07 October 2009

Published in: Investment risk, Market risks

Swiss Re focuses on realigning its investments

Matching them with the long-term obligations of the reinsurance business is the key, says asset management head David Blumer in an interview with Stuart Collins

During 2009, strengthening Swiss Re's capital base has been the dominant theme, according to David Blumer, Swiss Re's head of asset management and a member of the firm's executive committee. The reinsurer de-risked its asset portfolio to "create the flexibility to allocate capital to the most profitable lines of business," he said. In the second quarter of 2009, Swiss Re reduced notional exposure in its asset management portfolio by Swfr7.1bn, mainly by moving investments out of corporate bonds and securitized products and into lower risk assets such as cash, short-term investments and government bonds, explained Blumer.

Recall that in 2008 the reinsurer posted a net loss of Swfr864m for the full year 2008. Healthy profits from the company's core operations were more than wiped out by operating losses of Swfr5.9bn from now discontinued activities such as structured credit default swap transactions that the company put into a "legacy" unit. The reinsurer's shareholders' equity decreased to Swfr20.5bn at the end of 2008 from Swfr31.9bn at the end of 2007. This has since increased to Swfr23.8bn at the end of June 2009. By then, the company estimated that its excess capital at the AA level had improved to Swfr4.5bn.

Core focus

Since taking on the role of chief executive officer in February, Stefan Lippe has championed Swiss Re's strategic focus on core property/casualty and life/health reinsurance, pointed out Blumer. This new focus has also meant a realignment of asset management at Swiss Re, starting in the second half of 2008. It is now tightly focused on consistently aligning its investments with the long-term obligations of the reinsurance business, explained Blumer, who joined Swiss Re last year from Zurich-based bank Credit Suisse where he was also head of the group's asset management activities.

"The aim should be to get an integrated view of all the risks in an insurance company and how these are interlinked with capital and assets. This effort is on-going and continuous calibration is necessary." 

Liquidity has returned, to some extent, in the market for securitized assets. Swiss Re has taken the opportunity to sell some assets at a higher value than it had priced them only shortly before, he said. And because Blumer expects the corporate bond business to retain a certain amount of volatility and certain companies to run into difficulties, Swiss Re will continue its hedging of these bonds.

Risk awareness

Swiss Re has also taken steps to improve risk management at the asset management side of the business and integrate this with the company's other risk management activities.

Blumer stressed the need to bring a "portfolio way of thinking" to the management of the reinsurer's various assets. "The aim should be to get an integrated view of all the risks in an insurance company and how these are interlinked with capital and assets," he said. "This effort is ongoing and continuous calibration is necessary."

Since the financial crisis Swiss Re has stepped up scenario-testing of its asset portfolio, a process already well established on the liability side of the business, said Blumer. "Scenario-thinking keeps you on your toes. It makes you think on a day-to- day basis about what potential changes will mean for the portfolio, and what contingency measures can be put in place. It is healthy to continually question what you are doing."

"Scenario-thinking keeps you on your toes. It makes you think on a day-to-day basis about what potential changes will mean for the portfolio, and what contingency measures can be put in place." 

The financial crisis also showed the need for more transparency in asset portfolios, said Blumer. "There needs to be as much transparency as possible to get the right view of which assets are performing and which are not. We currently get a lot of transparency for individual assets but we also need a good aggregate view."

To deploy capital more effectively a reinsurers' risk management needs to be based on an "all-risk" approach, considering insurance risks, investment risks, counterparty risks as well as operational risks, Blumer said. Such an all-risk approach is a pre-requisite for true asset/liability management, he added.

But the financial crisis has made firms realize that ALM should not be a static process. "We need to adjust and adapt ALM, and continually ask the question: What happens if?," he continued.

Blumer also believes that insurers and reinsurers must employ fundamental analysis of the assets they invest in, and not overly rely on ratings. "We need to really understand the underlying risks of the assets we are investing in and where they are positioned in the overall capital structure. This will require more skills -- either internally or externally -- but this will come back into focus."

Lessons in valuation

The financial crisis also exposed difficulties in valuing assets, particularly in a time of market stress and illiquidity, said Blumer. He believes that market-consistent valuation of both assets and liabilities should become the principle that underpins the reporting of financial information and prudential oversight in insurance.

"Market-consistent valuation techniques offer sufficient flexibility and robustness if they are applied transparently, with rigorous controls, deep expertise, and following clear internal governance structures," he argued.

Some insurers have expressed concern that mark-to-market accounting rules would act pro-cyclically, aggravating the impact of falling asset values in a downturn, Blumer noted. But this could be avoided if accounting standards are coupled with adequate risk management techniques, he said. Convergence of international accounting standards would also help.

Outlook

Blumer is more positive about the economic climate then he was 12 months ago, but he remains cautious about the prospects. "We are working on the assumption that that the markets will remain volatile. But I also anticipate that, due to global monetary policy, we won't see any more such events in the foreseeable future as we did at the end of 2008 and at the beginning of this year," he said.

"We need to really understand the underlying risks of the assets we are investing in and where they are positioned in the overall capital structure." 

Swiss Re reduced its equity allocations to "few strategic holdings" in the third quarter last year. And despite the recovery of major stock markets this year, Blumer said there is still a lot of uncertainty. The current situation is a difficult one for asset managers because there are "no clear trends" in the economic outlook, and there is much divergence between financial market analysts' predictions, Blumer observed.

Insurers are likely to continue to be conservative in their investment portfolios, remaining predominantly fixed-income investors, Blumer said. But there will be changes in asset allocation as risk appetite increases over time. "Recovery of consumption in the US, job market trends and public-sector debt are factors which we monitor particularly closely in our market scenarios and which, if necessary, should be accompanied by relevant measures in the portfolio." Given the outlook on medium- to long-term interest-rate hikes, Swiss Re had shortened the terms of bond positions, he added.

"It will be interesting to see how the securitization market will come back. Liquidity has started to return to the market. There are highly varied underlying assets which are again being collateralized, such as automobile loans and credit card debt. But the industry has to transform itself nevertheless. In future, investors will assess the value of transparency very differently. Where transparency, in particular on the underlying risk, is not available, investors won't want to go near it," Blumer said.

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