P&C investment portfolios post-pandemic: Where to go next
How should insurance companies manage investment risk in 2021 and beyond? It requires a focus on fundamentals with added patience & caution.
The economic stress and market disruption from the COVID-19 pandemic in early March weighed heavily on property & casualty insurance company investment portfolios, but they have since recovered. However, moving forward in a time of less certainty will require bold and innovative thinking. Most are already skilled in the disciplines needed for success, but sober analysis, critical thinking, and carefully measured actions of another “P&C” sort – patience and caution – may also be valuable in preparing portfolios for the post-pandemic environment.
Confusion at the outset
The general confusion and uncertainty in the early days of the pandemic demanded a great deal of patience from portfolio managers as they sorted through the risks. Equity markets plummeted while credit spreads widened significantly. Holding extra liquidity was a prudent step in the face of such uncertainty — but should companies shed investment risk too?
P&C insurers faced business challenges beyond general account portfolio performance. Liquidity demands could arise from many risks:
- collection concerns due to lower employment-related premiums and to premium deferrals;
- negligence claims for workers’ compensation writers failing to take poorly defined “reasonable precautions”;
- regulators expanding business-interruption coverage beyond policy limits;
- fraudulent health and disability insurance claims; and
- stresses on medical professional liability firms from an overwhelmed health care delivery system.
The way insurers responded to these risks could determine their very survival.
‘Don’t sell into a panic’
P&C insurers generally followed a wise and patient investment strategy: Don’t sell into a panic.
In a study of seven decades of market activity during non-financial crises ― for example, wars, threats of war, assassinations, oil embargos, and sovereign defaults ― we find that the Dow Jones Industrial Average (DJIA) one-year post-event is positive about 75% of the time, with an average return of 16%. That is half again higher than the DJIA’s long-term mean.
By keeping cooler heads, most P&C companies benefitted greatly as markets came roaring back, and their portfolios have almost fully recovered from the March depths.
Through the use of cautious measures such as building strong capital positions going into the crisis, improving their risk management and modeling techniques, and applying lessons learned in the Great Recession a decade ago, P&C insurers’ capital has held up well.
Challenging basic investment tenets
How do P&C firms prepare for a post-COVID environment? Constructing a portfolio to fit an insurer’s unique requirements is as much art as science. Modern Portfolio Theory, macroeconomics, and the principles of finance are valuable to building a general account, but so too is knowledge of the insurer’s customer mix and comfort with risk. The basic tenets of portfolio construction are not changing, but they were certainly challenged during the pandemic.
For example, most insurers agree on the benefits of portfolio diversification. But when equity and bond markets panic together as they did during the pandemic’s early days, diversification appears to “fail.” Insurers in response suspended their routine investment plans to hold extra liquidity ― a prudent reaction ― but patience often rewards investors as well-diversified portfolios usually come back, as they have in the case of insurance companies.
Hand in glove with diversification is the principle of employing complementary assets, which for P&C insurers includes asset allocations dominated by high-quality bonds mixed with equity exposure and up to 20% of fixed income rated BBB or below. The immediate market panic of early March totally upended diversification and asset allocation as correlations climbed and asset values fell. What normally would protect general account values and surplus from wild swings instead delivered a double negative blow. It is the kind of unexpected shock that can disrupt an acceptance of long-supported practices.
In addition, properly assessing risks, both sources and degrees, in a portfolio’s asset allocation became more difficult in late March and early April. Our understanding of the virus was developing in real-time, leading to evolving government and healthcare policies and generating a fog, hampering a clear view of key data. As valuations fell for most risk assets, portfolio managers who might have seen value in solid credits and stocks often had to refrain from investing because other COVID risks were dominating. For some, that meant missing out on possible additional portfolio income.
For many P&C insurers, their investment focus has been disrupted. Claims-paying ability and maintaining solvency dominated during the initial stages of the pandemic as many had high cash-flow uncertainty. With “lower for even longer” interest rates as the dominant theme for insurance investment managers, insurers’ concerns have shifted to continued pressure on earnings.
New designs for a new world
As the smoke clears from the economic devastation of the first half of 2020, P&C portfolio managers have a revised ― but not upended ― asset allocation. We expect that those redesigning portfolios for the post-pandemic period will need to consider the possibility of rekindled inflation, low bond yields, a skittish equity market, and highly uncertain demand for insurance products.
These pressing considerations, some new and some old, require creative thinking and openness to new ideas. But bold or hasty reactionary moves in portfolios seldom work out well. Conning has great faith that basic investing tenets ― a deep understanding of business goals, a finely tuned investment strategy focused on the long term, and a diversified portfolio managed with discipline ― will continue to offer value. The shock of a pandemic or other exogenous event might threaten a portfolio’s effectiveness in the short run. But Conning strongly believes that, with patience, a prudent strategy focused on matching assets with liabilities and supported by sound fundamentals will hold up over time.
And by exercising “P&C” ― patience and caution ― in their analysis, P&C insurers may develop long-term strategies that could provide them with more “P&C” ― profit and confidence ― for the long-term.
Rich Sega is global chief investment strategist for Conning, a global asset manager for insurance companies with $180 billion assets under management. This article is based on materials previously published or distributed by Conning and is republished with permission.
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