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Navigating Change: European Insurance 2024 Midyear Outlook

23 July 2024

8 min read

Geoff Cornell, CFA| Chief Investment Officer—Insurance

Richard Roberts, ACCA, CFA| Head—EMEA and Asia Insurance Business Development

At the halfway point, insurers can bolster allocations, diversify and exploit market themes.

Over the past couple of years, insurance investors have faced an environment of high inflation with elevated and volatile interest rates. At the start of 2024, we explored the potential impacts on investment strategy and balance sheets. Now, at midyear, we assess how insurers have fared, the current landscape and key allocation decisions.

Strong Solvency Position

While asset-liability-management (ALM) positioning and liquidity levels may create headaches at times, insurers seem to have adapted effectively to the challenge, in our view, positioning themselves well for the expected moderate-growth environment and gradual policy rate cuts.

Increased policy lapses had been a concern, as policyholders shifted to products available at more attractive rates. This issue has shown up to some extent in Italy, but the trend was much more muted in other countries. Collateral calls on interest-rate and currency-hedging positions also have the potential to create a liquidity need, though this seems to have been handled well up to this point.

From an ALM perspective, the excess of assets over liabilities is near its highest level reported since the advent of Solvency II (Display 1). The reason: insurers entered the rising-rate period with a short-asset-duration position on the life side (much closer to neutral within the property and casualty segment). So both assets and liabilities declined in value, but liabilities fell more.

The strong solvency position doesn’t necessarily translate into a bigger investment-risk budget. But it does mean that current solvency budgets aren’t likely to face pressure in the near future, so we don’t see investment-risk appetite declining. Generally, the insurers we speak with still consider return on solvency capital (or solvency efficiency) as a key metric when assessing allocation changes.

Excess of Assets over Liabilities Near Highest in Solvency II Era

Insurance Balance-Sheet Strength

A historical assessment of insurance companies’ balance sheet strength metrics

Past performance does not guarantee future results.
Through December 31, 2023
Source: European Insurance and Occupational Pensions Authority and AllianceBernstein (AB)

Expect Central Bank Divergence and Volatility

Inflation generally declined closer to central bank targets across most regions over the first six months of the year, and moderate economic growth is expected across developed markets. In response, several central banks have started to cut policy rates, including the Swiss National Bank and the European Central Bank. The Bank of England has signaled its intent to follow suit in the near future, and we now expect the Federal Reserve to make its first move in September rather than December.

On the geopolitical front, 2024’s election calendar is one of the more active in recent memory, with no shortage of meaningful contests on tap. The UK and France are recent examples of nations that have seen power shifts at the ballot box, and the US is in the run-up to its own high-profile election campaign. Geopolitical issues still loom as potential tail risks for insurance investors—most notably conflicts in the Middle East and Ukraine.

Taking these elements together, we expect the next few months to see further volatility as markets grapple with potential divergence in central bank actions and the changeable geopolitical environment. However, insurance investors must weigh these potential twists and turns against a backdrop of moderate global economic growth and yields that remain quite attractive globally.

Corporate fundamentals are still solid, though we expect them to weaken marginally as the impact of higher financing costs plays out. Refinancing challenges will be somewhat eased by the prospect of rate cuts. Credit spreads range from near average to marginally tight in European investment grade, so it’s important for investors to pick their spots thoughtfully—and to actively avoid weaker credits.

Regulators Continue Fine-Tuning the Rule Book

Adjustments to Solvency II in the European Union are in progress, including an effort to make the long-term-equities category more accessible. Solvency UK efforts are introducing changes focused on bulk-purchase annuity players, with incremental changes to rules on the matching adjustment. Both initiatives intend to reduce the cost of capital for the risk margin, which should boost solvency positions.

By this point, insurers have largely adapted to the accounting standards of International Financial Reporting Standard (IFRS) 17 and IFRS 9. From here, we think the effects on insurers will largely be more business as usual—though we saw some allocation changes stemming from IFRS 9, particularly in reducing equity exposure to help manage profit-and-loss volatility.

In our view, these regulatory changes will alter insurers’ investment strategies, but largely at the margins. Regulatory changes in the banking sphere, interestingly enough, may have a bigger impact on insurers. That’s because as banks retreat from consumer lending, it presents an opportunity for insurance investors to channel capital to the alternative lending strategies helping fill the void.

Keep ALM in Line, Make Credit More Solvency Efficient

The evolving interest-rate environment and current outlook, as we see it, reinforce the importance of testing balance sheets to gain comfort with their resilience under a variety of scenarios.

From a rate perspective, we think it remains wise to keep asset duration well-matched to liabilities. From a credit perspective, focusing on quality, active issuer selection and diversification seems sensible, given where we are in the cycle. This approach points to a number of allocation options for insurers to consider when addressing different objectives and market opportunities.

With public credit, increasing quality and focusing on shorter duration could help improve portfolio solvency efficiency—measured as portfolio yield and/or spread over the solvency capital requirement for spread risk. Put another way, this shift could reduce the solvency consumption of the public credit portfolio without sacrificing much return, freeing up solvency budget to allocate elsewhere. This is possible because the solvency-capital curve is steeper than the spread curve for BBB and A assets right now. Shorter-duration credit is also more solvency efficient than longer-duration credit.

An example helps illustrate the implications of shifting from a broad-market corporate-investment-grade allocation to one focused on shorter duration and higher quality. We can start with a base portfolio allocation (Display 2) that includes a market-weight allocation to corporate credit, some sovereign bonds and private assets. It’s then possible to assess the changes under three scenarios to portfolio duration, yield and spread as well as the solvency capital ratio (SCR) for spread risk under the Solvency II standard formula.

Base Portfolio: Composition and Metrics

A base investment-grade insurance portfolio with bonds, private credit and real estate debt

Current analysis does not guarantee future results.
*Solvency capital requirement; represents yield/spread SCR as a percentage and spread/spread SCR as a ratio
As of June 30, 2024
Source: Bloomberg and AB

The first scenario adjusts the base portfolio composition; subsequent scenarios represent incremental changes to the previous scenario.

Reducing long-duration credit and increasing sovereign duration (to keep portfolio duration constant)
Replacing BBB-rated credit with A-rated credit
Reducing an element of public credit in favor of private assets

The allocation changes in these scenarios are intentionally large. The magnitude enables us to demonstrate that, directionally, allocating investment-grade credit exposure to the higher-quality and shorter-duration market segments would use solvency capital more efficiently in terms of yield/SCR and spread/SCR. These shifts (Display 3) don’t sacrifice yield.

In scenario one, yield is marginally higher than in the base allocation (4.0% versus 3.9%), with a lower spread SCR (7.3% versus 8.7%) from reducing the credit portfolio’s duration. Scenario two shows the spread SCR further reduced (to 5.5%) by increasing the quality of the credit portfolio. And in scenario three, yield rises (from 3.9% to 4.2%) with an increased allocation to private assets, with a spread SCR that’s still below that of the base allocation (6.2% versus 8.7%).

Scenario Portfolios: Composition and Metrics

Scenarios that incrementally adjust the base allocation to improve solvency efficiency

Augmenting Fundamental Active Credit Exposure

In addition to refining the solvency efficiency of actively managed public credit, we think it makes sense to explore augmenting that allocation with systematic public fixed-income and private credit.

Actively managed systematic strategies rely on a range of predictive factors, such as momentum, that traditional active investing approaches may not capture efficiently. Systematic returns are driven by different forces, so historically they have had a low correlation to traditional active strategies. In our view, this may enable insurers to add another dimension of diversification to active returns in an asset class that’s well aligned with their balance-sheet needs.

On the private-credit front, many insurance investors had already allocated to this segment in order to harvest an illiquidity premium. As the available universe has expanded, private credit has been recognized for its other potential benefits, including accessing non-public opportunities, diversifying risk drivers and pursuing sustainability goals.

Specialty finance is among the intriguing private credit segments. As banks pare back consumer lending in areas such as mortgages, auto loans, credit cards and small business loans, private lenders have stepped in—presenting insurance investors with an opportunity to access exposure. Except for mortgages in some countries, European insurers have historically had limited exposure to these segments. The assets have typically been accessible through public asset-backed securities (ABS) markets, but are treated particularly punitively under Solvency II rules. Accessing the underlying risk exposures through private markets offers potential diversification from the corporate risk that seems to dominate insurers’ balance sheets, at a significantly reduced capital requirement versus public ABS.

A growth segment in private credit is net asset value (NAV) lending to private equity funds, secured by the NAV of portfolio companies. Return potential seems attractive, and leverage is typically very low: loan-to-value (LTV) ratios generally range from 5% to 25%. Loans can be rated by an external agency, further reducing the capital requirement versus unrated debt (with expected BBB or A ratings).

Commercial real estate debt is a common play for insurance investors—many of them have exposure already. The market has suffered property-valuation declines over the last year or so, but we think much of the pain has been absorbed. A selective, underwriting-focused approach, in our view, can uncover attractive opportunities at LTV ratios that may provide a cushion against any further market declines.

To sum things up, as we sit midway through 2024, insurers seem to have weathered a period of change effectively. The macro landscape still warrants caution, but we do expect moderate economic growth and gradual rate cuts. Insurers have opportunities to further bolster their asset allocations, diversify risk exposures and capitalize on current market themes.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Geoff Cornell, CFA

Geoff Cornell is a Senior Vice President, Chief Investment Officer (CIO) of Insurance and a member of AB’s Operating Committee. He oversees AB’s Insurance Investment Management team, as well as insurance sales, solutions, relationship management and client-service efforts, and shares accountability for insurance marketing, accounting and operations with our centralized Marketing and Operations teams. Cornell partners with broader investment teams and the firm’s Business Development and Product Strategy & Development teams to deliver new insurance solutions and pursue inorganic opportunities. He provides investment oversight for the general account portfolio of AB's biggest insurance client, Equitable. Cornell joined AB in 2024 as the firm’s first CIO of Insurance. Prior to joining AB, he spent 30 years at AIG, where he held roles focused across asset classes and insurance portfolio management, most recently as the CIO of AIG’s life and retirement business (now known as Corebridge Financial) and the deputy CIO of AIG. Cornell holds a BS in business administration from Bryant University and an MBA from Fordham University. He is a CFA charterholder. Location: New York

Richard Roberts, ACCA, CFA

Richard Roberts is a Vice President and Head of EMEA and Asia Insurance Business Development. Working closely with the Insurance Portfolio Management team and AB’s client advisors, he is responsible for partnering with insurers across the EMEA and Asia regions to develop solutions that meet the unique requirements of this industry, be it yield, diversification, solvency efficiency or targeting sustainability objectives. Roberts also supports the development of insurance thought leadership for direct consumption by insurers across a broad variety of topics. Prior to joining AB in 2022, he was a global insurance investment director for abrdn, where he was responsible for supporting the development of insurance investment solutions for clients across the EMEA and Asia regions. Before this, Roberts spent 13 years with Zurich Insurance in a variety of insurance investment roles, culminating in the role head of balance sheet investments for their UK business, where he was responsible for investment strategy across both Life and Property & Casualty general accounts. He is a chartered accountant and a CFA charterholder. Location: London