The impact of the pandemic may now be in the rearview mirror, but other significant concerns have lingered in the insurance-investment world.
In 2023, Goldman Sachs Asset Management published its 12th annual insurance survey of more than 300 chief financial officers and chief investment officers. It revealed that 82% of respondents expect a US recession within the next three years.
While recessionary fears may have since receded to some extent, other thorny issues have hung around. Last summer, when assessing investment options for insurers, JP Morgan Asset Management commented that it had been “a tough environment for insurers to manage portfolios”. This was attributed to inflation and interest rates, as well as recession risk.
There are also the unknowns to look out for.
In Royal London Asset Management’s insurance investment outlook for 2024, Piers Hillier, chief investment officer, said: “Every year, something will pop up that catches people unawares or causes a change in market behaviours or thinking.”
Also, in its insurance outlook for this year, Wellington Management said that “insurers managing investments will need to be nimble, dynamic and forward looking”.
Pain points
In the meantime, investors are still grappling with what’s already in plain sight.
According to Goldman Sachs’ survey, inflation was viewed as the greatest macro-economic risk to investment portfolios with 81% of respondents anticipating that it would remain for the medium or long term.
And it is still one of the main topics for 2024, says David Thomas, head of insurance for the UK & Ireland at Schroders. “Uncertainty driven by the geopolitical and macro-economic conditions is giving insurers plenty to think about across their investment portfolios.
“Liquidity remains a key issue as they face higher redemption rates and lapse risk, driven by the cost-of-living crisis, coupled with managing unrealised losses from increasing interest rates: having sufficient levels of liquidity is still key to facing market shocks.
“Inflation poses challenges in properly reserving for those risks and in achieving real returns of assets over inflation,” Thomas adds. “Countless hours are being spent, across the industry, discussing the persistence of inflation and its impact on rates and duration views.”
Christian Thompson, a director in M&G’s insurance solutions team, also reflects on the issue of inflation. “Markets are sensitive to inflation data as they look to predict the size and timing of any 2024 rate cuts. While inflation is generally slowing across developed markets, employment figures remain relatively strong and central banks seem to be resistant to rate cuts until they are confident inflation is fully under control.”
“Therefore, we don’t see any immediate rate cuts; however, insurers may be looking to take advantage of current yields given the expectation that they will fall over the year,” he adds.
Sam Berman, director of UK insurance (asset management) for Allianz Global Investors, adds: “One of the most significant challenges for asset managers is seeking higher yields in a higher-rate environment. This often introduces complexities and hurdles around structuring. However, the asset management and insurance industries are well-equipped to address these challenges.”
Geopolitical concerns around forthcoming voter decisions as well as ongoing conflict may add to macroeconomic uncertainty. “This year has been dubbed the ‘election year’ with more than 75% of democracies in the world going to the polls,” Thomas says. “Although we can confidently predict the outcome of some presidential elections, the election in the US could go either way.”
“The ongoing and escalating conflicts in the Middle East are alarming and alongside rising US-China tensions, the impact on markets could be abrupt, with supply chains put at risk, driving further inflationary pressures,” he adds.
Considering other potential pain points this year, Thomas concludes: “Our investment teams spend a considerable amount of time looking at the probabilities of certain downside scenarios when constructing portfolios – be that sustained inflation driving higher rates for longer or a deteriorating economy causing an increase in defaults and credit risks.
“There is, of course, the unpredictable idiosyncratic risk that can surprise us all, but having robust processes in place to understand the impact to portfolios caused by known and unknown market stresses is critical.”
A step in the right direction
Reforms to Solvency II, the regulation which sets out insurer responsibilities in areas such as governance, financial resources and reporting, is also high on the agenda this year.
Charles Moussier, head of EMEA insurance client solutions at Invesco, says: “After last year was characterised by the debate over the extent of the reforms, UK Solvency II remains the key area to watch in 2024. The reform package encompasses legislation to reduce the risk margin, following the publication of draft regulations last June that proposed cutting it by roughly 65% or 30%, for long-term life and non-life insurance, respectively. Solvency II is also set to bring final rules on the matching adjustment (MA), as well as an attestation process for the amount of MA benefit being claimed.
“The Prudential Regulation Authority expects to publish final rules on the MA in Q2, coming into force at the end of June,” Moussier adds. “Public finances remain constrained, and the incoming government is likely to look to the private sector as a source of significant new investment capital. It is hoped that Solvency II will contribute to this by freeing up billions of pounds of capital for investment, meaning that the insurance industry will be under pressure to demonstrate that it is working as intended.”
Thomas says that insurers and insurance asset managers are working through how the reforms to Solvency II will affect asset and liability management, adding that the “devil is very much in the detail”.
“The regulation allows for additional asset classes available for investing which we see as a step in the right direction.”
Private interests
Considering how asset allocation might look this year, Thomas says: “As long-term allocators of capital we wouldn’t expect wholesale changes to insurers’ strategic asset allocation.
“We expect, and are seeing, insurers look at tactical and relative-value opportunities across asset classes such as agency mortgage-backed securities, for instance, which offer limited exposure to interest-rate changes and credit-spread moves.”
Allocation to private assets also featured in Goldman Sachs’ survey, which reported: “Despite growing worries about a US recession and rising geopolitical tensions, investor risk appetite remains healthy, with continued interest in the private-asset landscape.”
Thomas agrees that illiquids could stand out. “Private assets saw a slowing down of deployment during the recent rate hikes as insurers reassessed their incremental value,” he says. “But as increased rates become the norm, we expect investors to look again at the outsized returns on offer through private assets.”
Nick Humphreys, managing director of global insurance at Man Group, also anticipates an interest in private markets, but only after they build a liquidity buffer.
“In the current macroeconomic and geopolitical environment, we expect insurers to take advantage of elevated rates and focus on high-quality, liquid fixed income, holding more of a liquidity buffer than before − particularly as the cost of holding liquidity is currently at a post-global financial crisis low. Beyond that, we expect to see insurers continue deploying selectively into private markets with a particular focus on private-credit strategies,” he adds.
Uncertainty driven by the geopolitical and macro- economic conditions is giving insurers plenty to think about across their investment portfolios.
David Thomas, Schroders
Opportunities
Looking at where opportunities may emerge this year, Chris Howells, head of international insurance solutions at Macquarie Asset Management, says: “Private markets remain a major area of interest for insurers as they look to access illiquidity and complexity premia whilst benefitting from increased diversification. There is also a greater opportunity to invest in energy transition-related projects as more of these come to market and are made accessible in co-investment or fund structures.”
Thomas adds that the key objective for insurers is managing their core fixed-income assets prudently and choosing the right credits to avoid unrealised losses.
“The good news is that those assets are offering much higher yields than they have done over recent times,” he says. “It remains a critical role of insurance asset managers to ensure a balanced portfolio that offers yield enhancing, capital-efficient opportunities, while managing downside risks effectively.”
Paolo Gazzola, head of insurance advisory for EMEA at DWS, says: “Within fixed income, covered bonds are currently an attractively priced area of the market. Investment-grade corporates also have re-established their role as income enhancers, with 70% of the issues providing coupons above 3%, although we believe credit selection in 2024 will be key, in order to extract the most return per unit of economic and regulatory risk.”
Eric Larsson, managing director and co-head of Alcentra’s special situations team, says: “We will see economic fallout from the dramatic increase in global interest rates, regardless of whether we’re technically in a recession or not and that will lead to an increase in the supply of opportunities in our market. The opportunity that presents for insurance investors is already here – they can invest in a portfolio of around 30 senior secured loans and high-yield bonds, with an all-in return of around 25% and a running yield of 8% to 9%. We have not seen that in the last 10 years.”
Berman has observed rising interest in another potential opportunity. “We are witnessing increased interest in trade finance on the back of a move away from pure cash. It’s an interesting asset class that comes in a multitude of forms, including risk profile, underlying exposure, duration and so forth,” he adds.
“The insurers we speak with are interested in accessing ultra-short-duration trade-finance receivables to give cash-plus returns, providing rate protection and yield pick-up.”
ESG and impact investing are also still very much on the radar.
Goldman Sachs’ survey found that almost all (90%) of respondents were considering these factors in their investment decisions.
“Impact investing, investing predominantly in private assets, that offers strong investment returns and provides an environmental or societal benefit, is another area that is getting more focus from investors and is one we believe will continue to offer investment opportunity and gather momentum,” Thomas says.
Bringing in the professionals
Some insurers prefer to outsource investment to third-party asset managers. And when they do, they have a specific criteria in mind. According to Goldman Sachs’ survey, their top consideration is differentiated methodologies and capabilities, with performance a close second.
Thomas says: “We are seeing an increased number of insurers consolidate their assets to a specialist insurance asset manager, who are able to understand the investment challenges and look across the whole balance sheet to offer more efficient investment solutions.”
The question of resourcing could be a factor in their decisions too. Ghislain Perisse, global head of insurance solutions at Fidelity International, says: “Our 44 credit-research analysts follow a maximum of 20 to 30 corporates each, whereas in some insurers there might be two bond managers assigned to follow 250 corporates. As another example, on the private debt side, to undertake direct lending, you also need 20 to 30 analysts.
“In both cases, this could be very expensive for an insurer, so it might be worth partnering with an asset manager,” he adds.
Whether an insurer appoints an asset manager or decides to manage their portfolios in-house, they need to be equipped to face growing economic and geopolitical uncertainty.
This is set to be an “interesting” time for insurance investors.
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