Investment behaviour in the low yield environment

AuthorEuropean Insurance and Occupational Pensions Authority (EU body or agency)
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).

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