Insurance firms globally have been ramping up their allocations to private debt in recent years in search of higher yields, and that trend is continuing – but concerns are rising about what might happen to the asset class when the credit cycle turns, particularly in respect of liqudity challenges.
British insurers generally have a good deal more exposure to direct lending and other alternative credit strategies than their Asian peers, but the latter group is busy going down the same route, so they should take note of what Western firms are thinking and doing,
UK life insurers are believed to have around 40% of their annuity business portfolios in private credit, and they want to raise this to 50%.
London-based Phoenix Group, for instance, holds 20% of its £15 billion ($18.9 billion) annuities book in private debt but wants to double this to 40% in five years, said Daniel Blamont, head of investment strategy.
Asian insurance firms are well behind their European peers in allocating to private credit. The latter average an 8% to 10% allocation versus perhaps 3% to 5% in Asia, according to Alexandre Mincier, Paris-based global head of insurance at US fund house Invesco. But the Asian players are looking to build exposure.
Yet, increasingly, insurers are also getting nervous about what might happen to private debt at the end of the credit cycle – a point that the US market is nearing, Gareth Haslip, global head of insurance strategy and analytics at JP Morgan Asset Management, told AsianInvestor in December.
Insurance firms have poured lots of money into direct lending in the past few years, he said. As a consequence, they need to understand the impact of potential defaults, which are likely to rise during a recession.
Ian Coulman, chief investment officer of Pool Re, a London-based terrorism risk reinsurer, flagged some concerns during a conference panel in London on November 15.
“There’s a distinct lack of liquidity in markets today if you’re a forced seller, particularly in fixed income markets,” he said at the Insurance Asset Management Summit (IAMS), hosted by Clearpath Analysis.
However, insurance firms should be able to handle any liquidity issues, provided they are sufficiently diversified across asset classes, he said. Pool Re has not yet invested any of its £6.5 billion ($8.6 billion) portfolio in private markets, though it might do so.
Similarly, supervisory bodies and heavyweight official institutions are raising warning flags about liquidity challenges.
At Clearpath’s summit, Alan Sheppard, head of insurance policy at the Bank of England, said investors behave in a less predictable manner during times of political uncertainty, adding: “Before going ahead with increasing allocations to illiquid assets, particularly in the current environment, it’s important for insurers to have a rigorous understanding of their liquidity needs in normal times and in stress.”
Moreover, the European Insurance and Occupational Pensions Authority and the UK’s Prudential Regulatory Authority (PRA) are putting a greater focus on liquidity risk in both the public and private asset spaces.
The PRA’s objective is to ensure that insurers with illiquid assets can deal with the consequences of adverse credit events, said Phoenix Group’s Blamont.
“It’s a learning process for us and the PRA,” he added. “To some extent, some of the regulations and internal processes are evolving.”
Public market liquidity risk is also drawing more regulatory attention. In August the Monetary Authority of Singapore issued guidelines around liquidity risk management practices. This came after the International Organization of Securities Commissions released its own updated best practice recommendations in February 2018.
Institutional investors and asset managers must make sure they are familiar with best practice in this area, particularly given the current environment, said James Paull, a Sydney-based manager in the specialist advisory team at consulting firm Deloitte.
But some fund houses in Asia are struggling to implement the guidelines and are likely to need help with measuring and monitoring liquidity risk, he said on November 27 during a webinar hosted by financial data and analytics firm FactSet and AsianInvestor.
This story was adapted from a longer feature in the December 2018/January 2019 edition of AsianInvestor magazine.