Christine Senior reports on the shift away from sovereign debt as French insurers seek yield and reduce risk
Life assurance assets predominate in French institutional investment, with non insurance assets forming only 20% of the total.
Indeed, life insurance contracts are a popular form of long term saving for French households, encouraged by their favourable tax treatment. The Fédération Française des Sociétés d'Assurances, the French insurance association, calculates that insurance contracts make up the bulk of long term savings, at 57% of the total.
As fixed income takes the lion's share of insurance company portfolio allocations - around 80% - there has been some change in asset structure. The quest for yield and the European sovereign debt crisis in peripheral nations has driven investors to take on more exposure to corporate credit.
"Poorly yielding government bonds and the peripheral government crises in Greece, Portugal and Ireland have driven the change," says Sylvain Favre-Gilly, who has responsibility for institutional clients at BlackRock France. "Insurers have reduced quite substantially the number of countries where they are investing into government bonds. AAA or AA-rated countries yield very little, so they have had to increase the yield by allocating to quality names in investment grade corporate credit."
Emerging market bonds are moving up the agenda, even if it is relatively small scale. "Investors are quite cautious and making small allocations, but more and more we are being asked for emerging market bonds, not huge mandates but still small tickets in open ended funds, though it's a growing trend," says Francois Hullo, head of French institutional sales at BNP Paribas Investment Partners.
Equity investments have shrunk, partly as a deliberate policy of reduction in allocations by investors but also as a consequence of the equity market crash.
"Equity allocation has reduced," says Joseph Pinto, regional head of sales for Southern Europe at AXA Investment Managers. "This is from two effects, the mechanical one that when the assets were revalued, investors did not consequently rebalance their portfolio, so they had more bonds and less equity. But also a number of investors decided proactively to reduce their equity exposure."
Yet insurers need returns to meet the guarantees on their life policies, and against a background of low interest rates and poor returns from money market funds, that means they need to take some risk. So at the margins there are allocations to riskier assets. Allocations of up to 5% are going into alternatives, which include infrastructure, real estate, private equity and some hedge funds, according to Hullo.
BNP Paribas's infrastructure subsidiary Antin Infrastructure Partners had a successful €1.1bn closing in September last year, most of which came from French institutions, mainly insurers.
But Solvency II is already making its mark on insurers' investment policy. Faced with the prospect of having to hold more solvency capital to back their risk investments, insurers are rethinking their attitude to risk. Equity investments are shrinking - where once 10-15% allocations were the norm, these are gradually being pulled back to more like 5%.
Pinto says: "One of our clients told us they had made their calculations and realised their optimal weighting was 5%. According to their calculations of capital requirements any additional marginal point of equity exposure above 5% was becoming too expensive for them for the expected return, due to Solvency II."
Another part of insurers' strategy to risk reduction involves product design and sales policy. They aim to sell more products that transfer risk from their own book to their clients. This means a push on sales of unit-linked life insurance contracts where the risk is assumed by the policy holder, rather than more popular with-profits contracts.
For asset managers this would be a welcome development, enabling them to take more of a share in managing insurance assets which for the most part are managed in-house by insurers.
"With unit-linked the argument is clients can have a higher growth and equity exposure portfolio," says Favre-Gilly. "The insurer provides a selection of mutual funds, and being selected from a pool of funds eligible for composing the portfolio offers greater opportunities for us. That's where asset managers like us can grow their assets with life insurers. We can offer our expertise in commodities, equities, and so on."
Though LDI strategies have not caught on in France, there is some expectation Solvency II might change this. LDI might also appeal to insurers facing the rigours of Solvency II regulation, according to Favre-Gilly.
"Large insurance groups are considering in the run-up to Solvency II whether an LDI approach may help reduce the cost of solvency capital, given the fact they will be asked to have a precise match of their risk. But it's early days. Solvency II QIF5 stress testing has just finished and the conclusions may lead to other stress testing."
As a largely pay-as-you-go pension regime, assets funding for France's pensions is significantly lower than in other parts of Europe like the Netherlands or the UK. AGIRC-ARCCO, the organisation that runs the complementary pension scheme, is estimated to hold reserves worth just over €50bn, which exist to manage medium term volatility in the pay-as-you-go system.
Because the system is unfunded there are no explicit liabilities as there would be in a defined benefit pension scheme, but the system is facing imbalances. "There is no defined liability, but currently the schemes have technical deficits especially the AGIRC system for executives," says Frédéric Debaere, head of investment consulting at Mercer."The trend over the short term is to decrease the reserves because there are more benefits to pay than contributions coming in. Implicitly it means the investment horizon is medium term, three to five years. AGIRC-ARCCO has roughly 70% in bonds 30% equities, and there's a similar situation in many schemes."
AGIRC-ARCCO's regulation prevents equity investment of more than 40%, but its equity allocation is well below that and may reduce even further if it needs cash flows to fill the gap in pay-outs. But one positive is the pension reform of last December, which could provide some breathing space.
"The new regulations in December 2010 increase the normal retirement by two years could mean over the medium term the AGIRC-ARCCO system is again in a situation of positive technical flows," says Debaere. "This still has to be confirmed."
The imbalance between contributions and pension pay-outs is affecting all retirement institutions. Receipts are based on salary levels and employment rates, so the current economic situation of lower salary increases and higher unemployment rates has reduced contribution income. This is forcing a strategic rethink of investments, according to Pinto at AXA.
"A number of investors have to face short or medium liabilities, so they are moving to a tactical asset allocation due to a tighter risk monitoring. It has impacted on the asset allocation and we have seen a need for shorter term fixed income products. Investors are still looking for yields in a low interest environment and within the constraints of the regulatory rules."