Risk-managing the next generation of savings products

The challenge of increased longevity is confronting countries around the world, and governments are wrestling with the challenge of how to encourage people to save more to fund ever-longer periods of retirement.

Insurers, meanwhile, are busy developing the next generation of long-term savings and investment products. It is no straightforward task. Consumers want simple, flexible products that provide attractive growth rates and guarantees. Insurers need to find ways of providing these guarantees and options, without taking too much risk themselves, and in a way that is simple and cheap to hedge.

One approach being looked at is a fresh take on constant proportion portfolio insurance (CPPI) mechanisms, a structure that has been used for a number of years, such as for hedging variable annuities in Japan.

CPPI is a means of creating synthetic guarantees within funds using a dynamic asset allocation strategy, allowing insurers to offer guarantees without the expense of a derivatives programme to protect the fund from market downturns.

But orthodox CPPI structures have flaws, which were exposed in the financial crisis, when funds rebalanced into low-risk assets, becoming ‘cash-locked’ and leaving policyholders unable to take advantage of market upturns.

Now insurers, assets managers and banks are working on variants of this structure that address the drawbacks of the old model and which could be used to create a new breed of unit-linked products with guarantees. However, as we report this month (see page 14), there are some significant challenges to making these structures commercially viable.

Insurance Risk will examine other structures that are being explored in future issues.

Back to reality
Solvency II, like the metaphorical ‘black dog of depression’, has weighed heavily on insurers in many areas of their business.

One aspect that has been causing particular frustration has been the uncertainty surrounding the capital treatment of assets and which assets would be eligible for the matching adjustment. These uncertainties have held insurers back from making decisions on asset allocation that they felt were economically attractive, but which were at risk of being unattractive under Solvency II.

But the delays to Solvency II – the regime is unlikely to come into effect before 2016 – is lifting many of the immediate constraints. Insurers are beginning to assess their high-level credit asset allocation strategies, examining new asset classes and looking for ways to boost returns and optimise the trade-off between risk and reward.

Insurers are now focusing on economic reality and gearing up to making some fundamental decisions on their asset portfolios, which could pave the way for greater investment in infrastructure, social housing and commercial loans (page 30).