Investment behaviour in the low yield environment

• Author: European Insurance and Occupational Pensions Authority (EU body or agency)
• Pages: 11-24

2. INVESTMENT BEHAVIOUR IN THE LOW

YIELD ENVIRONMENT

Amid an already sustained period of low yield environ-

ment, the unexpected Covid-19 virus outbreak and the

economic disruptions that followed have further in-

creased the risk of ultra-low yields for longer. The low

yield environment challenges insurers both in their bal-

ance sheet positions and in terms of their prof‌itability.

Adapting their investment behaviour might be aresponse

to mitigate the overall negative eects of the low yield

environment. However, f‌inancial markets’ volatility in re-

lation to the poor macroeconomic prospects due to the

economic shutdowns during the virus outbreak, might

substantially complicate insurers’ resp onse and how it will

feed back to their risk prof‌ile.

In this chapter, the investment position of insurers is

discussed from the perspective of inferring signals of

achanging investment behaviour and how these changes

could amplify risks for insurers amid the Covid-19 impact

on markets. In the f‌irst section, the investment split of

insurers from 2016 until the fourth quarter of 2019 is pre-

sented. In the second, the investment split dynamics from

the perspective of potential search for higher returns are

investigated, covering bonds, equities as w ell as other as-

sets classes. This section is concluded by adiscussion on

how the search for higher returns could be riskier than

expected during and following the Covid-19 outbreak. The

third section elaborates on the assets-liabilities matching

perspective and how that strategy relates to additional

risks during and after the virus outbreak.3

In general, low interest rates aect both sides of the bal-

ance sheet of insurers. The overall eect depends on the

particular character istics of the insurance comp anies.

However, because the valuation of the liabilities is per-

formed using the EIOPA risk free rate curve, adownward

3 In the majority of the graphs in the s econd and third section, astable

sample of undertakings is used in the analysis, where only companies

with full reporting histor y are considered (16 quarters from Q1 2016 to

Q42019). Further asset-by-asset data cleansing is ap plied. Outliers (asset

for aspecif‌ic under taking) are excluded from the entire sample. Regard-

ing bonds, around 1200 co mpanies are kept on quarterly basis (~80% of

the entire quarterly SII sample of 1 500 companies reporting and in ter ms

of SII monetary value th e coverage is ~80%). In relation to equity, around

1050 companies are kept on quar terly basis (~80% of the entire quarterly

SII sample of 1350 companies rep orting and in terms of SII monetary v al-

ue the coverage is ~50%).

shift in the rates used to derive the risk free rate curve

would result in lower discounting rates and therefore in

an increase in the value of liabilities. On the other hand,

within the low yield environment before Covid-19 shock,

the market value of assets increased, due to increasing

values of f‌ixed-income portfolios as well as an upward

move of equity markets driven by low yields. Life insur-

ers typically hold portfolios with negative duration gap,

with f‌ixed income investments dominating, and therefore

adownward shift in the risk free rate curve would result

in ahigher increase in the liability side relative to the asset

side. Crucially, Covid-19 shock has further complicated the

eect on insurers balance sheet, amid the f‌light to qual-

ity behaviour observed in the markets and the increased

volatility. It is worth mentioning that however, Solvency II

tools could partially mitig ate the impact on insurers’ posi-

tions, for example via volatility adjustment and symmetric

adjustment for equity risk .

Persistent low yields could further amplify the pressure

on the balance sheets of insurers. Liabilities with long

durations are valued base d on the ultimate forw ard rate

curve, which is higher than the market yield curve that is

used for the valuation of risk free assets. This means that

if time passes, the value of these liabilities increase more

than the risk free assets, hence insurers might not be able

to make up for this dierence by enough capital gener-

ation.4 A protracted low yield environment might also

decrease the probability for apolicyholder to surrender

or lapse the contract and could exacerbate the increase

in the value of liabilities, weakening the overall eect for

insurers. Moreover, after the virus outbreak, households

can change their behaviour which could bring further un-

certainty on insurers’ b usiness: increased unemployment

could lead some households to surrender their contracts,

whereas other could prefer to keep their savings on more

liquid savings products or on their bank accounts. Final-

ly, maturing f‌ixed-income securities can only be replaced

with lower yielding securities, which further weaken the

4 “This risk (‘the UFR-dr ag’) increases substantially in an enduring low

yield environment. This issue could b e alleviated by achange of the LLP in

the 2020 review according to the Super visory statement on the imp act of

the ultra-low/negative interest rate environ ment issued by EIOPA in 19th

of February (see here).

IMPACT OF ULTRA LOW YIEL DS ON THE INSURANCE SEC TOR, INCLUDING FIRST EFF ECTS OF COVID CRISIS

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