James Bradbury, business development manager on Wellington Management's EMEA insurance team, tells David Walker how the manager's bespoke solutions are cut to fit its customers
Where does Wellington see the greatest opportunity in terms of insurance clients' future needs?
One prime opportunity is within the UK life insurance industry. The UK pensions crisis of 2022 resulted in many pension funds finding themselves in better funding positions. This led to a massive acceleration in risk transferal from the UK pension industry, into the life insurance market. This has resulted in a thirst for assets to back these liabilities. The sterling market is not deep enough to support this appetite, hence insurers are looking to diversify into other bond markets. Particularly in the US.
In addition, to the above, another focus, particularly from the non-life market is to ensure that asset portfolios are positioned appropriately for more volatile market cycles and more reactive central bank policy. Clients are looking for managers that can be defensive, whilst still recognising and capturing upside opportunities. To be a strong thought partner for our clients, Wellington have developed a robust framework for assisting our clients with undertaking frequent strategic asset allocation (SAA) studies. Importantly, through this SAA framework we ensure that any investment case is linked to the insurer's underlying business, whether that is regulatory risk capital, rating agency RBC, financial projections, or climate risk, for example.
We have witnessed increasing use of fund-based investing by insurers in various jurisdictions in recent years - about 20% of Europe's GA is now in funds, and much of the non-mainstream investing in Bermuda seems to be being done via funds. Has Wellington witnessed uptake as well? To what extent can fund-based investing replace mandate-based, or should it be a supplement to, not a replacement of?
We find that the majority of our clients prefer to work with us to develop customised solutions. This normally necessitates investments to be held in separate accounts, rather than fund structures. When clients opt for fund structures, these tend to be for a variety of reasons, such as liquidity needs, ease/speed of implementation, to access markets that are operationally demanding to set up, or if an allocation falls below a minimum threshold for a more bespoke solution.
However, we have seen specific demand for funds that take a dynamic approach for allocation between fixed income sectors. This is especially true during more volatile economic cycles where dynamic allocation between sectors can both protect capital and generate alpha. In addition to this, some alternative asset classes, such as private equity, can only be accessed through funds.
For those insurers that are looking to embrace a 'solutions mindset', in other words, working with asset managers to develop more bespoke solutions to meet particular requirements, we are seeing more of an appetite for utilising funds, in particular with a 'core-satellite' approach. This is more common for surplus assets, and given that most regions permit 'look-through' to the underlying assets (outside of the US), full transparency to the underlying assets can reduce capital consumption.
For insurers that have predominantly used mandates plus inhouse management, what would Wellington's points of advice be to CIOs, when delving into funds as well?
Funds are a good solution should the CIO want either quick access to a market, or if a separate account would be too operationally burdensome.
Should a CIO invest through a fund it is also worth highlighting that there are regulations that the asset manager must adhere to in treating all investors the same. This places restrictions on information that can be shared with clients on positional and performance data intra-month (or liquidity period). In other words, full transparency to the insurer's underlying assets is less available than it would be through customised mandates or through inhouse management.
Therefore, if a fund is required for any particular reason, but the CIO also requires customised guidelines and enhanced transparency, we can also explore implementation through a "Fund of One". This is a registered fund, with only one underlying investor.
How has Wellington evaluated the amendments to the rules of Solvency UK so far from an investment point of view and how do you see it impacting the life insurance space?
We see this as an exciting set of reforms, and we have been following developments closely. This is especially interesting for life insurers, which have typically been constrained with what they can do with their liability-backing assets especially within MA portfolios. Life insurers are often limited to certain securities, but the reforms will expand their asset universe considerably, with the potential for asset classes that have long been outside of the rules becoming eligible. Not surprisingly, we are partnering with our life insurance clients to ensure they are abreast of regulatory developments, and we are working with them to ensure they are considering the full opportunity set available for their liability backing investment portfolios.
Climate change now seems well embedded into European insurers' thinking. How does Wellington see and foster CIOs evolving thinking on identifying, measuring, mitigating the risk, and/or taking the opportunities that climate change may present to GAs?
We were early to the game with our partnership with Woodwell Climate Research Centre (WCRC), which is a leading research-provider on the physical risk of climate change. More recently we have worked closely with the MIT Joint Program on the Science and Policy of Global Change, to help us better understand the impact of transition risk.
Not only has our work with these third parties helped us to incorporate climate risk into our capital market assumptions, but it has also allowed us to significantly upskill our investment teams.
Ultimately, the utilisation of fundamental climate research helps our investors avoid deals where they aren't being compensated for a probable climate event such as single-borrower loans in coastal regions at risk of hurricanes, or drought-exposed industrials. We are still not seeing capital markets price these risks appropriately, and insurers, particularly those who are buy and maintain, need to be confident they will receive their principle back.
We have tools which allow us to engage more meaningfully with insurers on risk management across their total enterprise risk. We can also see where there is overlap between underwriting and investment exposures, particularly as relates to physical climate risk. For example, we recently completed a project for an insurance client where we looked at the overlap between their underwriting risks and investment portfolios – even taking into account those mandates managed by our competitors – running analysis on total risk exposures. It revealed an entirely new area of risk for this particular client to focus on – namely wildfire risk across certain US states, risk insights that had hitherto been unconsidered.
We also evaluate transition risk, working with our clients so they understand climate targets and what these can mean for portfolios. We were one of the founding signatories in the Net Zero Asset Management initiative, and as part of that we help our clients develop pathways to net zero.
If a somewhat off-piste asset class has become strategic for an insurer, what are useful yardsticks to gauge when an insurer might start building their own capabilities in it?
In our view, the yardstick would be the cost of building a team. Do the cost savings off-set the deeper access you might otherwise get into a given market? Wellington can help with that analysis. We start by providing data on the ability to access deals and the diversification and additional yield that could be generated by 'buying'. Ultimately, if the insurer feels they are getting access to the 'right' deals through their own broker network then 'build' may be the most economic option, once the expense of building out and maintaining a full investment/operational/risk team is factored in.
Some asset classes lend themselves to 'build', some don't. For example, origination of deals is something that requires long market tenure and a large investment platform before a firm will even have sight of deals from the brokers. For example, originating bonds within the investment grade private placement market can have a significant yield differential from the more common 'agented' market.
It is also worth highlighting that we have recently seen moves to reverse previous strategies to 'build' inhouse teams. This may be due to a number of factors. A less benign economic environment that requires increased resources to monitor and manage. Also, frankly, asset manager fees have trended down over the last 10 years, making the 'buy' option more attractive.
