The business of reinsurance has two sides: one is taking on insurance risks; the other is managing assets to cover those risks. At the end of 2010, Swiss Re’s Asset Management team oversaw a portfolio worth nearly USD 144 billion. To put this figure in perspective, it is greater than the GDP of New Zealand and the equivalent of almost one fifth of all equities listed on the Swiss Market Index.
Like every other global function of Swiss Re, the Asset Management team is focused on satisfying its clients’ needs. The only difference is that Asset Management has only one client: Swiss Re itself. That client needs, above all, to have its assets matched to the liabilities that the Group takes on in its re/insurance business, so that returns on investments closely match the scale and timing of expected payouts.
This may appear a straightforward task, but assets and liabilities move: The values of invested reserves and estimated future claims can both change significantly with fluctuations in the capital markets. Moreover, the team is not only balancing assets and liabilities: It is expected to manage Swiss Re’s portfolio to optimise risk-adjusted investment returns within the given constraints. Insurance, by its nature, is a business with variable earnings; Asset Management helps to minimise earnings volatility through prudent long-term investment.
Three layers of asset management
To meet these various mandates, Asset Management separates its investment activities into three layers: a ‘risk-free’ return, a market return, and an active risk-taking return. The ‘risk-free’ return comes from the liability-matching portfolio, which is mainly invested in a wide range of low-risk fixed income instruments, chosen for cash flow characteristics similar to those of expected future claims. The market return is generated by ‘top-down’ asset allocation decisions: putting more or less weight into various broad asset classes depending on the macroeconomic outlook. Active risk-taking return, finally, can arise through identifying and profiting from temporary market dislocations. The proportion of market return and active return to overall return depends on the risk capacity and the risk appetite of the Group. Thus, Asset Management has a significant influence on profitability.
The role of regulation
Swiss Re Asset Management believes that a clear and consistent ‘top-down’ investment strategy is appropriate for generating stable risk-adjusted returns. But investment strategy is only part of the picture: Regulatory requirements, which are currently changing at a fast pace, can also influence a company’s investment decisions. Some current reforms are strongly welcomed by the industry because they signal a move from a rigidly rules-based approach to a principles-based one like the Swiss Solvency Test and the EU’s Solvency II regime: regulation that takes account of the economic risks that insurance and reinsurance companies actually face. Other reforms, however, may make an already demanding environment even more challenging for insurers and reinsurers.
Increased regulatory and capital requirements and higher capital charges for some asset classes could force insurers to allocate more of their portfolios to government securities at a time when yields on these securities are extremely low – and some hardly qualify as ‘risk free’. Too rigid regulation of investments could jeopardise the stabilising role in financial markets that insurance and reinsurance companies often play, thanks to their long-term investment perspective. It could also hamper growth, because insurance and reinsurance play an important role in financing the real economy through premiums they invest in the financial markets. Worldwide, insurers hold around USD 23 trillion of assets. Together with mutual funds and pensions funds, they are by far the world’s biggest investors.
2010 was challenging for investors, with economic recovery proving bumpy and sometimes even uncertain. Many government balance sheets, particularly among developed nations, were stretched by the financial crisis, when the public sector took on private sector risks. The months ahead are likely to see fiscal consolidation and renewed governmental efforts to steer the global recovery into calmer waters. With uncertainty remaining, however, Swiss Re Asset Management will continue to pursue an investment strategy based on fundamentals; after all, as many investors discovered in 2010, ‘risk free’ does not always mean risk free.
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