The ALM and balance sheet situation after the inflationary event and near recession has caused concern for most insurance investment professionals, as well as those working in treasury and finance. However, there are strategies that can offset the volatility and its stress on liquidity, instead providing ways to use it as a boon rather than a bane.
At the Insurance Investor Live | Europe event, which took place in Q3 2023 in London, Angel Kansagra, Head of ALM, Lloyd’s, gave his views on the situation and what he’d seen over the past 18 months in a discussion alongside other senior treasury and financial figures from Canada Life and Aviva.
In the discussion, the group said they had seen unprecedented market volatility in recent time, which proved the benefits of having ample liquidity during those pinch points.
Kansagra, whose work at the world’s largest insurance market gives him a unique perspective on market dynamics, shared his views on the ALM and balance sheet movements he had seen from the time of the Covid-19 pandemic through to the market volatility that followed. Kansagra also shared his forward-looking ideas on where the market should be headed in 2024 to best achieve positive results.
What happens with balance sheets over the course of 2024 will be something to watch. In the US, Invesco said in December 2023 that the credit cycle shows signs of maturing but that the fundamentals were holding up. “Leverage has trended higher while margins, interest coverage, and revenue growth have fallen. We expect that corporates will prioritise debt paydowns to control borrowing expenses and defend balance sheets."
Meanwhile, in the UK, Fitch Ratings said in its UK Life Insurance Outlook for 2024 that there will be market moves driven “by strong structural demand from corporates de-risking their balance sheets”.
Kansagra’s full conversation appears in the Insurance Asset Management Europe report 2023, which can be downloaded here.
You can read highlights of the conversation below:
Angel Kansagra: On the ALM side, if you look at the P&C balance sheet it is usually very low duration, roughly two to three years so most of the assets are in short-duration securities, maybe cash, government or corporate bonds. As the cash allocation is going up, going into the rate rise cycle, there was a short duration on the asset portfolio. Now, if you expect interest rates to go down in the next year or two, you should be long-duration or at least be matching your duration with your liabilities from an ALM point of view.
For obvious reasons, we are not seeing this as you are getting good returns on cash, so you are still running short-duration portfolios from this point of view. I don’t see this changing in the next six months or so until we see inflation going down or central banks cutting interest rates - this is when the switch will happen into the other asset classes.
"It is giving you solvency capital rather than having you hold solvency capital
in your Solvency II, ratio and this is across a lot of the P&C firms."
From a capital point of view, although you run a duration mismatch, this is turning out to be positive. The reason for this is that in a P&C insurance company, say if 15-20% of your portfolio is in cash or cash-like assets. If you look at the distributions the means have shifted significantly to the right at 4-5%, so the 100-200 that you get is a profit and not a loss. It is giving you solvency capital rather than having you hold solvency capital in your Solvency II, ratio and this is across a lot of the P&C firms.
Angel: In terms of value creation, I would like to give an example of the whole Lloyd’s market in what we are trying to do. Across the Lloyd’s market there is close to £95 billion of assets in 100 syndicates, and 2000 capital providers and with these assets there is almost £15 billion held in cash. This cash is not required overnight or when you have a claim it might be required in a month but there is still a lot of cash being held. When I consider the cost of liquidity, I always think about the return that you lose by holding that cash because you just want to have it there rather than needing it there.
Currently, it makes sense because of the cash rates available in the market, but what about the value creation, from a strategic point of view, if you look three-to-five-years down the line? If this attitude doesn’t change in terms of holding cash then we can probably make use of some other cash-alternatives with funds ranging from T+0 to T+5 that are available as there is always something that you can do to get that additional yield.
"One solution we are launching gives you an additional 40 basis points return
net of fees on a money market-type investment."
What we have done at Lloyd’s is create something called the Lloyd’s Investment Platform, which gives access to the market participants to different investment solutions through third-party managers. One solution we are launching gives you an additional 40 basis points return net of fees on a money market-type investment. It is a natural evolution of a money market fund and 40 basis points doesn’t seem high but if you look at the money market funds that are currently available in the market and when investors allow for the fees they pay, which are quite high, the return is less than cash.
In terms of value creation, these are the initial initiatives that we are working on that might not be very relevant in the next month or two, but they can be a strategic investment sitting in your cash bucket giving you more returns effectively, so it is the yield enhancement that you get by utilising instruments that aren’t money market instruments but going into bonds and credit.
Angel: Yes, it is making a plug-and-play model so that if you come to the market you don’t have to worry about appointing managers, finding good investments and worrying about fees. You can have access to these elements straight away from a single platform.
