Recent conversations with European insurance CIOs surfaced discussions on several asset-allocation topics—from inflation expectations to liquidity considerations.
Over the first few months of this year, we’ve taken the opportunity to meet with many insurance CIOs across Europe. Discussions have covered wide-ranging topics, including the insurance investment outlook and exchanges on the biggest challenges they face in formulating investment strategy. Here, we share four takeaways from those conversations.
Inflation Concerns Not Consistently Factored into Asset Allocations
Many life insurers and property and casualty insurers generally agreed with our view that inflation is likely to be strategically higher in the medium- to long-term than central banks’ current targets. However, there was no common view on how to factor that outlook into allocation decisions. Among life insurers, there was little consideration or quantification of the inflation sensitivity of assets. That’s somewhat understandable since most liabilities aren’t linked to inflation.
With property and casualty insurers, we discussed how claims inflation has historically outpaced the Consumer Price Index, exacerbating the challenges that have been faced the past couple of years. Incorporating that reality into asset allocation requires the difficult task of finding an asset that’s sensitive to claims inflation—and over a short time horizon. The other complication of a strategic asset-allocation response is a change in the equilibrium view on inflation could have sizable allocation implications, which touches on topics of governance and career risk.
Inflation is much easier to hedge in the longer term, though exposure is harder to quantify. That’s why we heard a range of approaches centered on a desire to hold at least some assets with implicit linkages to inflation over the long term, such as equities and real estate. However, no firm approach emerged for assessing the allocation size. For the most part, insurers have handled inflation by using the policy-pricing cycle as the primary mechanism, with the hope of maintaining competitiveness.
Private Exposures Likely to Grow—with Broader Drivers than Illiquidity Premium
Expanding private market exposure was among the highest priorities for the vast majority of insurers we spoke with, regardless of their stage in the journey. It was reassuring to hear that the drivers for increasing exposure are a much broader set than a few years ago.
Accessing diversifying risk sources was commonly cited by the insurers we spoke with: infrastructure, mortgages and lending to private equity funds were all mentioned as good counterbalances to the typical corporate risk from public bond markets. ESG goals were also cited: renewable-energy exposures or socially beneficial investments (for example, social or retirement living) were seen as areas where private markets offer more opportunity than public markets. This view aligns with the broader notion of increasing private markets exposure as a way to broaden the investment universe, avoiding limitations on return and diversification potential.
Many property and casualty insurers expressed a desire to increase private exposure from a relatively low base; target allocations ranged from 5%–10%. Opinions on the approach varied. It was noted that the allocation size warranted considering a multi-asset approach, with one mandate enabling access to several areas. This requires finding a manager with a broad platform and strength in multiple areas that align with insurers’ balance sheets. It also calls for insurers to have a detailed understanding of the range of asset exposures they can take on. For those reasons, many insurers still favored an asset class–by–asset class approach.
Solvency Not a Biting Constraint, but Accounting Considerations Coming to the Fore
Solvency-efficiency metrics are one allocation driver, according to some of the insurers we spoke with. But on the whole, solvency budgets weren’t considered biting constraints. Allocation decisions weren’t being driven by the aim of reducing solvency budgets nor a desire to access more yield for a given investment without increasing capital.
Accounting considerations were prevalent, however. Only a small minority of those we spoke with had made investment decisions with these considerations as a significant factor, but the large majority were working to give more weight to international financial reporting standards (IFRS) 9 and IFRS 17 impacts in the allocation process. This suggests a closer interaction between finance and investment teams.
Where accounting had been a significant factor in allocation changes, shifting some equity investments into high yield was mentioned as a way to reduce profit and loss (P&L) volatility, as the unrealized movement could be held on the balance sheet rather than taken through P&L. The unappealing median return potential from private equity was acknowledged (though with a wide range around it), but insurers also cited the accounting appeal of the reduced volatility from its mark to market. However, it’s important to distinguish lower mark-to-market volatility from genuinely lower investment volatility.
Liquidity Is a Spectrum, Not a Binary Condition
In our conversations, we were eager to better understand whether insurers’ liquidity needs had been challenged by the surge in interest rates. While there was potential for pressure from higher policy lapses or lower new business volumes, it appears that insurers had this area very well-covered.
Nevertheless, liquidity is clearly in focus on the asset side of the balance sheet. The industry still uses the “public” and “private” market labels to divide the broad investment universe, but there’s an appreciation that liquidity can’t be defined in such a binary way. Capacity for illiquidity should not translate directly to capacity for private markets.
Instead, there’s a spectrum of liquidity across both public and private markets—and that spectrum appears very much in focus among the insurers we spoke with. In the private space particularly, the mindset had previously leaned toward “public = liquid” and “private = illiquid.” As insurers exposures have broadened, a more nuanced, detailed view of liquidity is being factored into allocation decisions.
