What a recession would mean for insurance investment managers

Insurance companies have done well at weathering economic storm after economic storm in recent years, according to Rich Sega, global chief investment strategist for Conning.

“From what I’ve been able to observe, the industry has done a pretty good job at weathering at the least the early part of [this economic downturn],” Sega said. He added that the economic conditions could become more challenging heading into 2023, despite a third-quarter rebound in the US economy, which S&P Global Ratings described as a “last hurrah” rather than a clear indication of economic recovery.

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Sega believes the US is “headed for recession,” in part because of the central bank’s interest rate policy, but he doesn’t think it will be a “long or deep recession” if the US can avoid more negative drag on growth. Sega sat down with Insurance Business to explain what a recession might mean for insurance company investors and/or portfolio managers in the coming months.

“The stock market has been very volatile recently, with big swings in both directions – mostly reacting to the Fed’s policy and inflation, and more recently reaction to election projections,” said Sega. “The fact is that we may have several recessionary quarters (periods below target and maybe even below zero growth) – that will crimp earnings, which means earnings support for current stock market valuations is weak.

“At the same time, we have the upward pressure on interest rates and the Federal Reserve trying to tame inflation … so, if earnings are going down and interest rates are going up, that’s tough on equity valuations.”

Regarding fixed-income securities, Sega described 2022 as “an absolute disaster” for any investors looking for a total return from long-term bonds. While he said the market “looks lousy,” Sega believes insurance companies with long-tail liabilities and long bonds can meet their obligations if they practice good asset liability management (ALM).

Bond duration is one measure of portfolio volatility. It is the weighted average of the payments received over time, discounted to the bond’s present value. If a portfolio is “overweight” or has a “long” duration, then it will typically underperform in a rising interest rate environment, and vice versa for “underweight” or “short” duration portfolios.

“Property and casualty insurance companies tend to own much less duration than life insurance companies because of their liability structures,” Sega told Insurance Business. “While rates are still going up, that’s good news for shorter duration companies that have positive cash flows.

“The problem comes on the liability side of the balance sheets, where it’s really a double whammy. Insurance companies project inflation out and build it into their pricing, but if inflation comes in a lot higher than that projection, then they have more adverse loss developments. It’s hard to cope with increased severity and frequency in products that you’ve priced in the past, so that stress on the liability side is where insurers must focus when inflation is high – and there’s not much that portfolio managers can do about that.”

Assessing the big picture, Sega thinks inflation is “rolling over” but it will take some time, and he does think the US will enter recession in the coming months.

“Hopefully, we don’t precipitate a credit crisis,” he said. “A short and shallow recession shouldn’t threaten either corporate or consumer credit. I think balance sheets are in pretty decent shape, which is one of the reasons why we think the recession won’t be very long or very deep.”