Why it's so important for insurers to manage financial market risk

Insurers have always had to be aware of financial market trends. But recently, the need to understand and act on these trends has grown more urgent and expanded to more facets of the insurance business.

While no one can consistently and accurately predict where markets might go next, for insurers to perform their core function of assessing risk and providing policyholders with attractive products, it is important that insurance professionals understand these market realities. This includes identifying the interconnection with insurance, and how to effectively manage the risk.

Two examples of where financial market considerations are becoming increasingly relevant during our discussions include:

1. Increasing complexity for capital management and investment functions

Sophisticated financial market knowledge has traditionally been the domain of insurers' investment teams. Now this skillset is becoming equally relevant for capital management and actuarial teams as Asia's regulators adopt Solvency 2-style capital frameworks and IFRS 17-style accounting standards. More recently, Korea adopted Insurance Capital Standard (K-ICS) and KFRS 1117, Hong Kong is now on HKFRS 17 and HK RBC, and Japan is set to implement economic value-based solvency ratio (ESR) requirements next year.¹² These updates already require insurers to pay greater attention to mark-to-market assessments of liabilities and assets and asset-side capital charges, amongst other impacts.

As assets and liabilities are marked to market, both sides of the balance sheet will shift more frequently, making many calculations moving targets and increasing capital considerations in the asset allocation discussion. In other words, actuaries will have to become much more sensitive to real-time financial market conditions and work more closely with investment functions to become more skilled at preempting the mid- and longer-term consequences.

2. Designing new insurance products to plug the savings and retirement gap

The market opportunity of investment-focused insurance products is especially large in APAC, as the region’s developed markets have some of the world’s fastest-ageing populations and the developing markets generally lack the comprehensive social safety nets found in regions like Europe and North America.

A recent Swiss Re Institute report highlights how life insurers can play a crucial role in addressing a retirement savings gap that is estimated to nearly quadruple to a combined USD 483 trillion across major markets by 2050. Japan’s retirement savings gap is expected to expand at 2.5% per year, while in China and India it will grow even faster, at a respective 7% and 10% annually.³

This shortfall is driving demand for insurers to structure and market products that combine protection with savings and investment elements that provide policyholders with income for their retirement. Developing attractive products requires insurers' cross-functional teams to have knowledge of not just biometric risks, but also new investment exposures and structures. This trend exposes primary insurers to a sizeable market opportunity but also financial market risks which need to be managed.

Insurers without an understanding of what financial markets can provide will be challenged to gain and/or maintain market share in this attractive space.

So, how should insurers prepare for a period of higher financial market importance and volatility? I believe this comes down to three key strategies: dialogue, education, and partnerships.

Through regular dialogue at an industry level, insurers can boost their understanding of the forces currently at play, how these might affect models and portfolios, and the latest financial techniques that can be used to address this volatility. It is also important that actuarial teams interact with product and propositions teams, investment teams, and economists to cultivate a more holistic view of how financial markets work.

Because Swiss Re works across our clients' actuarial, product and investment teams, we can help bridge this gap in knowledge and provide insights to our clients on how financial market risks feed into various aspects of the insurance business. Our global reach also means we can provide an informed international perspective on macroeconomic and financial market trends, both in developing and advanced markets – the latter where regulation has, in some cases, developed faster.

Reinsurers are also risk-taking partners, absorbing some of the capital management burdens imposed by demographic and regulatory changes, and new financial market realities. Primary insurers can turn to us to help manage financial market risks, by stabilising balance sheets, minimising earnings volatility and ensuring capital is deployed as efficiently as possible. Additionally, reinsurance can help act as a buffer against complex issues like asset duration mismatches, lapse risk and longevity risk, which are rising as populations age.

In response to today's volatile conditions, pooling our knowledge and resources means we can develop and maintain a baseline of financial markets understanding and risk management capabilities to deliver the solutions needed to foster the resilience of our APAC clients for the long term.