The implementation of Solvency II will force insurers to be far more proactive in terms of how they analyse and forecast their investments, says John Townley and Arthur Manners.
A
nalysing the success or failure of relative investment strategies is not generally a great predictor of future returns. But given the impending implementation of Solvency II, the importance of
looking back at historic returns and forward at the potential changes the new regulations might bring has never been more relevant.
Any insurance company that is unable to analyse how past performance
was achieved and that incorrectly forecasts the impact of investment strategy on future capital requirements could quickly find itself at a competitive disadvantage. Board members and senior management must ensure that they are aware of and are managing the market risks, which, according to the European Insurance and Occupational Pensions Authority (EIOPA) QIS 5 results, constitute 32.8 percent of the total risk in non-life insurance business.
Looking back, the Lloyd’s market as a whole is traditionally considered a conservative investor with an investment time horizon of only one or two years ahead in terms of the degree of asset risk that is taken. Over the past 20 years, this has been a generally successful strategy as government bonds have yielded relatively high rates of interest, cash rates have been high and, in more recent years, declining bond yields have generated capital gains, maintaining a relatively high risk-adjusted return on investment.
Looking in more detail at the market investment returns overall, it can
be seen that Lloyd’s has returned between 2 and 5 percent each year, demonstrating the consistent and conservative nature of investment strategy.
2,500 2,000 1,500 1,000 500 0
6 5 4 3 2 1 0
2006 2007 2008
Syndicate investment return (LH scale) Investment return on society assets (LH scale)
2009 2010
Notional return on FAL (LH scale) Investment return (RH scale)
Source: Lloyd’s, Aon Benfield Market Analysis However, looking at individual company returns highlights the wide
discrepancies that exist in investment strategy and subsequent results. The
chart below shows that in 2008 and 2009, listed insurers’ results varied by between +7 and –7 percent.
8% 6% 4% 2% 0
-2% -4% -6% -8%
Amlin Beazley Brit Catlin 2008 Chaucer Hardy 2009
Source: AON Benfield, company data In the past few months, listed Lloyd’s insurers have disclosed a variety
of outcomes from their investment strategies for 2010 that continue
the theme and warrant further understanding. It is worth recalling that at the start of 2010, considerable uncertainty still persisted from the financial crisis and strategies were put in place either to take advantage of the unwinding of this dislocation or to mitigate the risks that became apparent during the crisis.
By the end of 2010, the disparity of returns between cash and bonds
became very marked. Short-term interest rates were held low by central banks and, driven by spread contraction that had started in 2009, overall returns were higher from bonds.
Although equities delivered acceptable returns during a year in which
the MSCI World Index returned 9.6 percent, hedge funds outperformed equities. The Dow Jones Credit Suisse Hedge Fund Index was up 10.95 percent overall. Despite the positive overall return for alternatives, there were many hedge funds that underperformed considerably, highlighting the difficulty of picking the winners and losers.
Those who chose to invest in alternatives faced the challenge of avoiding
volatility while reaping the benefits of additional returns over traditional investments. The returns in the chart directly overleaf depict relatively consistent cash and bond results but highlight the risks of seeking additional performance from more volatile assets.
September 2011 | INTELLIGENT INSURER | 39 Hiscox Novae Omega 5.9% 4.2% 2.7% 5.9% 4.3% 3.0% 1.7% 2.8% 7.2%
£ millions
Investment return %
Investment return (reported currency)
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