Twelve Capital positive on re/insurance sector investing for 2022

Investment manager Twelve Capital has explained that it believes the insurance and reinsurance sector has positive attributes as an investment asset class for 2022, with both macroeconomic and idiosyncratic tailwinds expected to drive returns this year.

Twelve Capital is a Zurich-headquartered catastrophe bond, insurance-linked securities (ILS) and reinsurance linked investment fund manager, with strategies both in the ILS sector, as well as in insurance related fixed income or debt, insurance equities and insurtech as well.

With this holistic view across the various investment access points of the insurance and reinsurance market, Twelve Capital’s insights suggest a year where there could be positive fundamentals for all of these areas of insurance-linked returns.

Most interesting and perhaps with the strongest read-across to insurance-linked securities (ILS), Twelve Capital notes key factors for 2022 as higher interest rates, the improving pricing environment, legacy portfolio optimisation activity and an increased focus on environmental, social and governance (ESG) factors.

Most ILS, particularly catastrophe bonds are floating rate instruments and will ultimately benefit from higher interest rates, as the collateral related returns will boost coupon payments.

The improving pricing environment has been generally driving insurance and reinsurance rates higher and this has especially been prevalent in catastrophe risks of late, due to loss activity and heightened risk aversion.

Legacy portfolio optimisation is an interesting one, as it speaks to better management of portfolios and legacy risk books, which is positive for insurers and reinsurers putting their businesses on stronger footing, making them a better bet, when it comes to risk transfer, but also perhaps driving an ability to consider different forms of risk transfer, as the legacy exposures are managed.

Finally, ESG, a critical piece of the puzzle for re/insurers generally and one that as it gets adopted in the traditional industry, will result in higher ESG quality of portfolios and more chance of ILS investments meeting ESG criteria as well.

Twelve Capital explained its positive outlook for credit and equity investors focused on the insurance and reinsurance space.

“Macroeconomic trends as well as idiosyncratic factors are expected to support stronger insurance fundamentals in 2022, which is positive for both credit and equity investors in the sector. In particular, we see the rising yield environment in the USA and UK, and to a lesser extent in the European Union, as the key positive driver from a macroeconomic standpoint,” the investment manager said.

Adding that, “Higher rates alleviate the capital pressure of legacy life contracts with guarantees (also known as back-book) and support capital releases. Moreover, higher interest rates will also have a positive impact on ongoing operating capital generation (OCG) for both life and non-life insurers as their investment income increases and the capital strain of new business reduces.”

It’s important to note that Twelve Capital also believes that despite the rising yield environment re/insurers remain focused, with of greatest relevance to our readers, “property and casualty (P&C) insurers keep focussing on underwriting discipline.”

Twelve Capital also noted that inflation is a factor, but that this can also be mitigated by passing short-term inflation on to policyholders through repricing.

“Higher long-term inflation (and social inflation) would represent more significant headwind for long-tail lines (such as general liability, D&O, and casualty) although we do not expect it to cause sector-wide reserve strengthening,” the investment manager also explained.

Twelve Capital sees “positive momentum for M&A, disposal of back-books, and investments in technology” with a chance of M&A in the Lloyd’s market and UK motor, while it’s also possible some re/insurance groups could look to break up and simplify themselves, and legacy or run-off activity could help to strengthen solvency and capital remittances.

On reinsurance, Twelve Capital is also more positive, explaining that, “An overall benign pricing environment with hardening rates, a reduced appetite for higher frequency structures, and changes in the overall risk appetite (with higher diversification in some cases, and higher protection with lower retention levels in others) are all supportive factors for 2022.”

Summing up on the fixed income side, the investment manager said, “Strong fundamentals, underpinned by stable earnings and a solid capital position which translate into historically low default rates, support our investment thesis in insurance fixed income that continues to yield in excess of other corporate sectors.”

Further explaining that investments into insurance fixed income can offer “attractive and higher credit spreads than other investment grade sectors.”

“Twelve Capital believes that this excess spread is mostly due to the industry’s complexity for generalist investors,” the asset managed explained.

While on investments into insurance and reinsurance equities, Twelve Capital said, “The reliability of insurers’ cash flow generation and dividend capacity, together with the attractive valuations at which the sector trades sustain our positive view on investments in insurance equity.”

On the equity side, the fact so many re/insurers trade at a discount, compared to the wider market, is seen as an attractive opportunity.

“We believe insurance equities look attractive as they trade at relatively low multiples and are supported by positive sector and macro outlooks.

“The sector’s characteristic reliable yield positions it well against other sectors and should appeal to investors in a still low-yield environment,” Twelve Capital concluded.