2024: A step nearer normality?

Just what should we expect of 2024? After the relative calm of the last 12 months will this year deliver more of the same or will there be new hazards to negotiate? Our team of experts looks at what 2024 might hold.

This week they take a look at some of the “big picture” issues that will create the context for portfolio management this year. It could be a year when the financial world takes another cautious step towards normality with interest rates following inflation down to at least something nearer pre-financial crisis and pandemic levels. That path is by no means certain as there are some major disruptive issues ominously bubbling away in the background.

Next week they will look at some of the implications for specific asset classes and investment strategies.

Our Pundits

Pramila Agrawal (PA) director of Custom Income Strategies, Loomis, Sayles & Company

Simon Richards (SR) Head of Insurance Solutions at Insight Investment

Andrew Torrance (AT) Chair, Insurance Non-Executive Directors Forum and Tokio Marine Kiln Syndicates. Former chief executive of Allianz Insurance plc

Erik Vynckier (EV) Board Member, Foresters Friendly Society & Chair of the Institute and Faculty of Actuaries (Research & Thought Leadership Board)

David Worsfold (DW) freelance financial journalist and contributing editor to Insurance Investment Exchange

  • Geo-political volatility continued to disrupt financial markets in 2023 with the added challenge of sustained higher inflation and interest rates. Looking forward to 2024 how should insurers position their investment portfolios in the face of these pressures?

PA: Higher interest rates are going to be here for a while. That is a huge advantage for insurance companies in terms of capturing higher carry in the fixed income markets – the question is how to take advantage of that higher carry. Following a long pause in asset allocation changes, we are now seeing clients looking at long-term capital market expectations and starting to make some changes. While all-in yields are higher, valuations are getting very compressed so insurers will want to consider that carefully and position their portfolios higher on the quality spectrum to lower their risk posture. We expect geopolitical risks to remain at high levels and at high level of global impact.

We would recommend insurers assess current exposures to understand how geopolitical tail events (Russia-Ukraine, Middle East war and China-Taiwan-US tensions) might impact their portfolios. We would actively diversify portfolios to reduce potential impacts from these outcomes by adding to other geographical areas.

SR: With ongoing wars in Europe and the Middle East, and the risks in the Asia-Pacific region, geopolitical volatility is something that all investors ought to take into account - portfolios should be positioned to avoid obvious trouble spots and authoritarian regimes. We look to take advantage of downside option protection when volatility is under-priced, as is currently the case.

For active managers market volatility is helpful as it tends to lead to market dislocations and wider dispersion across the corporate issuers. Historically, geo-political risks have led to a flight to quality reaction from markets meaning that government bond yields in the largest developed markets have tended to decline, as investors seek safety. We believe that interest rate risk is attractive currently with Central Banks indicating that they have finished their hiking cycles and would contemplate bringing rates down to a more “normal” level once they are certain inflationary pressures have subsided. Obviously, this needs to be aligned against an insurer’s liability profile.

AT: Continued uncertainty and volatility will likely mean insurers position their portfolios conservatively for 2024. The large number of elections due to be held during the year [or for the UK by Jan 2025 ] is a factor to consider here.

EV: The burst of inflation has been attributed to the need to redesign supply chains in proximity and in securely and strategically sound relations and geographies as well as the own goal of “transitory” disruption to supply chains over the lockdown. However, this is a very incomplete and short-sighted evaluation. Inflation is hard to beat as it is promoted by the political environment: negative productivity shocks often originate from political choices and lobby impact (particularly ESG considerations), and are not just embedded in the usual demand side macro-economics, fiscal and monetary factors. 

DW: Forward thinking is going to be key in insulating portfolios against the potential downsides of geo-political upheavals. There is a need for a new mindset which assumes such uncertainty is now the norm and not the exception. By far the most serious threat of potential impact on insurer portfolios is an escalation in tensions between China and Taiwan. Much will depend on the approach the new President of Taiwan takes to relations with China but if tensions escalate, Western sanctions could follow. Prudent managers will already be looking at the potential implications.

  • What are your predictions for interest rates in 2024? Will the main markets – Sterling, Dollar, Euro – move in alignment or diverge? 

PA: We expect six cuts from the Fed, beginning in May or possibly a little later since there really has not been a signal showing a significant slowdown. Inflation has started coming down, and the Fed has gone to great lengths to disabuse the market of the notion that they will cut early. We do expect to see some divergence among central banks. The US Dollar has had a phenomenal run, and there is some support for it given the resilience of the US economy. However the expectation is that when the Fed starts cutting on back of weaker growth, there will be some weakening in the Dollar. We anticipate a similar scenario with the Euro, although the cutting cycle may begin later than the US with a less sanguine economic outlook for Europe. There is a bit of divergence on the Sterling. The economic outlook on UK is a little dismal, but the Bank of England is likely going to keep rates high. They may even have to hike as they have the highest inflation in the Euro zone. Geopolitical risk could make threading the needle on the last mile of inflation challenging, especially in Europe given the greater oil dependency. Given this divergence and uncertainty, insurers should maintain tight ALM in interest rate and currency exposures. 

SR: With growth decelerating and inflationary pressures coming under control we would expect Central Banks to seek to normalise interest rates in mid-2024. We are forecasting the Bank of England to cut Base Rates from the current level of 5.25% to 4.5% by the end of this year, a lower level of cuts than predicted by the broader market, with the first cut from the BoE expected to come in August.

The Federal Reserve is also expected to reduce interest rates cutting from 5.50% to 4.75% with the first cut in June. In Europe the ECB is expected to bring rates down to 3.25% from the current level of 4%. Given the very weak economic data coming out of Germany and France, it is possible the ECB cut first.

AT: I expect the Bank of England to keep rates higher for longer than either the Fed or ECB. Globally, markets are already discounting a series of rate reductions during the year. I suspect the markets have got ahead of themselves and that whilst rates will come down during the year, they will not fall as fast as markets currently predict. I also expect plenty of volatility along the way.  

  • Regulatory reform in the UK has been framed as stimulating competition and freeing up long-term investment in infrastructure. How will this play out in insurer portfolios? Will they be using their money to meet the government’s expectations?

SR: The key regulatory changes mainly impact a subset of insurers: those with Matching Adjustment (MA) portfolios. For these firms, the changes will provide some additional flexibility at the margin and could provide access to certain types of investment opportunity that was previously off-limits or at least unattractive.

While insurers will typically be keen to expand their universe to seek extra returns and greater diversification, this will only be the case if a compelling investment case can be made. 

In Europe, consideration is being given to penalising particular types of investment eg relating to fossil fuels, requiring higher capital to be held against these types of exposures, to reflect potential links between transition risks and market risks.

DW: Regulatory reform in itself is unlikely to achieve the aim of unleashing a wave of investment in infrastructure projects. It will also require confidence in government policies around major projects which has taken a severe knock with the cancellation of large parts of HS2. Then there is the matter of quality of assets and their ability to deliver the secure long-term returns insurers will need.

The other regulatory issue that springs from the current UK government’s approach is divergence from other international regulatory regimes, especially the European Union. This could become a challenge for multi-national insurers needing to ensure compliance across multiple jurisdictions and may influence boards in setting strategic priorities for their portfolio management.

  • Artificial intelligence has arrived. Will it be your friend or foe? How/If will you be harnessing it in 2024?

SR: Ultimately a friend – but in short-term, impact more modest – focused on improving efficiency.

AT: AI brings opportunities and threats. Also, I think you need to distinguish between machine learning type AI which has been utilised widely in the personal lines claims and pricing spaces for quite a while and the generative AI which burst on the scene during 2023. For generative AI, I see great potential in improving productivity by allowing data to be ingested more rapidly into organisations. Also, I see the ability to improve pricing decisions which ultimately could have a big bottom line impact. The biggest issue for me, particularly in the personal lines space, is how to avoid introducing unacceptable biases when training the AI tool. So far, I have not heard a really convincing explanation of how this can be accomplished. I expect regulators to have a high interest in this.

DW: Clearly, AI is going to be a powerful tool with huge potential to take data analysis to another level, especially when bringing together datasets from multiple sources. It will also inject a new level of automated decision-making power into many complex processes. The challenge here will be maintaining the “human in the loop” because all the indications are that is what regulators will expect to see. The fear that bias could be easily imported into AI decision-making and the potential lack of transparency are things that insurers will have to maintain vigilance to avoid.

Complied by Contributing Editor David Worsfold


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