Insurers will need to be more selective and opportunistic with their allocations to fixed income assets in 2013 as low interest rates put pressure on profitability, BlackRock's global insurance outlook warns.
Head of BlackRock's financial institutions group, David Lomas, expects insurers to embrace new ways of achieving profitability targets as a means of overcoming the low interest rate environment.
"Not only is profitability being squeezed, but the investment returns insurers generate from traditional fixed-income assets - to match their underwriting liabilities - are now harder to access at attractive risk-to-reward levels," Mr Lomas said.
He added that central bank purchases of quality fixed income assets, coupled with the global thirst for high quality income, has created an environment where newer bonds are being issued with lower interest rates.
According to BlackRock's report, 2013:The Year Ahead, market volatility, regulatory changes and increases in capital will force banks to deleverage by exiting businesses, selling assets and transferring risks.
The report predicts that larger insurers will help to fill the void as they seek higher yields and superior risk-adjusted returns.
"We are likely to see increased inflows into areas such as opportunistic credit, real estate debt, infrastructure project finance, social housing and high-yielding bank loans," the report states.
Insurers are also expected to find attractive opportunities in leveraged loans and collateralised loan obligations.
"Insurers may look to growth and higher investment returns in emerging markets in order to increase and diversify revenue," Mr Lomas said.
Furthermore, insurers will begin to increase their exposure to the illiquidity risk premium by settling illiquidity budgets.
BlackRock also expects insurers will increase their use of exchanged traded funds (ETFs) to gain immediate access to credit markets.
For example, Mr Lomas believes insurers in the developed world, seeking to diversify away from the historically low levels of domestic sovereign fixed income, will look to deploy assets in flexible credit orientated ETFs.
In addition, the report predicts that insurers "seeking exposure to more illiquid fixed income markets, such as high yield or emerging market debt, will increasingly implement their allocations with ETFs".
In an attempt to improve investment outcomes, insurers will also move beyond their core markets in the search for new clients.
The report predicts insurers will open offices and make acquisitions in emerging markets.
"In order to achieve success in these new markets, insurers will need to make a significant investment in terms of 'boots on the ground', via either hiring or acquiring local expertise," the report states.
"And with exposure to new countries comes exposure to new currencies, underscoring the need for robust currency-management solutions."
But as insurers recognise that interest rates will eventually have to rise, they will take action to protect capital.
"We expect insurers to place core assets into the hold-to-maturity bucket of their portfolios, thereby insulating them from mark-to-market treatment under GAAP rules," the report states.
"With core portfolios averaging four to five years in maturity, and a reasonable likelihood that rates will remain subdued over that time frame, the hold-to-maturity portion of the balance sheet appears to be a good home for these assets."
