Long-term nature of PPOs will require a ‘shake-up’ of existing strategies

pension fund scheme trustee magazine investment training

Use of periodic payment orders (PPOs) to settle bodily injury claims is presenting new investment challenges to insurers and requires a shake-up of existing strategies, according to Towers Watson.

The actuarial firm said in a new research paper that non-life insurers looking for a silver bullet to offset the liabilities from the increasing use of PPOs in the UK are likely to be “sorely disappointed”.

Non-life insurers are used to managing their invested assets to offset the short-term liabilities they typically face. However, PPOs, which are annual payments rather than a lump sum, are introducing long-term liabilities to insurers’ balance sheets.

This creates new investment challenges that the companies may not have previously faced, the Towers Watson contends.

There are additional difficulties and uncertainties associated with predicting the life expectancy of PPO recipients and the fact that PPOs are index-linked to the Annual Survey of Hours and Earnings (ASHE). No asset class currently provides any direct link to ASHE, Towers Watson said.

The company said in its report, Investing for PPOs, that all of these factors will require a shake-up of existing investment strategies.

Towers Watson head of UK investment strategy Alasdair MacDonald said: “The UK non-life market has progressively moved more of its assets into bonds since 2000 but it is not possible to fully match the PPO payments using bonds given their particular characteristics. In addition, attempting to match the payments from the PPOs using long duration bonds is currently unattractive due to the very low level of yields.”

He added: “Conceivably, affected companies may have to fundamentally revise their investment strategy with their PPO exposure in mind.”

MacDonald said that insurers could learn from pension funds’ investment strategies which have always had to deal with matching assets to payment commitments that might last for a very long time with an uncertain term of payment.

“Even then, the risks inherent in PPOs are greater because of the typically longer payment term (the average age at settlement is around 34 years) and the lack of available data for the life expectancy of people with severe injuries,” MacDonald said.

However, he added: “The work our investment team has done with a number of pension funds shows that a better fit of assets to liabilities can be achieved by restructuring the asset mix and using derivatives.”