder lapses, could result in large – and certainly unpalatable – realised losses.

The issue is not whether insurers should hold liquidity. They clearly should. The issue is whether that liquidity budget is being put to work in a way that is genuinely resilient through volatility, rather than merely appearing conservative in normal markets. And, that the liquidity element can ‘earn its keep’ through an adequate yield.

The surplus asset challenge:
liquidity without unintended risk

Surplus assets are often treated as the natural home for defensive liquidity: assets that should protect the balance sheet, support claims and collateral needs, and remain available for redeployment when opportunities emerge. Historically, that has pushed insurers towards cash, Treasuries, liquidity funds and high quality short-dated instruments. The logic is understandable, but it can be incomplete.

Treasuries remain highly liquid instruments, but liquidity is not the same as price stability. When rate volatility rises, government bond holdings can generate mark-to-market losses that flow directly into surplus volatility. If an insurer needs to realise liquidity during such periods, the theoretical safety of the asset can translate into a very practical capital cost.

Short-term credit presents a different risk. It may reduce headline duration exposure and add carry, but in a tight-spread environment, the cushion against spread widening is thin. Assets that appear low risk in benign conditions can become harder to trade, more capital intensive, or simply less rewarding once liquidity premia reprice.

The result is a surplus asset challenge defined by liquidity quality rather than yield alone. Insurers need investments that can earn a credible return over cash, avoid unnecessary Treasury-duration volatility, and retain sufficient liquidity to meet stress, collateral and redeployment needs.

Building resilient liquidity:
a different approach

Despite the new and enduring risks in markets, and the complexity of managing to RBC standards, a deliberative approach to liquidity management can deliver tangible benefits for insurers. Aviva Investors designed the ReturnPlus (R+) strategy specifically for insurance investment. It can provide the combination of liquidity, resilience, optionality, and a better risk-return profile than traditional approaches.

The key features of ReturnPlus strategy are:

No interest rate duration exposure. The strategy is not locked into current government yields. Volatility becomes a source of opportunity, not a drag on performance.

High-quality, short-dated credit. The strategy's sensitivity to spreads (delta) is materially lower than that of lower-rated alternatives. If/when spreads widen, the profit and loss impact is muted.

Attractive risk-adjusted spread. The target return over swaps of the strategy exceeds the equivalent spread of a lower-rated bond, offering a better credit spread risk/return trade-off. The strategy has a break-even spread of approximately 25 basis points, thus providing investors with a substantial cushion before spread widening erodes income.⁴

Liquidity. The strategy invests in liquid bonds, preserving the ability to reallocate if spreads widen meaningfully. By diversifying across geographies and asset classes, the strategy can provide holistic liquidity, that is, liquidity which is resilient to localised shocks.

A low regulatory capital charge. With no duration risk and only investing in short dated, highly rated credits the strategy also offers capital efficiency.

Covered bonds: a uniquely beneficial asset class

Covered bonds stand out as a fundamentally appealing asset class, although not necessarily for the most obvious reasons.

From a liquidity perspective three key facts stand out:

Aviva Investor’s ReturnPlus strategy typically has a core allocation to geographically diversified covered bonds.

Source: Aviva Investors, Bank for International Settlements (BIS).

Applications of ReturnPlus strategy for insurers

The distinctive characteristics of the R+ strategy mean it can be deployed across multiple areas of an insurer’s balance sheet. Key applications include:

Conclusion

The current market is undeniably challenging. Yields have returned but so has volatility. Spreads are tight, breakeven spreads are thin, and the traditional playbook, whether for liability-matching or surplus assets, feels increasingly strained. On top of this, regulatory standards have changed. Insurers have adapted, but room remains to optimise.

Within this context, liquidity is and remains a core component of prudent portfolio construction. Here optimisation can take the form of broadening horizons beyond pure cash and Treasuries to consider other opportunities, which can potentially enhance portfolio resilience and deliver better overall outcomes.