Shrinking bond yields are challenging some of Australia’s most conservative institutional investors -- the nation’s general insurers -- as they struggle to generate income and safeguard thinning margins.

With yields on the safest securities plumbing record lows, companies such as QBE Insurance Group, Suncorp Group and Insurance Australia Group Ltd. may be tempted to put more money into areas such as corporate credit and equities to bolster returns, Fitch Ratings analyst John Birch said. Australia’s general insurers saw their combined total return on investments plunge 47 percent to A$2.2 billion ($1.7 billion) last year, according to a report from Fitch.

“They might consider buying riskier assets, even though they have pretty strict constraints in regards to the credit ratings on what they can invest in,” said Jason Kim, a money manager who helps oversee Nikko Asset Management’s A$5 billion equities portfolio in Australia.

While Aussie bond yields are among the developed world’s highest and appear more attractive than U.S. Treasuries or the negative interest rates on offer in Japan and Europe, they’ve nevertheless been dragged down by the global flight toward fixed-income assets and bets that the Reserve Bank of Australia will be forced to lower its cash benchmark from an already record low. Australia’s 10-year government bond yielded 1.95 percent as of 9 a.m. on Wednesday in Sydney, after dropping to an unprecedented 1.84 percent on July 6.

QBE, Australia’s biggest internationally-focused insurer, told investors at a briefing in May that it had “strategic appetite” to invest up to 15 percent of its portfolio in growth assets over the next few years. The company had about 12 percent of its funds in growth investments at the end of 2015. A spokesman declined to comment.

IAG’s fixed interest and cash investments fell from 88.8 percent to 85.5 percent in the 12 months through Dec. 31, as the company increased exposure to equities and alternative assets, according to a company presentation on Feb. 17. A company spokeswoman declined to comment.

A Suncorp spokeswoman said in an e-mail on July 22 that the insurer had not changed the composition of its investment portfolio, and it remained “low risk.”

Low yields are a potential headwind for the likes of QBE, Suncorp and the general insurance businesses rely on investment income for about 40 percent to 65 percent of their pretax profits, according to a May 20 note from Andrew Adams, a Sydney-based insurance analyst at Credit Suisse Group AG. The insurers manage a combined A$52 billion, the bank said.

Natural Hazards

Even as earnings are likely to rebound this year from 2015, when losses from natural hazards jumped, weak investment returns signal the need to consider shifting toward higher-yielding assets, according to Fitch.

While Australia’s insurers are limited in how much they can alter their investment portfolios, there are signs of change “around the edges” as they increase their exposure to equities, said Fitch’s Birch.

The Aussies aren’t alone in their hunt for higher yields. Life insurance providers in the U.S. have been placing bigger bets on junk bonds as regulators weigh up easing capital charges on some speculative-grade debt.

For now, Australian companies are managing to offset some of the effect of lower investment income with cheaper reinsurance and increases to the premiums they charge individuals, according to Credit Suisse. They’ve also embarked on cost-cutting drives in recent years to help prop up earnings. Still, these strategies could sour in 2017 as the companies face headwinds from lower investment income and a difficult market for products aimed at businesses, Credit Suisse said.

Low yields might not be forever though. Nikko’s Kim reckons that there will be an increase in bond rates as central bank benchmarks eventually rise. In the U.S., there’s a 49 percent chance that the central bank will raise its benchmark by the end of 2016, according to futures market pricing.

“I know it’s very hard to imagine that yields will rise,” Kim said. “But I just think that things aren’t as dire as everyone thinks.”

Source:
courtesy of BLOOMBERG

by Ruth Liew

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