The UK’s world leading insurance industry is a vital contributor to the economy, managing investments of over £1.7 trillion which is equivalent to around 20% of the UK’s total net worth. And recently published ABI statistics reveal that in 2016 insurers’ income on those investments stood at £78bn, helping to support the economy and benefit society as it drives sustainable economic growth.
Insurers will have different investment approaches depending on the types of insurance being written, the scale of the business, and the risk appetite of the firm. In particular, the pattern of investment varies considerably between long-term and general business. The ABI’s recently released 2017 Invested Assets statistics show that general insurance companies, driven primarily by the need for liquidity and short-term certainty, tend to invest largely in cash and ‘Overseas Debentures, Loan Stocks, Preference & Guaranteed Stocks & Shares’. In comparison, long-term insurance companies, driven by the needs to both deliver good returns long-term, and match assets against long-term liabilities, focus much less on these areas, and more on traditional equities and property.
Across the market, diversification is a key method of risk-management. The principle intention of diversification is to mitigate the risks of volatility in financial markets, and striking a balance between returns and certainty.
Within long-term insurance, we also see a significant proportion of assets invested through Unit Trusts, which themselves are comprised of a diversified portfolio, and so any shortfalls within certain investments will likely be offset by gains in others. Unit trusts have rapidly become a popular investment choice for customers (now over double the figure from 2008) within long-term savings, as they allow exposure to a wider range of underlying investments than would otherwise be possible through the customers investing directly in the same assets.
Investment fund managers keep a keen eye on a range of factors to inform investment decisions. One key trend continuing in 2017 relates to inflation; the overall pattern of investment within non-index linked Government bonds has been on a gradual decline since 2005, although they are still more popular than their index-linked counterparts. Inflation can erode on investment returns, and so speculation of inflation growth can be a plausible explanation, where fund managers may want to reduce any risks associated to loss of earnings.
Another trend is that insurers have increasingly invested in overseas assets – both bonds and equities. This allows insurers to diversify against any risks associated with investment within UK markets. Foreign investment also opens up avenues to beneficial exchange rates, and a direct example of this is the effect of Brexit on sterling for those who invested in overseas stocks and shares. Conversely, this can also present itself as exchange rate risk. If a UK insurer buys foreign stock, and the currencies in the overseas territories weaken, the investment returns for the UK insurer will decrease.
Fund managers will continue to adapt their investment strategies based on these factors, yet other influences such as political uncertainty and climate change regulation may also have a significant transformational impact on the investment landscape.
Despite efforts to provide certainty of investment performance through diversification, ABI data shows that this performance remains highly uncertain. Total investment returns stood at 4.5% in 2016, a 2.8 percentage point increase from the previous year, and this is just one of many large fluctuations in the data over the last decade. With Brexit approaching and the ongoing low interest rate environment, there is little doubt that this uncertainty will continue for the foreseeable future.