Why and how insurers could embrace a solutions-oriented mindset in 2023

In the past decade, most assets delivered strong returns, largely on the back of easy monetary policy, which encouraged above-trend economic growth and prompted risk asset prices to respond positively. But the past year has seen several global economic shocks, as Russia’s invasion of Ukraine sent inflation spiraling and caused energy prices to spike.

In 2023, insurance investors should plan for much more economic and market uncertainty as deglobalization trends gather pace and central banks try to lower inflation while also trying to avoid pushing their countries into recession.

It can be difficult for many insurance companies to capture the fabled alpha – where an investor gets higher returns than a benchmark or target – amid short-lived market dislocations, because of their relatively lengthy governance procedures. Often, by the time an insurer vets an investment idea, has it signed off and finally acts on it, the opportunity has already gone.

In March 2020, Covid fears pushed high yield credit spreads to historically wide levels, but once the US Federal Reserve announced that it would help backstop the US economy, high-yield spreads snapped back at a rapid clip. Given the current macroeconomic backdrop, with less market consensus around outcomes, it will become much more important for insurers’ investment managers to be able to adjust their exposures quickly.

The good news is that while insurers should brace themselves for higher volatility and unpredictability, we believe today’s market landscape is ripe for active management in 2023. This is not to say that every major sell-off will offer an attractive opportunity; that assessment still must be made on a case-by-case basis, using good, old-fashioned fundamental research.

But insurers should consider taking three steps now to make sure they’re well equipped to identify and utilize attractive investment opportunities in 2023 and beyond.

1. Expand your investment horizons

2. Maximize your purchasing power

3. Implement effective investment solutions

We’re conducting more strategic asset allocation analyses on behalf of insurance clients than ever before, to leave no stone unturned in our search for higher returns. All appropriate asset classes are included in the discussion, including those that may not have been considered before, such as a structural allocation to alternative or private asset classes (such as credit or equity) and other varieties of securitized assets (including collateralized loan obligations and other more esoteric asset-backed securities. Reach for your existing investment policy statement (IPS) and challenge the legacy strategic asset allocation (SAA) guidelines to ensure it remains fit for purpose.

Interest rates are rising again, at long last. This should be welcome news to insurers that have struggled to prevent their book-yield from eroding during the past decade or more, when rates were at rock bottom. But higher yields are only helpful if you can capitalize on them! So, with further interest-rate volatility likely in 2023, fine-tuning your cash-flow sources and uses is critical.

Here are a few ideas for insurers to consider.

• Be more strategic in your approach to reinvestment plans for coupons, principal, dividends, and maturities

• Optimize operating cash balances

• Explore off-balance sheet funding sources

• Look for relative value trades within the current portfolio to reinvest in elevated market yields

Insurers have recently demonstrated a growing appetite for bespoke multi-strategy or multi-asset investment solutions. There are several reasons for this: there are now more asset classes to invest in, investment markets are more complex than they were, and insurers are showing a greater desire to be more tactical in their investment decisions, while dealing with more constraints from rating agencies in their regulation and accounting practices. In our view, the hallmarks of an effective insurance investment solution include:

• Designing it to achieve specific risk and return objectives, for example focusing on total return or generating income.

• Helping streamline the implementation of new investment ideas. By investing in a solution with a broad opportunity set, a portfolio manager can implement a new idea presented by the markets without a long-drawn-out governance process

• Considering other insurance-specific considerations, such as capital consumption (both rating agency and regulatory models), ESG goals, or profit-and-loss account volatility and drawdown limitations.

We believe insurers need to find more creative investment solutions in 2023 to boost their investment returns. We explore the options in more detail in our 2023 Insurance Outlook, which, along with embracing a solutions-oriented mindset, offers three other themes that we believe will be key for the insurance industry to successfully navigate next year’s turbulent investment markets.

1. Approach illiquid allocations through a more nuanced lens, by developing a better understanding of the relative value between public and private credit.

2. Consider a portfolio “pivot” from growth to value equity – how a return to value and dividend equities could provide a compelling return opportunity.

3. Pursue ESG integration 2.0, by combining forward-looking metrics with statistics that provide a snapshot in time.