The global equity sell-off earlier this month, sparked by weaker-than-expected U.S. nonfarm payrolls data for July, has shone a much-needed spotlight on the vulnerabilities facing institutional investors in a global market that is more sensitive to shocks than ever. From pandemic-related market crashes to sudden sell-offs in technology companies, this latest upheaval is not an isolated incident, but rather part of a broader trend of increasingly frequent market disruptions.
While large institutional investors have ample resources to adapt to and profit from these rapid changes, some of the more esoteric areas of the investment world, such as unit-linked insurance plans (ULIPs) and unit-linked funds (ULFs), are more vulnerable. These investment vehicles, designed to link insurance products to market performance, face unique challenges that need to be addressed urgently. ULIPs combine investment with insurance, meaning they must match investment returns with the insurance cover they provide. Therefore, any sharp decline in equity values creates a situation where the insurance component is likely to require additional funds, either through higher premiums or by diverting a larger portion of the policy value to cover insurance costs, further undermining the investment component.
The problem is that ULIPs and ULFs can be heavily invested in equities, many of them in US S&P 500 companies, meaning their performance is significantly affected by the performance of the stock market. Any large-scale market sell-off can lead to significant declines in the underlying assets of these products, thus causing significant declines in their net asset value (NAV). Unlike traditional insurance products, which typically offer stable but unspectacular returns, ULIPs and ULFs are more sensitive to market fluctuations. These funds are also designed as long-term investment products, often with a minimum lock-in period of 5 years. Any significant short-term market volatility can therefore undermine the confidence of policyholders, who may be forced to rethink their financial goals and risk appetite.
Even though the market has recovered over the rest of August, this is unlikely to fully offset the immediate impact on investors whose lock-in period is about to end. Largely due to these lock-in periods, ULIPs and ULFs are often subject to liquidity constraints, meaning that investors in other asset classes such as mutual funds or exchange-traded funds (ETFs) may react more quickly by rebalancing or liquidating their positions during the sell-off. ULIP and ULF investors are more constrained in their ability to exit or adjust their portfolios, potentially compounding their challenges during a sell-off.
Unlike these other types of investment vehicles, retail investors in ULIPs and ULF policyholders often face significant delays and lack of transparency in pricing. The delay in pricing – which is often only updated daily or weekly – means that investors see prices when the market opens in Europe that may not reflect the latest information if there have been significant changes in Asia that have global implications throughout the day. This delay can further amplify the impact of market volatility, as policyholders are faced with outdated valuations that do not reflect the most current market conditions.
The broader economic context, including upcoming actions such as the Fed’s expected rate cut in September, further complicates the picture, impacting both the performance of ULIPs and insurers’ balance sheets. Indeed, depending on the rate decision, many insurers could be grappling with increased liabilities and reduced asset valuations, putting potential pressure on their financial stability.
Addressing these challenges is no small task and requires a concerted effort to modernize the existing infrastructure that supports ULIPs and ULFs. Implementing intraday pricing mechanisms helps mitigate the delays associated with market fluctuations. By providing multiple price updates throughout the day, these systems enable more accurate valuations and better adaptation to real-time market conditions. In addition, adopting more advanced technologies can also improve the transparency of trading activities. Real-time monitoring and processing of trades can ensure that all orders are executed promptly and accurately, even during periods of high volume. This not only helps manage investor expectations but also strengthens the internal controls and governance requirements needed to maintain trust and compliance.
The only thing investors can be sure of is that it is only a matter of ‘when’ and not ‘if’ when the next sell-off will happen. Due to their direct equity exposure, long-term structure, liquidity constraints and of course their dual investment and insurance nature, ULIPs and ULFs may need to be better prepared than most. By adopting more flexible pricing strategies, these investment products will be more resilient to future turbulence. To maintain confidence and achieve long-term financial goals, it is imperative to ensure that investors have access to timely and accurate information. As market disruptions become more frequent, a proactive approach to reforming and modernising the infrastructure underlying these financial instruments is key to protecting investors’ interests.
The author is Chris Watts, Insurance Solutions Specialist at Clearwater Analytics