Sander Dekker, Insurance Strategy Consultant - Scenario & Asset Valuation, Ortec Finance, discusses how insurers can respond to market volatility with scenario analysis and balance sheet simulation.
Andrew Putwain: Can you explain the short- and long-term implications of market volatility in the insurance industry? How can it impact investment strategies?
Sander Dekker: Whether based in the US, APAC or Europe, our global insurance clients consistently highlight volatility as their primary concern. While everyone is finding ways to navigate it, assessing its impact requires us to examine the distinct waves of volatility we have seen so far.
It began with geopolitical tensions last year, particularly in Europe and the Middle East.
The more recent source of volatility was policy-induced, with the implementation of tariffs, shortly followed by a 90-days pause, triggering a shock-and-relieve-wave. Around that time, we also saw the independent position of the Fed Chair openly being questioned, shocking markets further.
This leads to examining how these events influence investment strategies, with both short-, and long-term effects. Some impacts are direct, while others are more indirect.
You could argue that, despite earlier signals, - market participants, including insurers, did not anticipate the Trump administration would implement the tariffs on such a large scale. In that sense, you could say it was a miscalculation by the markets. On the other hand, this was also a classic example of a ‘tail-risk’-event, low in probability but significant in impact.
Whilst we must wait for the result [of the impacts], we saw Japanese life insurers immediately respond by actively selling bonds. You could also conclude that, while equity markets did rebound, the recovery was modest, so those investors with higher exposure in equities will likely not have recovered all their losses.
We also observe a split between public assets versus private assets. Public assets tend to respond swiftly, while private assets, have shown minimal movement. It’s likely there's a lag for the effects to materialise, if they do at all. In the short-term, insurers appear well equipped to manage this stress. This event was a real time stress test for the system, and insurers are naturally prepared to withstand such challenges.
In the long-term, we consider this from two lenses: microeconomic and macroeconomic.
One key impact comes from the trade wars impact on global confidence, consumer spending, investments and corporate decision-making, stemming from the macroeconomic channel.
There are also microeconomic effects on institutions. For US Non-Life insurers, such as car and homeowners’ insurance providers, rising claim costs will have a direct impact.
However, the significant impact is on the life insurance sector, where the macroeconomic implications are much more fundamental.
The question then becomes, is this truly a trade war as it has the ingredients to become something more substantial. The start of more regionalism in certain areas of the world, for example, in APAC certainly indicates this.
Within the first week after the tariffs, we saw South Korea, China, and Japan agree their own trade deal. China and Vietnam quickly followed suit, showing solidarity and cooperation within the production economy.
On the European side, there have also been some strategic shifts. We saw investments in Europe pick up, with increased capital flows into the corporate sector and government bonds. European investors are also showing a stronger focus on domestic opportunities closer to home.
These are direct impacts, but further developments could come, leading to more fundamental shifts in production, financial flows and trades. While it is still too early to say definitively, we can see multiple potential outcomes emerging.
So, what can insurers do? The best way of managing risk in terms of uncertainty is the combination of scenario analysis and balance sheets forecasting as it enables every investor to integrate uncertainty into their investment decisions.
The key is that with scenarios, you grasp the unique behaviours of asset classes under a variety of circumstances, including trade wars or deglobalization patterns. Then you assess the impact; the key is to translate what's happening in the outside world against the impact on your own balance sheet.
In our role, we support clients in addressing these challenges early on. We find that the impact can be significant, depending on the level in which they have prepared. This requires having a holistic and realistic view of both asset allocation and liabilities, and the interactions between the two. The dynamic between assets and liabilities and how they interact with each other, can strengthen or be detrimental to an insurer’s position, depending on how well they are managed.
Regulators put a lot of emphasis on scrutinising this area, modelling policyholder behaviour is an example of this. With APAC introducing the new Insurance Capital Standard (ICS), there's additional attention on dealing with these dynamics. The idea is based on the volatility in the outside world, impacting policyholders’ decisions, potentially resulting in extreme or unexpected outcomes for the insurer.
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Sander Dekker
Senior Consultant