A family member recently asked me the specifics of a few different life insurance policies and it got me thinking about the metamorphosis the insurance industry has undergone globally the last few years and how it came about. It is really quite remarkable. We have gone from an insurance industry operating in the status quo of managing specific asset or liability allocation pieces in relative isolation to a highly correlated and severely stressed market with a great increase in underfunded ALM portfolios. This was spurred by the massive 2007-2008 market crisis and continues to be today’s hangover with historically low rates in the bond market and flat volatility. And this is all coming at a time with significantly more regulation at a global level, like Solvency II, with significant structural costs and a need for redesigned risk analysis systems.
A lot of factors are at play here that led to the awakening of the sleepy giant that is the global insurance industry. Much of this change is for the common good. After all, this better risk management translates to better financial backing and a better chance insurance companies will honor policy holder contracts. But this is also coming from an industry that historically relied on the fact that longer term unrealized losses would likely never be realized on the balance sheet in the shorter term.
It will be even more interesting to see the industry transformation under central clearing and the likely higher costs flowing through to end clients. Migrating to a central clearing world will restrict certain instrument types and can result in hedging mismatches.
In the end I am optimistic as we are already starting to see insurance companies up their game as they take a more dynamic approach in managing risk via stressed market simulations to help them remain competitive (and solvent). And we are seeing a lot of insurance companies come in with the mandate to help them more effectively manage balance sheet, deploy capital, and make better allocation decisions while planning for the worst black swans. Some are seeing this as a chance to nimbly move ahead of competition. This will certainly be a large improvement over historic practices with month end (or quarterly) risk processes and lack of hedging programs.