Market Performance and Uncertainty

Key Developments During 2018

Economic Changes

  • Since the UK vote to leave the EU, foreign and domestic investors have been worried over the uncertainty and economic impact of Brexit on the UK economy, so they have sold sterling-priced assets and bought elsewhere, which has in turn sent the value of sterling down. The value of sterling against major currencies such as the dollar and euro has generally fallen, but it has also regained back some of these losses whenever some form of positive news or certainty over future trade relations has come to the fore. However, as the value of sterling has dropped the FTSE 100 index has tended to go up reflecting the rise in value of overseas revenue from the multinationals making up the index.
  • The UK’s withdrawal from the EU will have far-reaching consequences on the European economy. However, the ultimate consequences of Brexit depend on the final agreement, which remains uncertain. The consequences for the stock and financial markets are therefore also uncertain.
  • Brexit impacts on occupational pensions schemes could include a requirement for them to disinvest from significant proportions of their overseas investments to realign their portfolio to be primarily invested in UK markets, changes to the strength of employer covenant due to relocation or business impacts on employer solvency. A hard Brexit could trigger a rise in aggregate UK pension liabilities, driven by the impact of falling gilt yields, falling interest rates, weakened sterling and a corresponding rise in inflation on schemes’ long-term pension obligations. Higher than expected inflation could impact actuarial work in other sectors e.g. current assumptions used for estimating general insurance liabilities based on recent benign history may no longer be appropriate if shortages or delays in sourcing parts and labour drive up costs.
  • Interest rates since the Global Financial Crisis have fallen to record lows. However, there are signs of normalisation of monetary policy in some territories e.g. US Federal Reserve is now ‘rolling off’ its balance sheet by allowing for the bonds it has bought to mature and the ECB is tapering its bond-buying. These conditions have put insurers and pension funds under increased pressure and led to actions such as a shift from guaranteed savings products to unit-linked, an increase in reinsurance transactions and bulk annuity deals, takeovers of less well-capitalised groups and changes in investment strategy.

Alternative Investments

  • Pension funds (DB and DC) are looking at investing in alternative asset classes: Mercer reported that the proportion of DB pension plans allocating assets to private debt increased from 7% to 11%, while secured finance strategies emerged from close to zero exposure last year to 3% of plans in 2018. The UK’s Investment Association called for greater access for DC funds to illiquid assets, such as infrastructure and property. Actuaries should be aware of the limitations in modelling illiquid or unusual asset classes and could make use of scenario testing to help decision makers evaluate the impact of investment conditions and changes in business strategy.

Market consolidation

  • 2018 has seen continued consolidation in the life insurance industry (e.g. Life Company Consolidation Group acquired Equitable Life, Phoenix Group acquired Standard Life Aberdeen’s life assurance business). The consolidators, some of which are backed by private equity groups, aim to generate economies of scale by combining businesses into a single capital structure and IT system. The complexity of these groups may increase the risk of maintaining accurate data and in selecting appropriate models and assumptions.
  • Similarly, in the non-life sector there have been mergers of insurance and broking groups as the abundance of capital has driven consolidation. The non-life sector has continued to face a soft market cycle with only small rate increases despite the significant natural catastrophe losses in 2017. In September 2018, the PRA wrote to Chief Actuaries of non-life insurers to highlight its continuing focus on realism in firms’ business planning and underwriting policies and the risk of inadequate reserving or underestimation in the assessment of capital requirements. Where firms re-underwrite their portfolios or move into new lines of business actuaries may face challenges in selecting assumptions due to the limited historical data available.

Pensions Risk Management

  • TPR’s 2018 Annual Funding Statement reports that trustees need to monitor and understand the scale and nature of risks (investment, funding and covenant) and notes that tools such as Integrated Risk Management (IRM) can help. On Brexit, TPR expects open and collaborative discussions between trustees and sponsors to understand the potential impact for the scheme and the sponsor. Actuaries are key advisors for pension schemes and can help users to assess the uncertainties arising from market conditions.

Summary of 2017 Discussion and Actuarial Implications

  • Economic and market conditions have a direct impact on the assumptions used for pricing products, reserving for risks, assessing pension funding, asset pricing and allocation and calculating capital requirements. All the areas where actuaries are employed are affected – from insurance to pensions and investment, as well as wider fields such as regulatory or consultancy.
  • The unusual economic conditions and persistent low interest rates, which have not been experienced in living memory, mean that past experience may be a poor guide to future outcomes. It is uncertain how long policies that were adopted by Central Banks to manage the financial crisis, to respond to Brexit or to support climate change commitments will remain the same or what their impact will be on economic growth.
  • Market innovations to achieve higher yields, a lack of rational market behaviour and the use of Quantitative Easing also mean that historical relationships cannot be relied on, thus increasing a potential for step-changes in risks. This is leading to a greater uncertainty in selecting and communicating assumptions.
  • Insurers and pension schemes may make strategic decisions to manage this uncertainty e.g. investment policy, business model changes or benefit modifications. There is a risk that actuaries do not take into account the risks associated with the new, complex investments created to provide higher yields. To some extent the risk is influenced by group think and commercial pressures with a risk of herding around particular solutions even if they are not appropriate in the individual circumstances.
  • Actuaries will play a role in helping decision makers manage these uncertainties. Actuaries could use stress and scenario testing to look at a range of potential outcomes. However, there is a risk that economic conditions mean the management actions assumed in these scenarios are no longer valid e.g. the ability to attract capital may have changed.

Further Reading

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