Portfolio strategies: consolidation, conservatism and caution?

As the long, grey month of January shuffles to its conclusion, clarity gradually begins to emerge on prospects for the year. When it comes to insurer investment strategies, caution reigns, writes Contributing Editor David Worsfold.

This is hardly surprising given the level of geo-political and economic uncertainty and the volatility that comes in its wake. 2022 reminded everyone of the need to expect the unexpected, not least regulatory authorities and central banks. They have lost little time in reminding major financial institutions that resilience in the face of unexpected shocks is not just a boardroom talking point but an essential feature of sound operational management.

The recent “Dear CEO” letter sent out by the UK’s Prudential Regulation Authority in the wake to the recent stress tests on insurers pulled few punches in reinforcing this message:

“Insurers need to adapt to changes that threaten to disrupt business models, while maintaining high standards of governance, risk management, and resilience that result in their continued provision of vital insurance services to the real economy. Our main focus for 2023 will be on: financial resilience; risk management; implementing financial reforms; reinsurance risk; operational resilience; and ease of exit for insurers.”

It goes on to spell out some of the regulator’s specific concerns:

“For life insurers, growing concentrations, in particular to assets that are internally rated and valued, may result in a greater exposure to credit and concentration risk. We expect life insurers to stress test their capital planning against prolonged adverse credit scenarios robustly. 

“For general insurers, 2023 will likely see a continuation of pressures on claims inflation, as we mentioned in our October 2022 insights from our recent thematic review across the general insurance sector. Our review identified a number of observations relating to how claims inflation differs by line of business and geography. There is uncertainty in the severity and duration of claims inflation expected, and there may also be a lag before it materialises. Consequently, this gives rise to additional uncertainty around future claim settlement costs. Therefore, we expect general insurers to factor general and social inflation risk drivers into their underlying pricing, reserving, business planning, and capital modelling.”

What does this mean for investment strategies? It seems likely that consolidation and conservatism will be common responses.

It will dimmish the appetite for alternative assets that grew over the last decade as the search for yield dominated strategies, often with the added attraction of uncorrelated returns. The upward swing in interest rates has already cast a more favourable light across core fixed interest assets. No chief investment officer is going to be criticised by boards or regulators for redirecting funds in this direction, although shifting the emphasis away from diversification might not always be easy if some of the alternative assets are unperforming or less liquid than anticipated.

Those with long memories will see this is a return to normality and a less exciting, less adventurous world but one that most will probably welcome.

As the world strives to shake down inflation and ease back on interest rates – or at least hold back on increases – the question will be: how long will it last?


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