The investment portfolios of consolidators could be more resilient to market shocks than the typical insurer portfolio, latest research by Redington reveals.
The consultant studied the performance of a typical insurer portfolio versus one consolidator investment portfolio under a range of market scenarios and stress tests.
The study showed, following a 2008 shock scenario, the funding ratio of assets to liabilities would have reduced by 12.8% in the consolidator's investment portfolio, against 25.3% in the model insurer portfolio.
Additionally, the funding ratio at risk sat at 7.5% in the consolidator's portfolio while in the model insurer portfolio it was 8.5%.
In a 99.5% market shock situation, the funding position of the consolidator's investment portfolio would be expected to worsen by 16.3%, while the model portfolio worsened by a larger 17.6%.
Reasons for this outcome were largely due to the fact consolidator portfolios are not constrained by Solvency II regulation, enabling them to invest in higher-yielding credit and real assets.
Redington said these assets tend to allow for a more rapid portfolio recovery than investment-grade credit. For example, the average time for high-yield credit to recover after 5% drawdown was 2 years and 11 months, compared to 6 years for investment-grade credit.
Chief investment officer of global assets Pete Drewienkiewicz said he was not expecting these results and imagined the two portfolios would be a lot closer.
He said: "We had a sense that there was a value of diversification, and that the scope of assets, that Solvency II heavily favours, is reasonably narrow."
"We had a sense that it might be a closer contest than you might think off the bat. It was somewhat surprising, but when we did the work, and we then step back from it, it makes a lot of sense," he continued.
Particularly during the financial crisis shocks, Drewienkiewicz noted the insurance portfolio "has a very difficult time".
Redington thinks consolidators could represent an option which significantly improves outcomes for members, despite a lot of scepticism in the industry.
Head of integrated consulting Marian Elliott said: "It is quite interesting that there has been this perception in the market that consolidators may not be as secure. What we found is that the way that they invest their assets means their investment portfolios are actually more resilient than the typical insurance company."
There were also clear differences between the portfolios in the time to recovery after market shocks. Drewienkiewicz said: "Because the majority of the credit that insurers find favourable to hold is very high quality and therefore quite low yielding, the recovery period is longer and your portfolio is not healing itself as quickly with yields.
"Whereas a more diversified and high yielding portfolio, even if it suffers the same shock, is able to recover from it quicker."
Elliott did note however that the differences found in the portfolios does not necessarily mean that the insurer will always be less secure than the consolidator, as there are always "other key drivers of security" and all insurer portfolios will be different.
She added the security of each solution will be driven by factors such as:
- The reserves actually held: insurers tend to hold reserves well in excess of the solvency capital requirement
- the mechanism for capital release in a consolidator fund
- the scale of insurers vs consolidators and therefore the costs that they are subject to
- the different regulatory regimes and compensation schemes which apply to the two different solutions
Redington also noted that it isn't yet clear whether consolidators will be subject to risk based capital requirements, which may offset some of the benefit of the high-yield investment identified in its analysis.
Elliott added: "The ‘right' solution will be heavily dependent on the particular circumstances of each scheme and sponsor. We need to work together as an advisory community to bring the covenant, legal, investment and funding considerations together, to help trustees make what is a nuanced and multi-faceted decision."
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