The world has been in an interesting economic environment over the past 18 months, particularly from a rates perspective, said Zach Goodman, Partner at EY, in a new report from Clear Path Analysis, when speaking with Transamerica’s Chief Risk Officer, Pooja Rahman.
Rahman was speaking at a Fireside Chat at the Insurance Investor Live | North America event in December last year in New York, which is now featured in the Insurance Asset Management North America 2024 report.
In the chat, Rahman discussed how rates are rising pretty rapidly to accommodate the inflation that the markets are facing.
“We are entering a disinflationary period – the latest readings are closer to 3% with core inflation a bit higher than that – but the expectation is that, at some point in 2024, the US Federal Reserve (Fed) is likely to start reducing rates,” said Goodman wondering if we were at the end of the tightening cycle and what we could see going forward.
We’ve already seen that the US’s unexpectedly high growth rate in 2023 mean that investors were watching to see if the Fed would keep interest rates higher for longer at the same time that investment experts have said that expectations of a cut should be “dialled down”.
Read an excerpt from their conversation below with links to read the exchange in full as well as the rest of the report at the bottom.
Pooja Rahman: They say that ALM is the heart of insurance, and it should be. It is never going to be perfect because problems are not known, and solutions are never going to be perfect. It is not a zero-risk paradigm. We don’t operate and do business in a zero-risk world.
Rates going up quickly isn’t my ideal scenario. In my ideal world, they go up slowly and our assumptions would not have to change dramatically year-on-year. It creates a contrast; we have what we have on the current book that we manage. We also sell new business with up-to-date assumptions.
"On risk mindsets and ALM, I am a big believer in looking at the present value
of liabilities and the market value of assets."
So, a rapidly moving interest rate environment gives me headaches on both sides: on in-force and on new business. This is because – and this is finance 101 – when interest rates go up market values go down. That impacts the current book unless both your asset and liability cashflows are fixed and completely matched (which is practically impossible). On new business, the assumptions of today may or may not be around tomorrow when the new business recurring premium arrives.
On risk mindsets and ALM, I am a big believer in looking at the present value of liabilities and the market value of assets. I know that the time element of how these cash flows evolve from a liability perspective and on the asset side matters. Because of the nature of our liability profile, we have the ability to rebalance portfolios without constantly living in a market value world. The market value and present value world gives us directional input that is critical for us as we tune our books on cashflow basis.
Rates went up quickly. The short end kept going up; the long end went up and was north of five and everyone got worried, and then it came down. Who knows where it is going to go next? 50-60 basis point moves are nothing these days.
Market values are depressed from market risk. Whether there is a credit component to it – well, that becomes hard to see. If there is a credit issue in the system accompanied by rising interest rates, it becomes difficult to figure out how much of the asset valuation is coming from core credit versus market, treasury, or interest rate movements.
"Ours is a business of financial management: asset valuations
and how much they are moving."
We use the best possible assumptions in an uncertain environment. I would love for a more normal environment to return because we are going to receive premiums in 2024/25/26 and beyond for business priced and sold today. No one has certainty on what investment yields we will get on those future premiums. We make the best guess possible based on current market rates and the current yield curves. They are imperfect, but they are better than anything else. This is where you get into how matched you can get. Simply put, it is a moving target.
Ours is a business of financial management: asset valuations and how much they are moving. How much is the environment moving? Are your liabilities fixed? Industry studies new business profitability numbers, and you do your due diligence. You see that you are meeting your cost of capital and internal rate of return (IRR) hurdles at the point of issue. As public companies, a lot of us do manage a return on capital beyond just the point of issue.
It is certainly not straightforward.
