No. 7: Capital
Equity markets have done remarkably well since the low point last March. Insurance accounting rules require close attention to stock market trends to maintain capital adequacy and company financial strength. Companies that have seen meteoric increases in equity valuations should consider rebalancing their stock allocations back to long-term-target risk levels.
(Photo: SkyLine/Adobe Stock)
No. 6: Corporate credit
The Biden Administration is signaling its willingness to spend. Be it for stimulus, infrastructure, climate or the environment, the checkbook is open. This spending and ultra-accommodative monetary policy lead us to a couple of conclusions. The U.S. economy is finding more solid footing with renewed fiscal support, which will likely lead to impressive growth this year and expectations for stronger earnings. Corporate credit has long been the mainstay of insurers’ general account assets, and high-grade credit will likely remain so on the strength of those earnings despite the possibility of rising interest rates.
(Photo: Beth Swanson/Shutterstock)
No. 5: Commodities and inflation
The Federal Reserve’s massive expansion of its balance sheet, repression of short-term interest rates, and recent Average Inflation Targeting (AIT) approach increase inflation risk. This reduces the return potential of investing in dollar-based assets and lowers the marginal demand for dollars, which is itself inflationary. It is recommended to continue watching commodity prices for signs of inflation as they usually are a precursor to wage inflation, which we have yet to witness in this recovery. If inflation emerges, investors will likely favor real assets and companies whose valuations are based on real assets.
(Photo: Vintage Tone/Shutterstock)
No. 4: Central banks
Super-accommodating policy fueled asset returns during the 2020 depression but also suppressed insurers’ income and earnings since the end of the financial crisis. As governments consider taking spending to new levels, it appears that some central banks are just printing money to pay for it. This could become a desperate move by the banks, which are often able to slow hot economies but are less effective at speeding up lagging ones. In Conning’s view, the central banks appear to be out of conventional firepower and may think that this melding of fiscal and monetary policies is an attractive alternative. Policymakers are expected to keep short-term rates low; Conning suggests watching the long rates for inflationary expectations. This could lead to higher interest rates, a welcome trend for companies with positive cash flow. Favoring shorter durations and assets that benefit from rising rates, such as CLOs, may be a sensible strategy.
(Photo: Angel Navarrete/Bloomberg)
No. 3: Congress and the Biden Administration
In particular, taxes, tort law, and unemployment may affect portfolio appetite for marketability, duration, and tax-preferenced income. Some proposed federal spending may help increase near-term growth and business activity, but other policies, such as raising taxes and increasing the minimum wage, may tamp down growth and employment. While we have not yet seen the net effect of new policies, Conning expects that increasing allocations to tax-exempt municipal securities may be appropriate.
(Photo: Melina Mara/The Washington Post/Bloomberg)
No. 2: Claims
Despite the global pandemic, Conning’s analysis suggests P&C industry results for 2020 are very good, continuing a 15-year streak of favorable loss development. But researchers also note that the benefits were very product-specific: property coverages, private passenger auto, and mortgage insurance were the major winners due to reduced exposure and the short-tailed nature of the risks. Conning has seen those same factors, along with rising “social inflation” (such as trial jury awards), weighing on long-tailed lines such as workers’ compensation and medical professional liability. Portfolio managers may want to monitor claim trends and court cases to assure liquidity is adequate for the evolving economic recovery.
(Photo: Emilie Zhang/Adobe Stock)
No. 1: Coronavirus
The pandemic and lockdowns will likely continue to affect insurers’ business prospects, portfolio performance, cash flow and liquidity. Vaccines and safe-opening protocols should help return the economy to a more normal state but expect interruptions from sporadic outbreaks. The uncertainty may mean less reliable business plans, affecting insurers’ ability to execute effective asset-liability management. Maintaining restraint in overall portfolio risk may be wise.
(Image: Peter Varga/Adobe Stock)
Charting a course through the uncharted waters of a post-pandemic year, we still see rough seas ahead.
When managing U.S. P&C insurer investment portfolios, asset allocators should be alert for the seven signs of heavy weather outlined in the slideshow above — based on research from Conning — and know where to find safe harbors.
As the storm clouds of the past year clear and we navigate through the shoals of 2021, we recommend remaining true to the guiding principles of quality, liquidity and diversification.
Rich Sega is global chief investment strategist for Conning, a global asset manager for insurance companies with almost $200 billion global assets under management. This article is based on materials previously published or distributed by Conning and is republished here with permission. For more information, send email to [email protected].