Insurance 2024 investment outlook

Regulatory Outlook 2024 
Solvency II reform: the beginning of the end 

2024 should mark the beginning of the end for reforms to Solvency II.  Having fired the starting gun in February 2019¹, almost four years later the Commission, European Parliament and European Council are negotiating the final contours of the reform package.  Although leaders are aiming to conclude the negotiations by the end of the year, there is a realistic prospect of continuing into Q1 2024. 

Political and technical negotiations (trilogues) running in parallel

The European institutions are currently seeking to close the gaps on both technical differences of detail as well as areas of political contention.  Topics still under negotiation include the extent of sustainability disclosures, long-term guarantees and EIOPA’s role in cross-border supervision.   

2024 reforms will focus on the Delegated Regulation 

Once negotiations on the Directive are complete, work will begin almost immediately to amend the more detailed Delegated Regulation which underpins the Directive.  Initial work on a draft Delegated Act began in 2022 and we expect the Commission to publish the draft text as soon as a trilogue deal is reached.   

The draft is expected to support the key changes made to the Solvency II Directive – as well as potential further areas of reform, such as to the volatility adjustment, matching adjustment and the extrapolation of long-term interest rates.²    

A new recovery and resolution framework

Alongside reform of the Solvency II Directive, the European institutions are also negotiating on the final form of a new Insurance Recovery and Resolution Directive (IRRD) which aims to provide a set of resolution tools if (re)insurers are failing or likely to fail.  As with Solvency II, the institutions are aiming to complete negotiations by the end of the year, but there is also a possibility that they drag into Q1 2024. 

New policy priorities under new European Commission and Parliament 

Despite their expected finalisation in 2024, changes to Solvency II are not expected to come into force until mid-2025.  In the meantime, a new European Parliament will be elected in June, and a new set of commissioners appointed to lead the European Commission.  As such, all eyes will be on the new Commission in H2 2024 to understand to what extent insurance will feature in their policy priorities for the next legislative mandate 2024-2029. 

Macro: growth continues to soften 

We expect a “bumpy landing” for the US and the Eurozone to go from a slowdown into a contraction. Both scenarios imply a favourable backdrop for fixed income, especially higher quality assets, as central banks should be at or near the peak of their hiking cycles.  

Rates: commencing our descent? 

Current market pricing suggests easing rates on both sides of the Atlantic in Q2-Q3. The decent is relatively gradual, with the ECB deposit rate finding a new range around 2.75%. Hedging costs for USD issues are likely to remain in the 1.4-1.6% area.  

There are a couple of drivers for softer conditions in Europe: first, the monetary transmission mechanism is more efficient than in the US, so rate hikes have been swiftly passed on to households and firms.  

Second, the supply shock effects of the Russia-Ukraine conflict are now abating; we can see that the contribution of energy (in blue) to headline inflation has turned from strongly positive to negative in recent months.  

Absent another flare-up in this conflict, or an expansion of the one in the Middle East, at the current trajectory we should see the headline rate fall back within the target range by year-end. 

Credit fundamentals: holding up 

In the US, the credit cycle shows signs of maturing. Leverage has trended higher while margins, interest coverage, and revenue growth have fallen. We expect that corporates will prioritize debt paydowns to control borrowing expenses and defend balance sheets. Downgrade activity escalated in 2023, albeit from a low base, and upgrades still outweigh downgrades.  

The European cycle is further ahead with credit events picking up among weaker rating categories. We expect these to continue rising in 2024 given more challenging refinancing conditions. We have seen an uptick in disappointments during the Q3 2023 earnings season, but we still view these as idiosyncratic rather than systemic.  

Overall fundamentals are still reasonable, however. Euro Stoxx 600 leverage is close to record lows and earnings margins are still elevated. We are expecting interest cover to deteriorate gradually, but this is not an immediate concern given well-spread maturity profiles.  

Valuations: moderate to good  

We think spreads on investment grade look reasonable given the macro environment and corporate fundamentals. Euro and Sterling issues are trading substantially outside of their long-term medians while US ones are slightly inside – likely due to the stronger growth dynamics in the US.  

As always, the spread levels for an overall index conceal wide variations therein – and there are many relative value opportunities for investors who can pick and choose securities with a global viewpoint.  

Insurance Asset Allocation 

In the current risk-averse environment, European insurers are naturally over-allocating to high quality bonds which exhibit much better spread than during the last decade and which could withstand a potential recession. Besides their median duration mismatch narrowed to around -5 years, as the duration of liabilities decreased more than that of assets. 

Amongst the driving factors of this asset allocation change, we can count the increasing need of liquidity notably in Italy and the denominator effect impacting private assets.  

Private assets perfectly played their role of shock absorbers over recent years but their relative importance in the balance sheet increased and neared the liquidity risk limits. Though the denominator effect slowed down the allocation to private assets over the last 18 months.  

We expect a repricing of the private assets at year-end and a stabilization of the liabilities’ cost which will leave more room for diversification in 2024.  

Public markets, Fixed income remains the story of the year. 

• CMAs for most FI asset classes are significantly higher than historical returns. Some higher yielding credit assets are expected to outperform even the riskier parts of the equity market (Loans > EM) at much lower levels of risk.  
• Global equities are still expected to return near 6%, however the relative expected outperformance continues to shrink, especially when adjusting for risk and cost of capital. If the current level of volatility subsists, equity risk hedging programs could be an efficient way to reduce the cost of capital and maintain the equity allocation over time.
• On the capital management side, geopolitical events can impact volatilities of all assets, asset classes, sectors and countries. The introduction of a larger share of commodities or precious metals could reduce the volatility of the asset allocation and stabilise the eligible own funds considering our CMA are quite constructive for the asset class in the long run.

On the private markets side, we over allocate to debt over equity to cushion the volatility and refinancing risk and benefit from opportunities which are a good fit for insurers’ risk appetite & ALM: low LTVs and strong covenants. 

The focus on diversification and the increasing appetite for inflation linked assets will probably attract new investors in the real estate debt space since higher interest rates have resulted in an attractive entry point thanks to repricing. Besides reduced bank lending creates a compelling opportunity for alternative real estate lenders. 

Private Credit quality has also improved since 2022 via lender-friendly documentations and lower leverage profiles notably on the middle market side. Considering loans offer some of the best yields in fixed income despite their senior secured status, we believe their low correlation with traditional asset classes of the insurance balance sheet make them an attractive way to reinforce asset allocation in 2024.