The yield on Germany’s ten-year Bunds is negative, and it is still unclear when interest-bearing securities will start to carry reasonable returns again. Are persistent low interest rates driving insurers to more lucrative but riskier investments? Might they be taking on too much risk with their investments? It seems not, according to a survey carried out by BaFin in the fourth quarter of 2020 (see info box, “BaFin researches investment behaviour”).

The survey did indicate that insurers were prepared to take higher risks in investments in order to generate a decent yield despite the low interest rates. This is why they are including alternative investments in their portfolios. However, insurers are not currently taking excessive risks, nor are they investing more in poor-quality investments or relaxing credit standards. In fact, some insurers are withdrawing from credit business, at least temporarily. The results in detail:

Alternative investments

When traditional investments no longer generate the necessary returns, we need to look at how heavily insurers are investing in non-traditional investments, i.e. in alternatives. Alternative investments include infrastructure and commodities, private equity, private debt and investments in securitisations and hedge funds.

BaFin’s survey is now able to provide information on the proportion of these non-traditional investments in insurers’ investment portfolios: they currently make up just under 6 percent. Infrastructure investments make up the largest share, at 2.1 percent. Private equity accounts for 1.4 percent, private debt 1.2 percent and investments in securitisations 0.8 percent. There are differences between the various lines of business: Pensionskassen have a much higher proportion of their investments in alternatives (8.1 percent) in comparison with the industry average, while reinsurers have a much lower proportion (3.7 percent).

Hedge funds, commodities and leveraged loans were almost completely unrepresented in insurers’ investments. Leveraged loans are a subcategory of private debt. They include loans to companies whose ratings are sub-investment grade and that are therefore very high-risk. Another finding from BaFin’s research: no insurers had any investments in cryptocurrencies at the time of the survey.

More investments in alternatives in the future

The information provided by the insurers on their long-term strategic asset allocation reveals that they expect the proportion of alternative investments in their portfolios to increase significantly in the future. In particular, they plan to expand their investments in infrastructure and private debt. However, alternative investments are in some cases far more complex and less liquid than traditional asset classes, and have the potential to move the risk/return profile of a portfolio in the direction of higher risk.

This is a prospect that BaFin expects insurers to take into account in their risk management. This might mean that they need to hire more staff for their risk management teams and/or provide additional training to their existing staff. Every insurer needs to be able to sufficiently identify, assess, monitor, control and manage the risks associated with their investments. This is a requirement set down in section 124 (1) sentence 2 no. 1 of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG).

Creditworthiness of issuers in decline

The research also indicated something else: more than half of the insurers stated in the survey that, for new investments, issuers’ average creditworthiness has declined over the last five years. BaFin also wanted to know what effect the COVID-19 pandemic had had. Most insurers stated that they had not made significant changes to their investment behaviour due to the pandemic.

There is also no evidence to suggest that credit standards for lending have been relaxed. In fact, some insurers have even withdrawn from credit business, at least temporarily.

The majority of the insurers surveyed are making use of derivatives: 30 percent invest directly in derivatives, and two-thirds have indirect holdings in derivatives, primarily via investments in Spezialfonds (special funds for institutional investors). 22 percent of the insurers stated that they use derivatives both in their direct holdings and in their fund holdings. They explained that derivatives were primarily used for hedging, in particular against currency risk and interest rate risk, and for the efficient management of their portfolios.