Ask an insurance company in the US or Europe to describe the typical investment portfolio and they are likely to have the largest exposure to the debt asset class. One reason for this is the reasonable ability to predict returns from the debt capital markets, even for an industry that is built on expecting the unexpected. Although not completely risk free, debt instruments, especially the exposure to bonds, are an optimum investment choice that match predictable liabilities against predictable cash flow.

The Middle East insurance sector on the other hand has traditionally been underweight in debt since a significant portion of the portfolio accounts for high-risk high-growth assets such as real estate and equity capital markets. Recently, however, that has been changing, albeit slowly. In recent months we have begun to get a real sense that the debt market as a concept is gaining widespread acceptance among the region’s insurers.

So what explains the paradox of strong investment appetite for the debt asset class in a climate of economic turmoil? Put simply, when regional governments are seeking an accessible source of financing to reduce fiscal deficits, several market participants are becoming bullish on debt markets and predicting a spike in bond issuances — both conventional and sukuk.

For instance, Saudi Arabia alone raised a total of $26 billion (Dh95.5 billion) through the international sale of conventional bonds and sukuk in the past nine months. As the region rolls out ambitious plans to wean the economies off their dependence on oil, other GCC states such as the UAE, Kuwait and Oman have all issued sovereign bonds in the past few months. This combined with an array of corporate issuances makes a strong business case for insurers to be a part of the GCC bond party.

Underpinning the appeal of the debt market for insurers are the high-grade instruments which the region lacked before the oil price glut that began in 2014. Currently valued at approximately $300 billion, according to a recent report by Franklin Templeton Investments, the GCC bond market will continue to evolve and attract investors, primarily driven by the high-yields these bonds offer that are virtually non-existent in Europe and North America, especially now.

Providing further cause for optimism is the regulatory environment, particularly in the UAE, that has evolved in the past couple of years, encouraging insurers to improve exposure to the debt market. The regulations that enforce limitations on exposure to a single asset class would undoubtedly benefit both insurers and consumers in the longer term. More specifically, the new regulations are widely expected to bolster governance, compliance and risk management, simplified product structures, and international-standard regulations, among others.

Setting these factors aside for a moment, a perennial problem for the regional insurance sector has been the pressure on short-term profitability — in large part due to local shareholder structures. This ultimately leads to increased allocation towards equities and real estate which deliver volatile returns. If this trend is reversed, which the new regulations are predicated on, it can only point towards a bright future for the sector, underpinned by better earning and asset quality.

Furthermore, the road ahead for the insurance sector offers significantly more cause for optimism over the longer term as the new regulations may also ease price competition. Given that the UAE industry is currently comprised of a handful of very large players competing against many smaller and localised operations, it does seem that the new regulations could also trigger industry consolidation.

In conclusion, stronger regulations, such as increased capital adequacy requirements and more conservative investment guidelines, make a strong business case for regional insurers to increase exposure in debt capital markets. This trend, if sustained, will go a long way to encourage the continued blooming of the regional insurance business, particularly life, the potential of which is arguably unrivalled anywhere in the world given the still incredibly low penetration levels of life insurance in the region.

— Adil Abid is a Partner of Financial Services practice at KPMG Lower Gulf