investment viewpoints

The next input for insurance asset liability management

The next input for insurance asset liability management
Ritesh Bamania - Head of UK and Ireland Institutional Clients and Solutions

Ritesh Bamania

Head of UK and Ireland Institutional Clients and Solutions

Insurers can potentially find themselves exposed to an unexpected duplication of risks which then appear on both sides of their balance sheets. In our view, incorporating ESG metrics into asset liability management can not only improve profitability in the long-run but also mitigate hidden risks.

The asbestos crisis, which emerged over a 100-year period, showed the material impact hidden risks can have on an insurance company. These were risks that nobody foresaw, but that ultimately contributed to the insolvency of numerous insurers. 

As the crisis unfolded, many insurers saw the threat to their businesses purely as a liability risk, but a more sophisticated risk analysis, using environmental, social and governance-based (ESG) metrics, shows these types of issues impact both sides of their balance sheet. Insurers face a duplication of risks, first on the liabilities side through their everyday business activities, and also on the asset side through their investment portfolios. 

The concept of incorporating ESG metrics into asset liability management is relatively new in some parts of the insurance industry, but we firmly believe it can help mitigate risk, diversify investment portfolios and improve solvency. Insurers may consider enhancing their asset liability models to reflect both known and unknown risks.

We believe that there are practical steps insurers can take in order to reduce their exposure to ESG risks which form a three-tiered approach. The first step involves identifying the key known risk exposures in assets and liabilities by timescale. The next stage requires risk quantification, where the potential impact of major ESG-related events on assets and liabilities is determined. Finally, ESG asset liability matching encourages portfolio diversification in order to ensure assets are no longer correlated to major risks.

In our view, incorporating ESG considerations for both assets and liabilities in the ALM framework will likely improve both risk appreciation and return potential for insurers. 

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