European life insurers see inflation as biggest macro risk

A survey of European life insurance companies that collectively oversee €2.73 trillion in assets, commissioned by AlphaReal, the specialist manager of secure income real assets, reveals inflation is the biggest macro risk facing the sector.

The Eurozone’s headline inflation rate (HICP) recorded a high of 10.6% last October and remains above the European Central Bank’s 2% target.  Likewise in the UK, the CPI was at 11.1% last October and is still significantly higher than the Bank of England’s 2% target.  Stubborn and persistently high inflation presents challenges for European life insurers, as does the risk of future inflation shocks.  This is because Insurers have substantial inflation-linked liabilities.  AlphaReal’s survey revealed that 21% of European life insurers have more than 60% of liabilities linked to inflation. A further 73% of respondents have between 30% and 60% of liabilities linked to inflation. Six percent have between 10% and 30% linked to inflation.

Two-thirds of life insurers surveyed by AlphaReal link liabilities to domestic inflation, with the remining third pegging to Euro-wide inflation rates.

When asked the term of their liabilities, almost three-quarters (72%) of life insurers have medium-dated liabilities (10-20 years), one-quarter say they have less than 10-year duration, while 3% have greater than 20-year duration.

Looking at macro-risks facing the industry, other than rising inflation, European life insurers identified politics (both domestic and geopolitics) as the second largest risk, while monetary tightening by central banks through increased interest rates was rated third. The threat of recession was the fourth biggest macro risk identified by European life insurers, while equity and credit market volatility was rated fifth.

Shajahan Alam, Director of Strategic Investment Solutions at AlphaReal said: “Continued higher than expected inflation is a genuine challenge for life insurers with liabilities linked to inflation and the associated higher for longer interest rate scenario as central banks continue their fight to tame inflation. Insurers face a double jeopardy; higher inflation not only means higher claims outgo than those originally priced into policies, but insurers with fixed rate bonds will also suffer from lower asset values. The long-term nature of life insurer balance sheets amplifies this dynamic.  As a result, increasing holdings in long-term inflation linked assets are likely to be a priority for insurers.”

Phillip Rose, CEO of AlphaReal said: “Europe’s life insurance companies are beholden to investing in core fixed income to meet regulatory and rating agency restrictions on assets backing reserves. However, given the current economic conditions, it makes sense for them to look beyond conventional bonds and diversify into higher yielding alternative assets, particularly those with strong credit characteristics and linkage to inflation. We are seeing a trend of life insurers investing in private asset classes such as real estate and infrastructure which can help mitigate the impact of inflation risk.”

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