Global Insurance Midyear Check-In: A Conversation With Industry Leaders

Q: What key risks do you see for your investment strategy in the second half of 2023?

Nenna: We think there are five key threats.

First is the supply of investable opportunities, or the potential lack of supply.

Second, going along with the first, we believe demand is very high.

Third is liquidity. The volatile interest rate and inflation environment has created a need for collateral, or posting of collateral given that we hedge our exposure, and that extra liquidity buffer does impact our willingness to invest overseas.

Fourth is what we call a “timing mismatch” – when macro events don't tie up nicely with our investable and available cash.

And fifth, but perhaps most importantly, is climate risk. We all have net-zero targets, and as a group, Just Group is committed to net-zero by 2050 and to getting halfway there by 2030. So, we’ve already started to take financed emissions into account in our new investment decisions.

Q: The UK Chancellor of the Exchequer recently stated that the UK has no choice but to raise interest rates to curb inflation. How does that fit in to insurers’ day-to-day investment decision-making?

Ashish: Our view is that certain factors are making inflation more of a problem than people are thinking, and the Chancellor’s statement is a continuing acknowledgment that inflation is a problem.

2024 is an election year in the US, and likely also in the UK. And that often corresponds with fiscal loosening. With that, we see a risk of policy divergence: Are you tightening too much? Are you slacking up too early? Policy risk is quite pronounced regardless of where you come out in the debate about whether we should tighten or not.

Q: How do inflation conditions differ in continental Europe and Asia?

Vladimir: I think one big difference between the situation in the eurozone and what we're seeing in the UK is the level of inflation and the sources of inflation. UK CPIH is now about 8%, unchanged from last month. Compared to the eurozone HICP, at around 6%, that’s about a 2-percentage-point difference.

The European inflation outlook seems to be a bit more driven by geopolitics, and potentially with a more transient effect from energy prices and the extra food and energy price inflation created by Russia’s invasion of Ukraine. In the UK, the outlook becomes a bit more ambiguous, with inflation driven by the potentially more persistent rises in costs of housing.

Turning to Asia, it’s important to remember that this region has many different narratives and different driving forces. For instance, the Chinese economy is on one end of the spectrum, while Japan, Taiwan, South Korea, and other developed markets are on the other end. Our midyear fixed income outlook is called “Looking East” – the name is a bit of a giveaway. Our outlook on Asia is that economic growth will continue, probably at an accelerating pace, which is good news for investors in the region.

Q: How do you assess the macroeconomic environment, and specifically the US inflation outlook?

Matt: We see core CPI coming closer to 4% by year-end. In addition to that, wage inflation is coming under control, as the gap between open jobs and unemployed workers has shrunk down from about 6 million to 3 million. We expect that to cause service inflation to come down, which will in turn help CPI. In terms of interest rates, we expect at least one and maybe two rate hikes through the rest of the year.

Q: What are some of the key regulatory developments in the US?

Luke: US insurers are regulated at the state level, and state regulators are currently reviewing the risk-based capital charges and the statutory accounting framework that’s in place. I think that’s because they recognize there’s been a lot of growth in private or structured assets going onto insurance balance sheets, and the original framework didn't necessarily contemplate that or maybe fully recognize some other forms of risk that insurers are taking. The biggest topics associated with that would be around CLOs. Currently, regulators are trying to determine the appropriate capital charges for CLOs across the capital stack.

Q: How do insurers view the impact of regulatory changes affecting CLOs and other assets, and will they affect investment decisions going forward?

Matt: It’s definitely something we're paying close attention to, and we try to adopt those [changes] into how we’re allocating capital. We believe that when going into structures such as CLOs or other types of tranches and securities, they need to have legitimate structures, in the sense that they’re not doing things the regulators don't want [them] to do. We don't push the envelope in terms of going into more aggressive structures, and we make an effort to size things right.  Right now we are optimistic that cooler heads will prevail, and nothing dramatic will happen in the CLO space, which is a very large space. Some of the original proposals would have had some really dramatic impacts on a lot of insurance companies. Things do seem to be moving toward a better spot, and it’s not necessarily changing what we would incorporate.

Luke: S&P is another capital model that we find is very important to many insurers, and that capital model is changing too. So, there's no shortage of things to follow and stay on top of. I guess that’s the joy of insurance investing – It's fairly nuanced.

Q: What are some of the regulatory developments outside the US that are material for insurers?

Vladimir: One material global development is the implementation of the International Association of Insurance Supervisors’ Insurance Capital Standards (ICS) for internationally active insurance groups (IAIGs), which will become the prescribed capital regime for globally active groups in 2025. It is important not only for the roughly 50 designated internationally active insurance groups, but also because it is the foundation for the risk-based capital regimes being implemented across several large Asia-Pacific markets. It has been implemented in South Korea in 2023, and it is planned to be implemented in Japan in 2025, and in Taiwan in 2026. Taken together, these three markets account for about five and a half trillion euros in general account investments. So, in terms of the scale of the assets being affected, it’s not too different from when Solvency II was implemented in Europe and the UK.

Insurance companies in these countries and the internationally active insurance groups under the ICS will start to operate under a regime that’s much more like Solvency II. This means significant capital charges for interest rate and currency mismatch and significant appetite for long-dated private-market assets, such as high-quality illiquid credit.

Q: How do insurers view the post-Brexit Solvency II reform underway in the UK?

Ashish: We greatly welcome the government’s intention and objective and what it’s trying to do when working closely, constructively, and collaboratively with the regulator. But in insurance regulation, while the intent is really important, the precise wording is also very, very important – and we haven't seen that yet. Until we see it, we are somewhat reserving judgment.

Nenna: We are also keenly awaiting the details, and the details are key.

Q: What is your view regarding the acquisition of insurance companies by private equity funds and asset managers?

Luke: We've been seeing a growing presence from alternative asset managers pushing into the insurance space in a variety of ways. Whether it’s acquisitions of insurance businesses through M&As or of blocks of liabilities through reinsurance, or joint ventures, there are a lot of different ways of doing it.

Yet I think it’s a marriage that makes sense. We tend to see it in the life and annuity space. So typically, it’s longer-duration liabilities. And a lot of these alternative asset managers do have the ability to originate private assets to match those liabilities that fit well within those insurance portfolios. And I think a lot of those liabilities are well suited to take the liquidity risk. As most people know, it’s much easier to predict those liabilities.

Q: What new areas of nontraditional asset classes are insurers investing in?

Luke: We've seen a lot of growth in what I'll call private debt, or private fixed income, and a variety of flavors within that. And a continued evolution of private debt and the insurance participation in that market, not only in terms of magnitude of investment. That's also just an area where we continue to see good innovation and ways to deliver those types of assets onto an insurance balance sheet that fit nicely.

Q: There’s a narrative saying that perhaps private markets are yesterday’s story. Do you agree, or do these assets still hold value today?

Nenna: There is no doubt that in certain asset classes, the illiquidity premium has become more compressed. And it absolutely has made us think twice when we’re committing to some illiquid transactions. And the relative value over liquid assets sometimes isn’t there. But there are many reasons why we do invest in private assets or illiquid assets, and one of them is pricing. Typically there is an excellent illiquidity premium, but the other side of that is credit protection.

Matt: Certain liquid products looked very attractive last year … but a lot has normalized. You’re kind of getting back to that typical illiquidity premium, but you’re also kind of getting some of that complexity premium. If it’s a newer product, maybe there are some worries around how some regulators have been treating structures; if there are new entrants looking for anchors or trying to launch a new product, if you’re willing to do the research and analyze the structure, sometimes you can get a little bit of complexity premium from it as well.

Q: What new sectors and assets are insurers looking to invest in over the coming year?

Vladimir: I would think given where we are in the credit cycle it’s difficult to identify broad sectors or regions that would look attractive. It’s more about being active and seeking niche opportunities within sectors. For instance, we see opportunities in lower-middle-market lending, where banks’ retrenching means that private credit managers have more bargaining power to secure better covenants and structure deals with portfolio resilience in mind. I think there are still opportunities in the real estate space.

Luke: I think very much underappreciated sometimes is the risk side of private markets. We talked a lot about the illiquidity premium and how much more you may get paid or compensated to take the illiquidity risks. But I think more and more insurers are now appreciating the risk side of it and your ability to shape the risks, and also shape the assets to fit your liabilities or balance sheet needs. So the customization element for private markets and the control element are very, very important.

Ashish: Maybe one small thing to add is when you’re thinking about illiquidity premiums compressing, and I agree, completely with what Nenna said. Now say you’re comparing private assets to, obviously, public bonds. You have to ask yourself, is it justified to call public bonds liquid? Are you really giving up liquidity versus some of the benefits that panelists have mentioned?

Q: What is your view of EM fixed income from an investment perspective?

Vladimir: If you look at European insurers bond portfolios, quite often, they will have a very high overweight to domestic markets. For instance, German insurers hold more German corporate debt that debt from all non-EEA countries combined. If you compare this allocation with the market cap of European, US, and Asian corporate credit, that’s a very significant overweight, and potentially concentrated risk in their portfolios.

I think there is a strong case to diversify these portfolios to make sure you are exposed to the full set of opportunities, and not just driven by proximity and convenience. From macroeconomic perspective, Asian economies for instance are in good health and are expected to deliver strong growth. Adding high-quality Asian names could also improve industry sector diversification. What we also find is that relaxing some of the credit quality constraints and allowing allocation to high yield debt within a given risk-based capital budget could really improve capital efficiency and help active portfolio managers chase a broader set of opportunities.

Q: Are there specific geographies you’re looking at now that are more interesting than others? And are there regions you were invested in before that you are now pausing or stepping back from?

Nenna: We see opportunity in the US. In the more liquid or public markets on a cross-currency-adjusted basis, US dollar credits definitely become more attractive. But then also, in the private markets we find that the regulatory backdrop is more favorable for some infrastructure projects. For example, with the US Inflation Reduction Act, I think we’re just seeing more interesting opportunities coming out of the US at the moment.

For a more in-depth explanation of these views, listen to a replay of our live webinar, Midyear Outlook: Navigating Headwinds, Assessing Opportunities for Insurers' Investment.