This article was produced by Invesco as part of their valued industry partnership to Insurance Investor.
Charles Moussier
Head of EMEA Insurance Client Solutions, Invesco
In the face of the 21st century’s first major erosion of purchasing power, insurers are unusually vulnerable. This is because inflation can cause both sides of their balance sheets to suffer, sometimes delivering the double whammy of a fall in asset values and a rise in liability values.
Traditional fixed income assets can seem safe bets in such an environment. High-quality ESG bonds, investment-grade (IG) bonds and inflation-linked bonds might appear particularly attractive at first glance.
Look closer, though, and their appeal becomes questionable. ESG and IG bonds have arguably been expensive, with yields insufficient to compensate for the year-on-year inflation of goods, while inflation-linked bonds ultimately amount to a bet that central banks will fail to bring inflation under control.
Insurers therefore need to look beyond traditional fixed income. In doing so, they should keep in mind two overarching considerations that could prove crucial to successful asset-allocation decisions.
The first is that addressing the difficulties of the current economic climate is not just a matter of seeking returns in testing circumstances. It is also a matter of defending against what might or might not happen in the months and years ahead.
The second is that effective inflation protection demands careful evaluation of risk. This should lead to the identification of suitably mitigating assets. For insurers, as for all investors, diversification is likely to be at the heart of the required response.
Given all the above, insurers may wish to consider a multi-asset approach. This might include Senior Secured Loans, which combine high income with protection against interest rate rises and credit risk, and unrated debts under Solvency II, whose significant illiquidity premia can help maintain the levels needed to offset inflation’s impacts.
In tandem, real assets with direct links to inflation can be a strong complement to other portfolio constituents. Insurers might especially think about increasing exposure to real estate, infrastructure and commodities.
Charles Moussier, Invesco’s Head of EMEA Insurance Client Solutions, explores each of these less widely appreciated options in detail in ‘How can insurers protect against the havoc of inflation?’. He also further explains why inflation threatens insurers’ business foundations and why conventional strategies could fall short in managing the associated risks.
