There is a bit of a vicious circle because you have an increasing pile of cash seeking ever greater returns so almost by definition a lot of these assets get more expensive.

Nicholas Gartside

Chief Investment Officer, Munich Re

What do historically high cash reserves mean for the global economy and how can insurers plan for the day of cash deployment?

Interviewer: Venilia Amorim, Content Producer, Clear Path Analysis

Interviewee: Nicholas Gartside, Chief Investment Officer, Munich Re

Venilia Amorim: What does it mean for the economy for investors to have high cash reserves?

Nicholas Gartside: This scenario is likely to persist and if you think what the underlying dynamics are of having a low growth and low inflationary environment, which means low interest rates and because of this, coupled with central bank actions, there is just a huge amount of cash that is literally being printed so there is a big excess of savings globally.

This means that there is a bit of a vicious circle because you have an increasing pile of cash seeking ever greater returns so almost by definition a lot of these assets get more expensive. This background is important because it reinforces the point that this scenario is likely to persist for much longer than a lot of people think. The risk is that we are in the exact same predicament, if not worse, in five to 10 years time.

When you bring this back to the perspective of an investor, particularly an insurance company, it is very easy to deploy that cash as there are many assets out there that you can buy. Deploying these assets sensibly is harder because it is an environment where stock or issue selection becomes much more important and this is an environment where the dispersion of returns is likely to get much greater between similar assets in the same sector and because of this it is an environment where the role of credit selection and the role of an analyst doing the due diligence becomes radically more important. This becomes the challenge for insurers as they look forward as they have to be able to access this expertise.

One of the other consequences is that it is an environment that really encourages this shift into non-public assets, i.e. private or more illiquid assets, and they have a number of benefits such as having a high yield because they tend to be more complex. Because they are illiquid you can harvest the illiquidity premium so they do look very interesting but you then need the ability to do all the due diligence. Of course when you acquire these assets by virtue of the fact of them being illiquid you are likely to be stuck with them for a long period of time.

With this as a backdrop it means that this shift into these types of assets which are easy to buy but in terms of making the decision to buy them the key lies in being able to do more due diligence than what you would need to for the publicly traded assets.

Venilia: What level of reserve ratios is typical for an insurance company?

Nicholas: It varies very widely and there is no one figure that you could give but the point is that they tend to be cash generative businesses. These are businesses that have constant cash generation and if you were to look at who the bigger holders of cash are globally, insurance companies are up there.

It is also reinforced because a lot of the liabilities within an insurance company are quite long dated such as life insurance, so it can be that many businesses are cash generative but the cash is in one day and out the next day, whereas typically with insurance companies the cash is with them for quite a period of time.

Venilia: How can insurers plan for a cash deployment strategy?

Nicholas: The range is very broad so it could be anything from a private equity, buildings i.e. real estate, infrastructure both debt and equity with the classic one being a wind farm, solar panels, regular infrastructure motorways, and so on. Pretty much anything that you use in your daily life is a suitable item for an insurer.

Typically, with a lot of these assets you have cashflow coming through constantly because people are using them and a lot of the cashflow tends to be inflation linked again because railways, water or power assets typically have some kind of fee increase that is associated with inflation so this can be very helpful to an insurer. Where some of the liabilities may also be linked to inflation, even if they are not, it preserves the real or inflation-adjusted value of those assets so fundamentally they look pretty good.

The other aspect is in the valuation and again if you think of the nature of an illiquid asset, to encourage people to buy these assets you need to offer a higher yield so in a world of lower yields on publicly traded bonds and other assets, you can pick up what is known as the illiquid premium, i.e. what an investor demands for holding an asset that they can sell but that isn’t of the liquidity of the publicly traded markets.

The other benefit is that for many insurers they don’t necessarily need daily liquidity because they have liabilities that tend to be long dated. If you have longer dated liabilities, you have an asset that itself you are going to be with for a long period of time and in the interim you are getting the cashflow.

It may be that we get more of the assets as well if you think of what many governments are doing as they are under pressure in terms of economic growth and budget deficits so it may well be that you get more of these assets released onto the market as well.

Venilia: How will the 2020 Solvency Review impact on insurers’ cash reserves going forward?

Nicholas: On cash reserves it shouldn't have a massive impact. The impact may well be more in how the accounting fee evolved.

Venilia: What trends do you see developing in the next 12-18 months in terms of cash holdings?

Nicholas: It is an environment where oddly insurers will be keen to reduce cash balances because it is an environment where globally interest rates are likely to go down. People forget but in recent years what has helped cash investors is the Federal Reserve raising interest rates, so dollar cash has given a yield of a couple of percent.

Again, with the shift in central bank behaviour this is likely to go down so this makes cash a much less attractive asset relative to where it was.

Venilia: Is this Europe wide or globally?

Nicholas: It is global if you think of virtually any central bank in the world it is going to be easing monetary policy and cutting rates, which again is partly designed to force investors out of holding cash into something more productive and into more risky assets. This means that going forward this is likely to reduce cash balances.

Venilia: Thank you for sharing your views on this topic.

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