I had the pleasure of sharing a delightful lunch with a couple of insurance luminaries recently, one a leading investment consultant and the other a prominent industry thought leader. Our conversation quickly honed in on an issue of singular importance: beer. Imbued with confidence gained from a recent brewing course, I passionately expounded the varying qualities of session IPA’s, amber ales and even fruit beers. On the latter, it’s safe to conclude one counterpart in particular failed to be convinced of the merits – and I wasn’t about to pick an argument with a Belgian on what makes a good beer!
When the debate on the pros and cons of home-brewing abated, we were finally able to move on to less contentious matters. In particular, I was keen to understand which single issue has been keeping the insurance community awake at night so far this year: “Illiquid Assets” was the unequivocal conclusion.
The shift from traditional into more esoteric asset classes is now a well-established theme in insurance balance sheet management. The twin forces of ongoing depression in developed-world rates markets and Solvency 2 have isolated the focus on yield. Back in July last year, the PRA had identified this shift in its paper: UK Insurers Investments in illiquid Assets. As we stand private equity, private debt, infrastructure and real estate have all now been considered fair game for the yield hunters. Throw in the newly emerging trend towards alternative fixed income and we really start to build up a picture of the confidence portfolio managers have for moving into these nascent opportunities.
Whether this is an intended consequence for regulators, in their desire to see improved capitalisation ratios, is up for debate. It is the hope of many that 2018 will be the year in which some of the apparent inconsistencies in the Risk Margin are ironed out. Debate on how this can be best achieved is ongoing, but it seems clear that traditional assets will continue to be decimated by re-allocation into these upstart sectors for some time to come.
What remains uncertain is whether systems developed overwhelmingly in favour of the status quo can keep pace with such new paradigm asset allocation models. Large sums of money have been invested in powerful reporting engines. However their (in) ability to flex to forensically capture the characteristics of illiquid asset classes is impactful for insurers, from a 360 degree operational risk perspective: Without appropriate tooling for pre-trade, asset allocation, risk and associated analytics, portfolio managers are at material risk of adverse selection issues.
FINCAD F3 offers the power, scope and flexibility to overcome all of these challenges. To find out how, or even just to share craft beer recipes, please reach out to me using the contact information below in my bio. If you are interested in learning how our solutions might help you overcome your unique valuation and risk challenges, reach out for a customised demo.