After years of very low interest rates, and silent inflation, the financial scenario has abruptly changed because of Covid-19 on the global production chain, and the Russia-Ukraine war that has increased the risk concerns of the market.
The response of the Central Banks of major economies has been to boost domestic measures in a challenge against these macroeconomic issues, which includes the US Federal Reserve raising interest rates and the tapering of assets purchased by the European Central Bank. This compares to the predictions at the end of 2021 when experts expected these rates to stay lower, with the consequence of increasing bond yields. This changing field is now the new ground where insurance investors are managing the asset portfolios, with a focus on the next steps by life assurance companies.
"It could be appropriate for companies to plan to put forward a circumscribed tactical solution: decide to sell the in-force bonds on residuals capital gains."
The increasing yield on bonds is reducing the unrealised capital gain progressively in the portfolio but is offering a better level of investment opportunity. It could be appropriate for companies to plan to put forward a circumscribed tactical solution: decide to sell the in-force bonds on residuals capital gains, and with low coupon rate and short maturity, switching at the current higher yield bond - for short to medium term duration, defending by next hike rates undiscounted in the assets turnover management.
This way it is possible to capitalise on the gains and enhance the portfolio’s return with the coupon rates delta. The entry point for the reinvestment solution could be in a short amount of time, so this would be a tactical wait – as it was seen as the final year with greater exposure of cash in the insurance portfolio allocation, on the expectation of rising rates.
The double combination of realised capital gains and reallocation to higher bond yield, planned with ALM analysis - to manage a sell and buy timing, curves, and tenors - can protect the return on the insurance policy against the direct investment in bonds. However, the safeguarding criteria specific to life assurance solutions for mixed investment and insurance into pay-outs is either a guaranteed minimum or its yield valuation.
"The average life insurance domestic market assets return, which was around 2.6% to book asset value, is more than half of the current Italian CPI."
The boost of the inflation perspective - 6% to 7% in the domestic market - is a concern for the portfolios’ present performance. The average life insurance domestic market assets return, which was around 2.6% to book asset value, is more than half of the current Italian CPI - 6.7% in March 2022 - with a negative real rate result.
In that context, a proper strategic asset allocation construction could be the most resilient solution to the matter. The private market investments can contribute to this, thanks to their low correlation to the macroeconomic drivers, which is around 0.4%. The insurance market view is driven by the potential to deliver an enhanced return profile in this asset class, which has been reinforced by the issues around inflation.
"The challenge for insurers in this scenario is to change actions rapidly after
years of low interest rates and inflation"
Also, global equity is typically an asset class that is capable of outperforming inflation over the long term, even if the actual scenario with high uncertainty and the capital requirements makes it less attractive and not significantly present in the Italian life insurance portfolio asset allocation.
The challenge for insurers in this scenario is to change actions rapidly after years of low interest rates and inflation, while also replicating the new level of yields in the insurance policies. The tactical achievement worked on a strategic portfolio solution must allow it to perform a flexible return but offer a stable yield to the macroeconomic risk dynamics, which could be achieved by the observance of reducing balance sheet risk and income volatility.
