Insurance investment trends in the LATAM market
Jose Carlos Justo, Equity Portfolio Manager at SURA Asset Management, explains the Peruvian market's current challenges and where they see big areas for growth.
Andrew Putwainposted on Tuesday, September 13, 2022
Andrew Putwain: What's your background and role?
Jose Carlos Justo: I have a bachelor's degree in business administration from the University of Lima, and I have more than six years of experience in asset management, for four years at Pacifico Seguros, part of Credicorp Ltd., the largest financial holding company in Peru. Currently, I work as an equity portfolio manager at SURA Asset Management, which is Latin America's largest non-banking manager of financial assets, and the leader in the pensions industry in the region.
"Latin American markets are currently at attractive valuations, trading below their historical averages, making them much more attractive compared to developed markets."
Andrew: Can you talk us through the current insurance investments market in Latin America, and Peru specifically, and what you're seeing?
Jose: In Latin America, there is political uncertainty in several countries, including Peru, which generates a depreciation in our currencies, and a generalised sell-off, especially in bonds and stocks. This volatility makes the investment management process complex since all the assets and insurers' investment portfolios lose value.
However, Latin American, and Peruvian markets are currently at attractive valuations, trading below their historical averages, making them much more attractive compared to developed markets, such as the US and Europe, which are trading at higher multiples. This represents a great investment opportunity since, in the LATAM markets, most of the sectors are related to commodities, such as materials, mining, and energy, which are benefitting from the current commodity cycle. Despite this volatility that we are currently seeing in the markets, insurance companies in Peru still maintain a risk-on investment approach with a progressively increased allocation to private equity. The main reason for this is because this type of strategy has many benefits, such as lower volatility and broader diversification, due to the low correlation to traditional asset classes, improving the portfolio's risk and return profile.
Andrew: What are the demographical and regional challenges unique to the Peruvian market?
Jose: In the local market, insurance companies have adapted well to the new environment, especially to the demands of customers. One of those is related to changes in consumption habits, mainly in the younger population; millennials are more familiar with digitalisation and interaction through digital channels. This has increased the presence of apps and social media in the market, which allows groups such as students to take advantage of the market and makes insurers more efficient and profitable.
One of the most important regional challenges is pension system reforms. Changes are being carried out in several Latin American countries, including Peru. In the local market, competition has increased between insurance companies and pension funds to attract people's retirement funds.
This has led to the creation of new types of products with greater flexibility within the insurance system so that clients can choose how they would like to receive their pensions. They can choose several years it pays out over or if they want to receive it in the local currency or US dollars.
These types of products impacted the annuity markets as the new flexibility makes traditional annuity products very unattractive. So local insurance companies are much more focused on offering these more flexible products since that is what customers currently demand.
Andrew: How do factors like the war in Ukraine and inflation, affect insurance companies in the LATAM region?
Jose: In recent months, we have seen an economic slowdown, which also brings the possibility of a global recession due to the rise in interest rates, impacting insurance companies.
"During recessions, interest rates drop, making it difficult for insurance companies to offer products with attractive interest rates, and their investment portfolios could also lose value."
The demand for insurance will reduce as many people do not consider it essential in tougher economic times, which could generate competition in the sector, higher reinsurance prices, cost pressure on the claims side, and greater sector regulation.
Additionally, during recessions, interest rates drop, making it difficult for insurance companies to offer products with attractive interest rates, and their investment portfolios could also lose value.
Andrew: How much has the current inflation and interest rate rises, both domestically and from other economies, affected Peruvian insurance and asset management?
Jose: Inflation has been high, affecting both sides of the insurers' balance sheet.
The impact has come mainly from P&C insurers. Their liabilities were quoted at cost, but inflation increases claim costs. Likewise, P&C investment portfolios have also been affected because they are primarily bonds, which tend to lose value due to the increase in interest rates due to inflation. Life insurers have been less impacted by inflation on the liability side since many of their products have fixed policy pay out amounts.
"A solution for insurers to protect their investment portfolios from this negative impact of inflation within the fixed income portfolio could be to reduce the duration of the assets."
However, on the asset side, they are affected because a large part of their portfolio also has long-term bonds. Nevertheless, the rate increase has also been favourable in a certain way since insurance companies have been able to invest at higher rates, allowing them to offer products with higher interest rates, which has attracted customers.
This has allowed them to generate more sales and to be able to recover from the economic impact of the pandemic more quickly. A possible solution for insurers to protect their investment portfolios from this negative impact of inflation within the fixed income portfolio could be to reduce the duration of the assets, such as bonds, and rotate to sectors of the economy that tend to do better in periods of inflation. For example, they may rotate into corporate bonds from sectors such as energy or with exposure to commodities or into more defensive sectors such as consumer staples, healthcare, and utilities.