How insurers can maximise the benefits of investing in illiquids

Good planning and having an appropriate liquidity buffer is critical for insurers that want to get illiquid asset investing right, says Christoph Hofstetter, Capital Markets Expert, Vienna Insurance Group

Insurance Investorposted on Monday, May 18, 2020

Photo by Levi XU

Insurance Investor: How can you maximise the benefits of investing in illiquid assets when you have liquidity to sell?

Christoph Hofstetter: Nowadays, how you do this depends even more on whether you are a property and casualty (P&C) or a life insurer.

This is because P&C insurers have shorter investment periods since cash-outflows are faster in line with the claims of their clients, so they need more liquidity.

In this respect, too much illiquid investment is not very appropriate for a P&C compared to a life insurer.

Life insurers can plan this in more detail as the majority normally offer endowment policies or at least policies with fixed conditions.  Having good control and planning in place that can forecast the exact amount of cash and when you need it is essential.

Cashflow planning is of more interest now than it was in the past due to the current interest-rate environment.

Regarding how you can maximise the benefits, when you invest in illiquid assets and have liquidity to sell, a big portion of the task is related to the asset liability management (ALM) department, so you need a good messaging system in the company and the ALM has to be very good in order to maximise it.

Good planning is the basis for this, because if you plan well and include a buffer within your calculations for unexpected events, you can invest in illiquid assets. It’s all about having a very good idea of how to transfer illiquid assets in time, in order to have the money ready.

There is variation from country to country, but a good asset manager will always have a percentage of assets that are very nimble and fast so that they can be easily converted into cash.

There are various elements to this. It isn’t just a question of comparing real estate to bonds but is about which bonds you take, what exchanges they are traded on and how deep the market is for the bond.

Of course, there is no free lunch, so it costs something to have this flexibility even if you
don’t get a higher return. But everyone just wants to ‘stay in game’ and that’s far more important and essential for every company.

The question is often when you will need the liquidity and there can be whole decades where you have been sacrificing some extra return.

But you can be sure, and statistics bear this out, that there will be events where you will need this liquidity buffer and you will be grateful to have it. Especially in the insurance industry – safety and liability are crucial. Thus a safety buffer is here even more necessary.

In Europe as elsewhere, one of the best ways to transfer assets into cash without a big loss would be to sell government bonds of very good credit, such as German bonds, via exchanges.

There is a good reason why yields narrowed in the past for government bonds and prices went up so dramatically. Discipline is a good virtue here because, after years or even decades of no crises, human beings tend to forget and jump into higher risks.

The problem is crises (e.g. the 2008 financial crisis or the current coronavirus crisis) come very suddenly.

Those asset managers who stay disciplined even under pressure from their managers to take more risk accompanied with higher illiquidity to deliver higher returns will meet this challenge better than others.

It is about finding the right path with your asset management and linking it to the liability side. So, the asset liability management of the business must also play a big part.

One should play with scenarios and also keep general macro-economic but also macro-social aspects in mind.  That’s why mathematicians and statisticians are more and more popular in asset management.

One must work through different scenarios and define a quantile as closely as possible, i.e. find the Value at Risk (VaR). Then one must say which probability they would like to have (quantile) in order to be sure to stay liquid.

This excerpt is from: Asset Management for European Insurers - A bespoke Report with Wells Fargo Asset Management


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