European insurers are entering a period of regulatory change; combined with the longer term evolution of the global macroeconomy, this presents opportunities and challenges. Over the summer, our Global Fixed Income, Currency and Commodities (“GFICC”) strategy committee increased our expectations for a soft landing for the global economy. We see a 60% probability supporting our base case expectation, supported by increasing fiscal expansion offsetting tariff disruptions. In a lower growth world, fiscal expansion is not without risk. When partnered with higher taxation, it reduces growth expectations. Bond markets will be watching fiscal accounts closely.

Solvency II review

In this quarter’s Insurance Edge, Valerie Stephan, European Head of Insurance Strategy and Analytics, offers insights into the EU’s current review of Solvency II. She notes that the proposed changes impact various modules of the Solvency Capital Requirement (SCR), including market risk, counterparty risk, and technical provision calculation. She focuses her analysis on the impact of these changes on insurer balance sheets. She notes that the proposed changes to the extrapolation of risk-free interest rate curves may increase technical provision values for longer dated liabilities, given the current downward slope of the longer end of the EU curve. Additionally, Val provides an assessment of the new volatility adjustment (“VA”) framework. Val endorses the new framework, which features a currency VA to which a country dependent macro-VA is added.

These proposals come at a time when fiscal discipline is in focus for bond markets. Governments find themselves increasing spending – for example, around defense – at a time when they are carrying higher public sector debt burdens. In Europe, higher social welfare safety nets impose a cyclical impact on fiscal policy through the consolidation phase. With other factors, this has consequences: Weaker public sector balance sheets help explain the summer’s other salient feature: investment grade credit spreads continue to tighten, especially in developed markets. We think this is a rational response to increasing fiscal risks, as private sector balance sheets have rarely been healthier. The summer earnings season saw few disappointments in the investment grade space, while margins remain supportive of repayment. Tighter credit spreads and rising sovereign yields have many an insurer considering tactical reallocation.

Alternative assets

“Reallocation” is no longer synonymous with “roll into higher-yielding sovereign debt”. We are pleased to highlight an interesting piece from Valerie Stephan and Aaron Hussein, Global Market Strategist, that looks at alternatives for insurance investors. As insurers continue to adapt to changing market dynamics and regulatory landscapes, the strategic inclusion of alternatives in portfolios can provide a competitive edge. By embracing private credit, infrastructure, and other alternative asset classes, insurers can target enhanced portfolio returns, mitigate risks, and meet policyholder expectations in terms of claims, premiums, and returns.

Insurers must remain agile and forward-thinking, leveraging the unique attributes of alternative assets to achieve their investment objectives and deliver value to policyholders. However, by embracing alternatives, insurers can not only enhance their financial performance but also contribute to economic development and stability in markets around the world. As the industry continues to evolve, the role of alternatives will only grow in importance, making them an essential component of any forward-thinking insurer's investment strategy.

Author: Giles Bedford, Senior Investment Specialist, EMEA Insurance