2022 Midyear US Insurance Investment Outlook: Inflation, Rising Rates, and New Capital Requirements Put Insurers at a Crossroads

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  • Insurance investment is well positioned overall, with rising interest rates allowing insurers to gradually roll into higher-yielding assets, enhancing statutory investment incomes. On the underwriting and claims front, life insurers can offer more attractive policy yields, a positive for growing premium written, while property and casualty (PC) carriers have been hiking premium rates amid skyrocketing inflation to help offset rising claim costs.
  • The National Association of Insurance Commissioners (NAIC) has implemented new risk-based capital (RBC) charges for life, PC, and health insurers this year, and more changes are to come, including S&P’s proposed updates to its insurance capital model.
  • Investment products that are more resilient to inflation, rising rates, and the new capital requirements may include floating-rate private investments, such as direct lending and select income-oriented real assets, such as mortgage loans. Senior CLO tranches may also offer attractive relative value on a capital-adjusted basis.
  • Given the wider spreads seen in public markets such as high yield bonds and leveraged loans this year, investment strategies that allow insurers to allocate dynamically across public and private markets offer an opportunistic solution amid volatile markets.
  • New regulatory and rating agency capital requirements, recent ESG trends for insurers, and intensifying regulatory scrutiny of related-party investments all have implications for insurers in the second half of 2022 and beyond.
2022 Midyear US Insurance Investment Outlook: Inflation, Rising Rates, and New Capital Requirements Put Insurers at a Crossroads

The insurance industry is at a crossroads amid inflation, rising rates, and regulatory changes. With rising interest rates, life insurers can now offer more attractive policy yields after decades of declining asset yields. And with headline inflation reaching as high as 8.6% in 2022, property and casualty (PC) carriers have been hiking premium rates to help offset rising claim costs. In addition, starting in 2022, the National Association of Insurance Commissioners (NAIC) has implemented new risk-based capital (RBC) charges for life, PC, and health insurers broadly, with more changes to come, including S&P’s proposed updates to its insurance capital model.

Several investment products that are more resilient to inflation, rising rates, and the new capital requirements may include floating-rate private investments, such as secured direct lending products; these may earn a higher yield as rates rise, and as private, secured investments, have better price stability and benefit from higher recovery rates. Income-oriented investments, such as mortgage loans for select property types and locations, may benefit from the potential for rising rents. Senior collateralized loan obligation (CLO) tranches may also offer attractive relative value on a capital-adjusted basis. Given the wider spreads seen in high yield bond and leveraged loan markets this year, investment strategies that allow insurers to allocate dynamically across public and private markets offer an opportunistic solution amid volatile markets.

Life insurers: a turning point for higher policy yields

Life insurers may benefit from higher interest rates barring an economic recession. After decades of decline, asset yields are generally going up, as indicated by the ICE Corporate Index yield and rising insurance asset yield (see chart). As existing portfolios run off, they are replaced by higher-yielding assets. As a result, insurers’ asset yields are trending up, enhancing statutory investment incomes. This is especially evident for those insurers that have invested in shorter-term assets tactically in anticipation of rising rates. In addition, their reserve assets are largely fixed income securities, typically held to maturity. Although there may be unrealized losses in a market downturn, so long as credit losses stay modest, and the insurer has ample liquidity, those losses are unlikely to materialize. Life insurers have minimal exposure to volatile public equities (1% at year-end 2021) but more private investments, such as private debt (20%-40% of overall assets), which are generally more stable.

On the liability side, rising interest rates can also be positive for growing premium written. For example, annuity carriers’ existing fixed-rate multi-year guaranteed annuity (MYGA) with a five-year term will pay the same rate for five years, while insurers can invest in higher-yielding assets at the meantime. For newly issued MYGAs, policy yields have increased materially from historical lows (see chart), making the products more competitive and attracting greater consumer demand.

Higher Asset Yields Allow Life Insurers to Offer More Competitive Products

Higher Asset Yields Allow Life Insurers to Offer More Competitive Products

Source: SNL life industry net yield on invested assets. ICE index yield, immediateannuities.com. MYGA rate, as of May 2022.

Non-life insurers: a mixed story

Non-life insurers are generally much more sensitive to inflation. While PC insurers may be able to hike premium rates annually in a hard market, for short-tail lines, such as auto and homeowners insurance, claims costs have risen due to inflation related to parts, labor, and so on. This may lead to greater risk of reserve strengthening if premium increases are inadequate or delayed. Long-tail lines, such as workers’ compensation and long-term care, typically are unable to be repriced quickly and are thus especially vulnerable to headline inflation and other types of inflation, such as medical and social inflation. In addition, PC insurers typically have far more exposure to public equities and less to private assets, which may result in greater earnings volatility.

Resilient investment products amid turbulence

Investment products that are more resilient to inflation and rising rates may include floating-rate private assets such as secured direct lending and income-oriented products such as mortgage loans. Because insurers are not subject to “bank run” types of risks – i.e., policyholders are typically subject to surrender charges for early terminations – their liabilities are stickier and more predictable so long as interest rates increase gradually. As a result, insurers generally have room to invest in less-liquid assets in exchange for higher yields. Also, secured assets may fare better if credit defaults were to rise. In addition, investment strategies that can dynamically allocate across both public and private markets are well positioned to take advantage of market dislocations. Recent widening in high yield (HY) bond spreads may offer opportunities to increase allocations to liquid assets. And as HY spreads tighten, managers may take profits and reallocate to less-liquid assets to enhance portfolio yields.

Optimizing yield through the lens of new capital requirements

Starting in 2022, the NAIC has implemented new RBC charges for life, PC, and health insurers. Notably, life insurers are now subject to lower RBC charges for AAA, BBB+, BB+, and B+ rated bonds.1 S&P also released its Insurance Methodology Request for Comment (RFC) in December of 2021. Among other changes, based on its updated risk calibration, S&P has proposed to reduce the asset risk charges on five- to 10-year maturity BBB, BB, and B rated bonds by 34%, 60%, and 67%, respectively, but to increase them for A rated bonds by 35%. S&P also expects 50% lower asset risk charges for sovereign or secured assets relative to those for unsecured debt, making blended sovereign and corporate emerging market debt strategies potentially more attractive.2

S&P’s Asset Risk Charges: Current Versus Proposed in Its December 2021 RFC

S&P’s Asset Risk Charges: Current Versus Proposed in Its December 2021 RFC

Source: S&P, December 2021 RFC, single-A stress asset risk charges.

These changes, if implemented, may drive insurers to reposition their asset portfolios. Amid economic uncertainties, insurers are likely to manage their risk budgeting more carefully, and that may mean seeking better optimization within regulatory and rating agency capital constraints. On a capital-adjusted basis, we believe private credits and commercial mortgage loans are well positioned, and senior CLO tranches generally offer attractive relative value, while the NAIC has proposed to revise the RBC charges on junior CLO tranches such as CLO equity.3 Finally, funds and rated notes that are eligible for regulatory and rating agency capital relief may offer insurance-friendly solutions.

Climate risk and ESG for insurers

Climate risk has long been central to PC (re)insurers’ underwriting considerations, due to their exposure to natural catastrophes (e.g., hurricanes and wildfires) and social risks (e.g., the US opioid epidemic). To help track insurance climate risk exposures, the NAIC has long adopted an Insurer Climate Risk Disclosure Survey and established its Taskforce on Climate-related Financial Disclosures (TCFD). More recently, insurers are increasingly integrating holistic ESG considerations into their investment decisions and regulatory disclosures. European insurers have taken the lead in establishing net-zero goals, while US insurers are more mixed in their progress and approach. The Net-Zero Insurance Alliance’s members, including some large US insurers, account for more than 11% of global insurance premium volume, although insurers’ exclusion policies may allow for continued exposure to fossil fuel and coal-related businesses.4

Intensifying regulatory scrutiny of affiliated investments

With more and more private equity (PE) firms taking ownership stakes in insurers and originating private assets for their affiliated insurers, regulators have raised questions about potential conflicts of interest regarding related-party investments. The number of PE-owned US insurers identified by the NAIC Capital Markets Bureau totaled 117 at year-end 2020; total cash and invested assets for these insurers amounted to approximately $487 billion.5 The NAIC’s Financial Stability (E) Task Force and Working Group exposed a “List of Regulatory Considerations – PE Related and Other” in December 2021, and stated concerns around lack of disclosures regarding controls and fees, etc. In April 2022, the Macroprudential (E) Working Group (MWG) released a document for further comment on Regulatory Considerations Applicable (But Not Exclusive) to Private Equity (PE) Owned Insurers (Considerations),6 and in June 2022 the NAIC MWG adopted a working list regarding PE-owned insurers and investments.7

Insurers have taken a wide variety of approaches to how they work with their affiliated asset managers. A growing number of insurers have thoughtfully addressed these issues, in our view, such as by using an open architecture investment approach that combines affiliates’ investment expertise with that of third-party managers to better align the interests of both policyholders and shareholders.

Leading in turbulent times

Looking ahead, PineBridge believes insurers overall are well positioned to take advantage of rising rates by judiciously investing in inflation-friendly assets and strategies that best fit their asset-liability management and regulatory needs. In addition, insurers are increasingly subject to greater disclosure requirements regarding ESG and affiliated investments. Finding the right strategies, structures, and investment partners to cover all these fronts will remain essential to competing in these turbulent times.


For more investment insights, visit our 2022 Midyear Investment Outlook.

Footnotes

1 Source: PineBridge Investments, “What New Risk-Based Capital Bond Factors Could Mean for Life Insurers,” June 2021.
2 Source: “Request For Comment: Insurer Risk-Based Capital Adequacy--Methodology and Assumptions,” S&P Global Ratings, 6 December 2021.
3 Source: “Risk Assessment of Structured Securities – CLOs,” NAIC, 25 May 2022. https://content.naic.org/sites/default/files/inline-files/2022-004.01%20-%20Risk%20Assessment%20of%20Structured%20Securities%20-%20CLOs%20v3.pdf
4 Source: “Path to net-zero: Get-out clauses undermine insurers' climate targets,” S&P Capital IQ, 14 June 2022.
5 Source: NAIC Capital Markets Special Report: https://content.naic.org/sites/default/files/capital-markets-special-report-private-equity-owned-2020.pdf
6 Source: Regulatory Considerations Applicable (But Not Exclusive) to Private Equity (PE) Owned Insurers: List of MWG Considerations - PE Related and Other (naic.org)
7 Source: RRC comments regarding Regulatory Considerations Applicable (But Not Exclusive) to PE Owned Insurers, May 2022. https://content.naic.org/sites/default/files/call_materials/Comments%206-13-22_0.pdf


Disclosure

Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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