Nordea cutting alternatives after shift to unit-linked products

Heightened lapse risk ends 20-year "romance" with hedge funds, says Nordea Life & Pensions CIO

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Nordea Life & Pensions plans to cut allocations to alternative assets, blaming high fees and changes to liquidity risk as the firm moves to providing more unit-linked products.

Although the Nordic insurer has been a big investor in alternatives – investing as much as 20% of assets backing guaranteed insurance products in hedge funds, private equity and real estate – higher lapse risk for new-style unit-linked policies is forcing a change.

"Almost two decades of romance might be coming to an end," said Jesper Nørgaard, group chief investment officer at Nordea Life & Pensions, speaking at the Insurance Risk Nordics Conference in Stockholm on May 31. "On average, our allocation to alternatives will go down in the coming years."

Private equity funds continue to charge 2% management fees and 20% of profits, and hedge fund charges – despite falling – remain too high for a sector that has had "serious problems providing appropriate risk-adjusted returns", Nørgaard said.

At the same time, the "market return products" Nordea increasingly offers to customers are more exposed to lapse risk, he said, making it harder to hold illiquid assets.

Funds backing traditional guaranteed products usually retain an investment buffer creating a need to generate higher returns, Nørgaard said: "With market return products, you don't have that problem.

"Investment in illiquid products for market return products will be inherently lower than for traditional products."

In addition to concerns about liquidity, holding alternative assets also brings more complex reporting requirements under Solvency II.

Nordea has moved sharply away from offering guaranteed products, with market return products climbing from 56% of gross written premiums in 2011 to 89% in 2015.

However, alternative credit might be one area where the insurer will increase allocations because of the attractiveness of private loans compared with high-yield bonds, Nørgaard said.

On the sidelines of the conference, he told the firm had historically invested about 10% of assets backing guaranteed products in real estate and 10% in hedge funds and private equity. Those numbers could change to about 10–12% in total, he estimated.

The insurer is moving in the opposite direction to much of the industry, which is increasing allocations to alternative assets as a way to match guarantees on legacy books. According to a survey by Standard Life Investments, alternative assets and real estate are the areas where most European insurers intend to increase allocations, with over 60% of respondents saying they would add to allocations in either or both.

Speaking at the same conference, Craig Turnbull, Standard Life Investments' investment solutions director, pointed out that annuity products in particular are "intrinsically illiquid liabilities". He said insurers with big annuity portfolios are increasingly looking at areas such as private credit markets to benefit from the liquidity premium that long-term liabilities allow them to unlock.

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