Insurance chief investment officers are becoming accustomed to an ever-changing picture, working with a different risk palette from quarter to quarter over the last couple of years. Back at the beginning of 2022, when economies were emerging from the pandemic fog, insurance business was growing in most areas, providing new cash flows, while losses and benefits were in line with prior years.
But then, in 2022, the Fed ended its zero interest rate policies to combat rising inflation. As inflationary pressures built, losses began to tick up in some underwriting classes, a trend that continued into 2023.
To meet bigger payments to policy holders, insurers had to use more new money to pay near-term claims rather than invest; capital decreased and higher interest rates pushed up their financing costs.
Meanwhile, on the investment side of the balance sheet, higher interest rates pushed more securities to a loss position. Concurrently, equity markets fell in value throughout 2023, driving more losses that insurers did not want to crystalize in their portfolios.
Fast forward to H1 2023 - how are insurers responding? Matt Reilly, a Managing Director and head of the Insurance Solutions group at Conning, the investment management firm that’s dedicated to the sector, says that converging trends have sharpened the industry’s focus on liquidity.
He says that set against a background of competitive short-term interest rates and challenging operating conditions, many insurers are holding more cash and short-term investments on their balance sheet. “We have seen more insurers looking to have wider funding access, which can take the form of a variety of programs including tapping the Federal Home Loan Bank (FHLB) system for short-term borrowing,” he adds.
Reinsurance costs rise
There’s another reason that the liquidity amber light is flashing on CIO dashboards. While many of the previously mentioned pressures have persisted, the reinsurance market has hardened significantly: “Many carriers are choosing to carry more risk on their balance sheet as a result. And for the risks they are reinsuring, they are paying significantly more than the year prior,” Reilly says.
The credit market disruptions, particularly with regard to regional banks, has many insurers looking inwardly at the risks they currently have and can project over the near term, foregoing long-term investments
Insurers have been able to capture some higher premium rates, but they are behind where inflationary pressures, both economic and social, would dictate they would ideally be.
“The credit market disruptions, particularly with regard to regional banks, has many insurers looking inwardly at the risks they currently have and can project over the near term, foregoing long-term investments,” Reilly adds.
The market turbulence hasn’t so much led insurers to abandon long-term business goals and objectives as put them on hold. But the double whammy of a hardened reinsurance market and trailing premium rates has created concerns over short-term funding, according to Reilly.
“As more carriers are retaining risk, they have to build more cash/conservatism into their investment strategy for their worst-case outcomes,” he explains. “Inflationary pressures continue to create future operational uncertainty, driving the desire to hold more cash.”
Private assets retain their allure
An investment trend that hasn’t been slowed by the weight of liquidity and operational pressures on insurers is the growing willingness to raise risk tolerance and entertain allocations to private assets. With lower interest rates persisting for an extended period, insurers are looking for ways to raise their portfolio returns and yields.
“One avenue is increased investment in less liquid and private assets,” Reilly says. “This could seem to run counter to the current environment and the operational and liquidity pressures on insurers, but over the long term, private assets serve a valuable purpose for many insurers’ general accounts.”
Reilly points to three main areas that have piqued insurers’ interest. Collateralized loan obligations (CLOs) have grown in size, attracting insurers, especially to the highest-rated part of the capital structure (AAA) and then down into other parts of the structure to boost expected yields and returns.
Real estate investments – both debt and equity, which have different associated expected risks and returns - can also provide diversification, access to different return streams and meaningful levels of yield for insurers’ balance sheets, Reilly adds.
Then there’s private credit, which can take on different forms. Private placement securities have long been a mainstay for large life insurance company portfolios, for example, and now their appeal is spreading.
“We have seen allocations marginally increase for non-life insurers as well as with smaller life insurers. Additionally, middle market loans are growing and many structures have presented insurance companies with access to the sector - and without punitive capital charges,” Reilly reckons.
ALM in the spotlight
For many insurers, their exposure to less liquid investments is manageable and tends to be well matched against less liquid liabilities, thus reducing the risk of a “run on the bank” type of scenario.
Liquidity risk management priorities
Conning’s Matt Reilly says that insurers can take steps now to get their short-term financing in order. These include reviewing new premium flows, cash and short-term securities on hand and upcoming maturities and interest payments. Insurers can also explore possible options for accessing near-term finance, such as the FHLB system, which has proved resilient to date.
From a macro perspective, insurers should design and implement an investment strategy that encompasses both their assets and liabilities. Planning for the prevailing environment makes sense, but insurers should also look at a range of scenarios in which interest rates remain high - and also where they fall.
Conning has a variety of tools to help insurers as they consider how their assets and liabilities will perform over a range of economic scenarios.
However, growing exposures to these areas and recent negative headlines highlighting banking sector disruptions will cause regulators to take a closer look, Reilly predicts: “Some areas are already under review, but these will have limited impact on most insurers in terms of their accounting and solvency metrics.”
For their part, insurers have developed a better understanding of the different liquidity management issues they face, Reilly says. They’ve been paying closer attention to asset and liability management (ALM) in light of the stresses some regional banks are experiencing.
Generally, insurers are unlikely to face a liquidity crunch of the same sort and magnitude as the banking industry because they don’t have the same amount of financial leverage on their balance sheet as many of their banking counterparts.
However, some of the issues besetting banks do exist for insurers as well, he stresses, and they should monitor the situation.
“Many investments are in a loss position and the actual economic surplus of these organizations might be less than is presented in financials due to book value accounting of many investments,” he says. “Conning works with insurers to develop investment strategies that incorporate both assets and liability needs. We also have a variety of ALM and stress modelling capabilities we utilize to help insurers better understand their ALM profile.”
