Investment Institute
Annual Outlook

Insurance investment outlook 2023: Adapting to the higher-for-longer paradigm

  • 06 December 2022 (10 min read)

Key points

  • With inflation at multi-decade highs, central banks have swiftly tightened monetary policy to restore price stability
  • Credit and equity markets have seen material adjustments while liquidity has deteriorated across asset classes
  • Difficult financial conditions point to recessions in 2023 with potential for further volatility and market downturns
  • Higher rates and risk premia offer an opportunity to rebuild book yields, but volatility disturbs asset liability matching and can hurt capital ratios
  • Insurers need to be agile in the way they manage their balance sheets and capture investment opportunities.

A shift is underway

For more than a decade financial markets enjoyed benign economic conditions: Muted inflation, central bank interventionism, abundant liquidity, and low interest rates. The ”lower for longer” and ”hunt for yield” narratives prevailed, and insurers adjusted their asset allocation and investment strategies accordingly, in order to keep matching their liabilities, mitigate the dilution of book yields, and preserve operating earnings.

A major trend has been active participation in the rapidly-developing private markets to harvest an illiquidity premium, including lower-quality private credit investments. In the core assets space, insurers have also gone down the credit spectrum in their search for yield and lengthened asset duration through longer-dated high-quality bonds. Low market volatility also permitted greater use of interest rate derivatives1 to hedge duration and convexity gaps at a reasonable cost.2

COVID-19 presented a massive exogenous shock to the global economy. It quickly revived market volatility which hurt investment portfolios. Supply-side disruptions and a significant rebound in consumer demand conspired to produce supply bottlenecks and an inflation rate not seen for decades. But a common view in 2021 was for a gradual absorption of the pandemic shock and for a normalization of global supply chains, allowing for sustained growth, a slowdown in inflation, and a digestible pace of monetary policy normalization.

Many deemed the inflation spiketemporary, y but the Ukraine crisis, together with lingering supply chain disruptions and tight labor markets, pushed prices even higher. The conflict led to steeper energy and food costs and more persistent inflation which had been turning more broad-based as high input costs were passed to consumers, and labor markets remain tight.   

With inflation at multi-decade highs and uncertainty clouding its future path, developed market central banks accelerated the pace of policy normalization in a bid to restore price stability. Interest rates have increased at an unprecented and uneven pace across markets while risk premia have widened across the board. Global growth has been slowing, and a consensus is building that the ongoing tightening of financial conditions, in combination with deteriorating real income and profit margins, point to recessions in 2023, with natural gas shortages adding to the risk in Europe.

Central banks are strongly committed to delivering on their price stability mandates and acknowledge the possibility of a hard landing. US Federal Reserve Chair Jerome Powell indicated in November that the peak rate was likely to be higher than previously expected, and the Fed would not cut prematurely. As labor market resilience and inflation persistence lead to the Fed delivering more restrictive policy, Powell acknowledged the path to a soft landing had “narrowed.”

In its latest Global Financial Stability Report, the International Monetary Fund (IMF) warned “the global economic outlook has deteriorated materially,” and “global financial stability risks have increased” with “the balance of risks… significantly skewed to the downside.”3 The IMF added  “financial vulnerabilities are elevated in the sovereign and nonbank financial institution sectors, while market liquidity has deteriorated across some key asset classes,” and “there is a risk… that a rapid, disorderly repricing of risk in coming months could interact with, and be amplified by, preexisting vulnerabilities and poor market liquidity.”

The information has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. This analysis and conclusions are the expression of an opinion, based on available data at a specific date. Due to the subjective aspect of these analyses, the effective evolution of the economic variables and values of the financial markets could be significantly different for the projections, forecast, anticipations and hypothesis which are communicated in this material.

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