Is it time for insurers to embrace tactical credit allocation?
Against a new environment of higher inflation, greater volatility and lower liquidity, insurers may wish to consider whether their current approach to credit provides enough flexibility to capture tactical opportunities.
Our research shows that with careful guardrails and both top-down and bottom-up analyses, introducing a tactical credit approach has the potential to enhance returns without meaningfully impacting risk levels or capital requirements.
How a tactical approach to credit could benefit insurers now
Unlike the past 20 to 30 years, there is now a clear trade-off between growth and inflation. Since the global financial crisis, central banks have generally acted to suppress volatility; moving forward, they are more likely to act to generate it. This will create more volatility going into and out of market cycles and cause a greater number of dislocations within global credit markets, such as mispricings or idiosyncratic spread-widening events, which may create tactical opportunities for credit investors.
Credit plays a critical role for insurance balance sheets, especially in the investment-grade category, which has historically offered steady income with relatively low default rates. The asset class often benefits from low turnover in portfolios as well as favourable accounting treatment, both factors that limit the impact of price volatility.
Insurers typically steer their credit exposures through their strategic asset allocation. As a portfolio strategy, setting a strategic asset allocation achieves three key goals for insurers: firstly, it identifies long-term investment opportunities; secondly, it ensures that overall risk is consistent with the insurers’ risk appetites; and thirdly, it provides reassurance that capital is deployed efficiently.
However, the long-term nature of strategic asset allocations itself means portfolios are unable to accommodate swift changes that might arise from unexpected events, such as a pandemic, or from market dislocations. This makes it difficult to fine-tune credit exposure up or down promptly, which limits the amount of income that insurers can generate, which in turn can impact shareholders’ return on equity.
Monthly Market Review — August 2024
A monthly update on equity, fixed income, currency, and commodity markets.
By
Brett Hinds
Jameson Dunn