Future Challenges for the Insurance Industry

The companies that make up the insurance industry together make up the largest group of institutional investors in Europe, holding financial assets equivalent to more than half of the EU’s gross domestic product. Insurers invest insurance premiums, collected from retail and institutional policyholders, in capital market and other assets. Given the long-term investment approach adopted by insurers, much of their investments focus on fixed income type of securities, such as corporate and government bonds and steady income stream such as real estate and infrastructure

Given their role in mitigating financial risk, the size of their investment portfolios and the predominantly long-term nature of their investments, insurers contribute to the stability of financial markets. Insurance companies are also less prone than banks to liquidate investments when financial asset prices fall.

The balance sheets of insurers are composed of relatively illiquid assets, such as bonds but also investments in real estate and infrastructure, reflecting their traditional preference for long-term investment horizons. These liabilities protect insurers against the risk of those sudden liquidity shortages, which frequently occur because of the banking sector’s highly liquid liabilities and reliance on capital markets.

In the EU, the importance of insurers to financial stability has increased in line with the growth of the insurance sector over the last decade. The latter has been driven by rising demand for non-life products and by Europe’s ageing population, which has been putting more of its savings into life insurance plans.

Insurers across Europe face deteriorating economic fundamentals, including an ageing population, rising customer expectations and a long-term stagnation in growth. Following the introduction of the EU’s Solvency II regime in 2016, many insurance companies started to revisit their asset-allocation strategy in favour of credit risk solutions that better match cash inflows from annuity payments. Favoured investments included fixed-income assets, such as corporate bonds, as well as direct lending to corporates and long-term infrastructure investments.

Although fixed income still remains the primary driver of yield for insurers, the insurance industry has been spurred to seek new investment opportunities and explore high-yield and equity-type investment solutions, including alternative asset classes. For many insurance firms, alternative investments represent a shift in their general investment practices, to achieve higher returns, but also to better manage risk through portfolio diversification.

As they attempt to maximize returns in a persistently low-yield environment, which has been further compounded by the Covid-19 outbreak and its overall negative impact on the global economy and financial markets, many European insurers are increasing their allocations to a wider array of alternative asset classes, including hedge and private equity funds.

Luxembourg is perfectly placed to accommodate this change of course in the investment strategies of global insurance firms. A first mover in the implementation of European UCITS regulation, the Grand Duchy of Luxembourg has played a pivotal role in building a bridge between European and international financial markets and cross-border fund distribution, granting European retail and institutional clients access to international investments. Today, Luxembourg-domiciled investment funds are distributed in over 70 countries, with a focus on Europe, Asia, Latin America and the Middle East. The world’s leading asset managers have chosen Luxembourg as the centre for their international fund ranges.

Building on the infrastructure and the cross-border expertise developed in the EU retail fund industry over the past three decades, Luxembourg also boasts a first-class alternative fund regulation, which has helped it confirm its role as a leading hub for the global private equity and venture capital industry. The Grand Duchy has developed a comprehensive legal toolbox to meet the different needs of private equity general partners (GPs) and investors in the global alternative investments landscape and facilitate cross-border acquisitions in private equity and real estate.

The insurance industry plays a pivotal role in the identification and assessment of new and emerging risks, such as climate change. No other financial sector takes a wider-ranging vision or more carefully calculated approach to future risk challenges. The approach of insurance companies to sustainability is therefore of the utmost importance, not just to the financial services industry, but to the very fabric of our economies and societies.

As the largest institutional investor group in Europe, the insurance industry is set to play an essential role in financing the transition towards a low-carbon economy. In recent years, insurers have increased their asset allocation in green investments, which will greatly benefit the European green economy in the future.

The Luxembourg insurance industry has the potential to become a driving force for a sustainable and responsible financial future in Europe, thanks to the cross-border features of the vast majority of its insurance contracts. As a pioneer in sustainability and, with an established financial ecosystem which is familiar with responsible and green investments, the Grand Duchy is a leading international platform for sustainable finance. Luxembourg supports a range of activities, from responsible investment funds and blended finance, to green bond listings and ESG fund labelling.

The European institutional investment scene is increasingly influenced by ESG values and retail and institutional investors are increasingly interested in green asset classes which reflect the consumer preferences of sustainability-conscious Millennials and Generation Z. In the aftermath of the UN Sustainable Development Goals, the Paris Climate Agreement in 2015 and the subsequent EU Commission sustainable finance proposals, Luxemburg’s insurance industry has been actively integrating ESG factors in its business models, risk management, as well as products and pricing structures.

By opting to promote ESG and sustainable finance, Luxembourg is also taking note of the desire of many in the global millennial workforce to work for organisations which have strong ethical and environmental values.

Insurance customers, both individuals and corporates, are at the very epicentre of the disruption tearing through the worldwide insurance industry. In these times of rapid digital evolution and continuous search for more cost-efficient business structures, insurance businesses have to innovate and also rethink their core products and services in order to retain their customer base.

The emergence of InsurTech, pay-per-mile car insurance models, the development of blockchain solutions in insurance contracts and the provision of cyber insurance services, which take into account consumer and EU data protection requirements, are driving fundamental changes across the insurance industry’s value chain. The traditional insurance approach has now reached the end of the line and future growth will depend on innovation and a greater focus on proactive prevention, instead of just protecting against loss. Faster adoption of new technologies by insurance companies is the key driving element towards success and growth.

Insurance companies have already contributed to the emergence of digital platforms by consolidating their position as trusted providers for third parties. Platforms interested in insurance companies are mainly establishing themselves as partners for insurers, providing them with the needed agility in order to boost each segment of their value chain. When looking to fully embrace Amazonisation, insurers must focus on improving the overall client experience. Transparency of products and pricing will be key as consumers gravitate towards the products best tailored to their specific needs. At the same time, leveraging huge amounts of data will be crucial to profitability, as more and more customers demand usage-based insurance.

Operating in a persistently low interest rate environment, which has now been exacerbated by the Covid-19 crisis, insurers face challenging economic fundamentals as well as relentless regulatory pressures at the international and European levels. Insurers already started transforming their business models in order to stay ahead of these disruptive trends