Episode 69: Investing for Insurance Companies: Prepare for the Worst and Expect the Best
Jamie Crapanzano of our insurance portfolio management team and Ann Bryant of our insurance strategy team join Macro Markets to discuss issues and trends in fixed-income markets—those that apply to all investors as well as those that are specific to the industry.
This transcript is computer-generated and may contain inaccuracies.
Jay Diamond: Hi everybody, and welcome to Macro Markets with Guggenheim Investments, where we invite leaders from our investment team to offer their analysis of the investment landscape and the economic outlook. I'm Jay Diamond, head of thought leadership for Guggenheim Investments and I'll be hosting today. Let's get started. Extreme economic uncertainty and volatility has spiked the market and it's challenging investors everywhere. Portfolio managers running insurance company assets are no exception to this challenge. Now insurance company management is woven into our DNA here at Guggenheim, where the majority of our assets under supervision is for insurance companies. So, here to discuss how we are preparing for the worst and expecting the best for insurance company clients to continue in generating attractive returns are Jamie Crapanzano, a managing director and a leader of our insurance portfolio management team, and Ann Bryant, an actuary and industry veteran who is on our insurance strategy team. Welcome, Jamie and Ann, and thank you for taking the time to speak with us today.
Ann Bryant: Thank you. Jay, it's a pleasure to be here.
Jamie Crapanzano: Thanks, Jay.
Jay Diamond: Jamie, I'm going to start with you. We're in an environment of economic uncertainty, policy uncertainty, slowing growth, and ongoing spikes in market volatility with each turn of the news cycle. So with the caveat that things are changing rapidly, what's our current outlook on the economy, inflation, monetary policy, and fiscal policy?
Jamie Crapanzano: Sure. And again thank you so much for having us. And thanks so much for that caveat. Because things really are changing quite rapidly. So, you know, at the risk of having any macroeconomic view completely upended by breaking news out of Washington, I will share that we think the U.S. economy is heading for a slowdown this year, with growth expected to just barely stay positive. And a big reason for that is the uncertainty around the new trade policies coming out of this administration, particularly the tariffs that were announced in April. These are expected to be a major shock to the supply chain, and that's starting to weigh on both consumer spending and business investment. Consumers, especially in lower income households, they're pulling back, their real incomes are shrinking, they’re growing more cautious. And at the same time, inflation is expected to creep up to around 3.5 percent this year, largely due to a jump in goods prices from the tariffs. So while we think this spike could ease as the economy cools off, we have some concerns that overall inflation expectations may stay elevated, which could make things tricky for the Fed. Even though growth is slowing, the data, particularly as it pertains to the employment market, has remained fairly resilient and this has pushed the Fed into this kind of wait and see mode on rate cuts. Where the market had been pricing in the expectation for a June cut, that's now been pushed to September, unless the Fed is pushed to act sooner, and they would have to see some evidence of a sharper downturn in the data. Given the backdrop of inflationary concerns, they may stay cautious longer than people expect.
Jay Diamond: So, Jamie, given this background, what portfolio strategy or allocation decisions are you making to help your insurance company clients prepare for the worst while still capturing opportunities? What looks attractive to you right now and what's your view on credit risk in this environment?
Jamie Crapanzano: With all the volatility, it's definitely helpful to zoom out and keep zooming out until things make sense. And despite all of the noise, our view and our strategies around that view, they've remained consistent. We maintain we are in a trading range in rates, and just using the ten-year Treasury as a guide, that's roughly between 3.5 and 4.5 percent. So when rates approach the upper bounds of that range, it makes sense to add to sectors we like: agency mortgage-backed securities, high grade structured products like ABS, non-agency RMBS. We really want to tilt investments towards higher quality. And higher quality can come in the form of structural seniority or rating. We like higher quality, higher carry instruments that can give you some cushion in a spread widening environment. And this is not a new theme for us. This up and quality narrative, that's one we've embraced for some time now, given how tight spreads have been. If you recall, we came into the year at historical tights. Yes, we had some volatility come into the market and while that did lead to wider credit spreads, spreads are not exceptionally wide on a historical basis. And given that we're in a new regime of elevated volatility, we think there's potential to further widen from here. At the same time, all-in yields remain attractive on a historical basis, and that's really driven by interest rates. So, we like yields here. Spreads are wider than they were but may still have some room to go. And we have this weakening macroeconomic backdrop which will likely prompt some action from the Fed at some point. So given that landscape, we think higher quality paper makes sense. And particularly for insurance clients, higher quality, longer paper, corporate paper, for example, which again has yields that look attractive on a historical basis, gives us the opportunity to extend duration to lock in those yields where we have these longer biased accounts. We, of course, also want to be mindful of this weakening macroeconomic backdrop, which means being selective with regard to some of the more sensitive areas of the market: manufacturing, consumer cyclicals, and certainly exercising caution with regard to adding below investment-grade paper or even kind of cuspier credits that might be IG now, but may end up getting downgraded in the event of a deterioration in the broader economic picture.
Jay Diamond: Now, Jamie, we're going to go into some of this a little bit later, of course, but how would this strategy that you've just described be any different for a non-insurance company client?
Jamie Crapanzano: I think a lot of the themes are consistent across the platform, certainly the higher quality, higher carry tilts within insurance. Our life insurance mandates tend to be income focused with a longer duration target. So naturally a higher percentage of our purchases tend to be longer. These are also portfolios that are willing to give up some liquidity in exchange for yield. So that can open up the investment universe to more off the run options like military housing or other more esoteric private investments, provided that there's still capital efficient. A P&C portfolio on the other hand, they tend to have liabilities that are shorter and the assets that match those liabilities need to be shorter duration with a relatively high liquidity, while those portfolios are more akin to our non-insurance mandates, they're benchmarked to a public index focused on both income and capital appreciation. But these two, they tend to be a bit more constrained from a gain loss perspective and opportunity set perspective. For example, in insurance, we're often less able to use derivatives to efficiently express views.
Jay Diamond: You know, that's a great segue. So to turn to you Ann, you're an industry expert, what are some of the industry themes and trends that are affecting P&C insurance companies now?
Ann Bryant: Well, thank you, Jay, and I appreciate that. Also, just to acknowledge Jamie giving that background of the macro trends and just the volatility that is happening, that is, of course, affecting all types of insurance companies. But even really, despite that volatility and despite some of the other macro challenges like climate change and inflation, still, property casualty companies have solid earnings, including very solid net investment income. This is for both the personal and commercial lines. And this is really due to disciplined underwriting that they have in place and also the rate increases that they've been able to get through, which aren't necessarily great for the insured population, given that they have to pay a bit more. But it has led to strong earnings for the insurance companies and to strong capital positions as well. On the investment front, the trends, you know, have been a little bit subtle. They continue to have conservative liquid portfolios, as was alluded to earlier, and then some other trends. They do have higher new money yields in recent years or recent months really, than they have in the past due to the increase mostly in rates, and then also the exposure to higher risk assets, which is not huge. But even so, it's been reduced a bit in recent months, along with a slightly increased allocation to high quality private assets. So even though P&C insurers prefer liquids or the most of their portfolio is in liquids, they do have some room for illiquid assets as well, and they are taking more advantage of that capacity more recently.
Jay Diamond: So you've pegged my next question Ann, which is the P&C companies have certain operating and competitive dynamics. But what are the trends right now for life companies?
Ann Bryant: Yeah. So for life companies, the story is different. The trends are very long. They've been long and coming and kind of related to the very low-rate environment that persisted for so long, that led to the search for yield and it also led to the rise of private equity backed insurance companies as major players in the annuity space in particular. Rates are now really at a point where they are favorable for annuities, where policyholders are benefiting from those higher rates. And then also the equity market volatility actually helps annuity sales, because there are products that are available that help to buffer that equity volatility while still allowing policyholders to capture some of the upside. So all of that has led to a real increase in annuity sales that is likely to persist. Along with that, because of this rise of the private equity backed insurers and the types of assets that they tend to originate, that has really caused other, more traditional types of insurance companies to also search for yield and to look for different types of asset strategies. So, it has caused a fundamental shift in the way assets are allocated into more private types of assets, more nuanced and complicated types of assets. And then that is, this also with the private equity firms and just the increase in annuity sales, that has led to more offshoring of reinsurance. So the reinsurance deals help the capital position of the traditional company. So that is one of the reasons for reinsurance, is that the company writing the business can then free up some capital if they reinsure part of their annuity blocks. And so that reinsurance is also offshore reinsurance as also been a major long-term trend that we've seen in the life industry.
Jay Diamond: So for the insurance industry, regulators play a very important part in determining how these companies are behaving and operating. So how are regulators reacting to some of these developments?
Ann Bryant: The U.S. regulators, the National Association of Insurance Commissioners, they have, seen an uptick in private assets and in these structures that maybe they're less familiar with, or they just can't see through the structure. So that has caused them to require additional reporting requirements and additional tests for the assets, such as the principles based bond definition that was put into place recently, and then some things on the actuarial side as well. There's something called actuarial guideline 53 that has required more disclosure about the assets and the reinvestment need and the robustness and resilience, really, of the investment strategy. So I think because of all of these tweaks and additions to the requirements and to the risk based capital formulas themselves, recently a new committee was put in place called the RBC Model Governance Task Force, and their role really is to put guiding principles in place to create a framework for additional RBC changes and to also make sure that all of these changes are in line and not conflicting with one another. So, as you might imagine, the NAIC has a fairly complicated committee and task force structure, and this committee is meant to bring everything together and make it cohesive and a little more proactive as well. So I think that's a good development. And then on the Bermuda side, Bermuda adopted solvency standards about ten years ago, which allowed then for them to become a reciprocal jurisdiction for the United States and for the U.K. And so they've seen a real influx of business in Bermuda. And as a result of that, they've also seen some things that they maybe were less familiar with in terms of asset classes and structures. And now they too are putting additional requirements in place to really drill down on those assets so that they can make sure that they have their arms around the risks.
Jay Diamond: Well, great. And for those of you who may not be aware, RBC stands for risk-based capital. Jamie, insurance companies, looking at their portfolios, have not been immune from the challenges facing real estate over the past several years. In fact, they're very big participant in the sector. So what are you seeing in the real estate sector with regards to, insurance companies right now?
Jamie Crapanzano: That's a good question given real estate is still top of mind as we look at the portfolios and consider risks for insurance companies. As real estate investors, they've had to contend with the trifecta of rising interest rates, reduced demand, particularly for office properties, and tighter credit. All of that is creating stress across their portfolios. And on the real estate equities side, higher interest rates have driven cap rate expansion, which in turn has led to lower asset valuations. And on the debt side, many borrowers are struggling to refinance, which has really led to a wave of amend and extend deals in order to avoid default. In more stressed areas like office, which really continues to suffer from a demand problem, we're seeing an increase in defaults at maturity situation where borrowers just can't meet new lending standards and given that liquidity in the space is tight as well, it can be really quite difficult to maneuver out of these positions, especially in this current environment. Insurance investors have been rethinking their strategies, what they want to do in the space, whether that's cutting back or shifting towards more opportunistic profiles. They're just reevaluating. And at the same time, for those with capital to deploy, this environment is creating opportunities. You've got higher yields, you've got tighter terms, so if you are able to deploy, it really can offer a defensive way to get income into the portfolio. So it's not without opportunity.
Jay Diamond: Is there a hesitancy to crystallize any losses in real estate sector for insurance companies?
Jamie Crapanzano: I think there's always an insurance, a hesitancy to crystallize losses. And again, it's a wait and see. Everybody was just trying to get to the point where you could breathe a little bit with regard to rates, and you're waiting for the Fed, and waiting to get that lift off, and in some ways, people are still waiting. And that's this whole amend, then extend, then pretend and I think that's true of the insurance company as well. Nobody ever likes to take a loss. But if you can just get through and rework the loan if you need to, but then also be prudent about the additional dollar and where you're deploying in the space. So certainly, I think there's a lot of wait and see and we would say hope is not a strategy, but there is a little bit of hope there too, that you get a bit rescued with regard to interest rates.
Jay Diamond: Now, Jamie, we've also observed the trend where insurers are increasingly investing in private credit. What's driving this trend and how does their risk rewards in this sector compare to public credit investments?
Jamie Crapanzano: The rise of insurer allocations to private credit, it's really part of a broader strategic shift. It's one where insurers are not only pursuing yield, but they're also forming deeper partnerships with asset managers, particularly private equity firms. Ann touched on this a bit and the goal is enhance your long term capital efficient returns. And in general, private credit tends to provide higher yields than comparable public securities and that's due to illiquidity premium and the custom structuring that's a feature of these type of investments. And in today's environment where spread compression in the public markets has been significant, insurers see private credit as a way to improve portfolio income without materially increasing credit risk. Private credit can allow for tighter covenants, senior secured positions, and a more tailored underwriting, which gives you a better risk-adjusted exposure. These are assets that can also be structured to be longer dated with predictable cash flows, which can then align well with asset liability matching needs there. Because it tends to be higher yielding, private credit is often more capital efficient versus public securities with similar ratings. And another key driver behind this trend and an important driver is this increase of these strategic partnerships with private equity firms, particularly in the form of block reinsurance or acquisition deals. This is where you have an insurer, but they'll see like a large block of legacy liabilities. These can be fixed annuities or life books that are in run off, and they'll feed that to an entity that's backed by a private equity firm. And these firms, in turn, manage the assets that are matched to the liability blocks. And in doing so, they often allocate a significant portion of investment to alternative credit and private lending strategies. That's what they know. That's what they do. And they're kind of happy to allocate there. And this model allows insurers to gain access to capital while leveraging the asset origination capabilities of the PE firms to improve their investment income. So, it ends up being a symbiotic relationship. You asked about the risks to private credit, those tend to be centered around illiquidity and limited price transparency. Right? A little bit of an opaque market there for sure. And it also requires a reliance oftentimes on external managers. This isn't really the type of thing that an insurance company is likely to do in-house. But when you have a private credit manager who can execute the strategy well, like a Guggenheim, these risks, they can be more than offset by enhanced returns, which is why insurance companies do find them so attractive.
Jay Diamond: So Ann, Jamie was talking a little bit about portfolio allocations. How do insurers determine the appropriate target allocations for various asset classes, including, as she discussed, real estate and private credit and other asset classes and sectors? And what's the rationale behind determining allocation of targets?
Ann Bryant: Insurance companies, just as it is in keeping with the theme that we have, they really prepare for the worst and look at all of these different scenarios and what could happen in a wide range of, macroeconomic scenarios, both on the asset side and the liability side. But in doing so, they also look for opportunities where they can capture upside potential as well. So maybe making the best use possible of their illiquidity capacity, and just pushing on other constraints and evaluating those tradeoffs. So that's the overarching theme. Then considerations that insurers have when they're looking at their strategic asset allocation: first, considering what are their objectives, what really are they trying to maximize, and how are they measuring that? And then, what are their risk tolerances?
Ann Bryant: And then again, modeling their assets and liabilities together to make sure that if rates go up or down, the movement in both the assets and liabilities produces the best outcome possible under those objectives and tolerances. And then there are other constraints imposed upon the insurance companies too, that affect the strategic asset allocation like regulatory limits, accounting dynamics, some internal constraints too, just in a prudent person rationale, and then also concentration and diversification considerations. Also, insurance companies want to consider the time horizon so that they can avoid forced sales of assets and also capture opportunities. So, a reasonable time horizon to really let something come to fruition. In addition to modeling the strategic asset allocation and scenarios, insurance companies also want to overlay practical considerations, such as what is their access to certain types of asset classes, and how will they be able to source those? Will they need to use external managers? So, what is the practical limitation that they have there? And then, more broadly, also just considering what is the role of private assets in their portfolio? Sometimes people refer to the private assets really as the bricks, because those kind of are what they are. And once those are in place, you own those until until they're paid back, versus the public assets, which are more the mortar and can be used to fill in the duration profile or other aspects of the portfolio that the insurer desires.
Jay Diamond: That's how the insurers determine target allocations. But what are some of the considerations in actually implementing the target allocations?
Ann Bryant: After establishing the strategic asset allocation and the targets and the limits, I think there's some comfort there then about what the outer bounds might look like. And so the tactical asset allocation considers the specific opportunities, the timely opportunities, and within that tactical allocation and framework, insurers will often develop relative value type of rules or parameters, that determine tradeoffs among certain types of asset classes. Like, how much is illiquidity really worth? How much additional spread is necessary on an illiquid asset of similar credit quality and duration as compared to a liquid asset? What is one notch of credit quality really worth? And so tactical allocation is about making those day-to-day allocations based on the opportunities that are available and understanding those relative value tradeoffs and then also understanding how long it might take to ramp private assets. So that's another practical aspect of actually implementing a strategy—that it does take time to ramp into certain types of asset classes.
Jay Diamond: Well, thank you. And by the way, thank you both for spending so much time with us today. But before I let you go, Jamie, as I noted at the top of our conversation today, you're a portfolio manager on our insurance company portfolio management team, which within our firm is a separate special unit within our investment process. Why have you organized it in this way? And what's the value of it to the clients?
Jamie Crapanzano: Yeah, we think this is an important distinction that while our investment themes and our overall process are consistent across the firm, there are nuances of insurance portfolio management, whether it's the customer liability benchmarks, the regulatory constraints, the idiosyncratic needs of each client. We think this requires a specialized team to really take all of these aspects into account. Every asset that is contemplated for our insurance portfolios is really viewed through an insurance asset management lens. Does it fit the liabilities? Is it capital efficient? How will it be treated by the rating agencies? Because the strategies are specific and unique, and the regulatory environment is constantly evolving, and we think it deserves a dedicated team and a team that it's not just focused on portfolio management, but on ongoing relationship management as well, so that we can really be best positioned to not only address today's needs, but to anticipate how those needs may shift in the future.
Jay Diamond: And are you completely separate from the institutional investment team here at Guggenheim, or is there more integration than you would expect?
Jamie Crapanzano: I think where it counts, there's a lot of integration. We have the view that's determined by the CIO. We work with our macroeconomic team. All of the broad themes, whether or not we, on a high level are choosing to be overweight or underweight duration, our view on rates, our view on spreads, that's all the same. But then it's how we apply within the individual mandates and what we can do, what we can't do and how things fit, that's a little bit different.
Jay Diamond: Again, thank you all very much. But before I let you go, Jamie, do you have any final takeaways that you'd like to leave our listeners with.
Jamie Crapanzano: In this market environment it’s easy to get distracted. There's a lot of noise, there's a lot of headlines. But if you can stay focused on your objectives within the bigger picture, there are also a lot of opportunities. We're still making the joke that the income is back in fixed income. There's a lot of attractive opportunities out there. And if you come back to the theme of this podcast, here at Guggenheim, you know, we genuinely believe that preparing for the worst and expecting the best, it's not a contradiction. It really is the definition of long-term portfolio stewardship. Our goal is to build portfolios that don't need a perfect macroeconomic backdrop to perform. And that's what we've pledged really to continue to do on behalf of our clients, regardless of the broader economic landscape. We want to, again, thank the listeners. Thank you for tuning in and for your support, and we hope we can continue to be a resource to you. Please share any feedback or any questions that you might have.
Jay Diamond: Oh, perfect ending. Thank you very much again for your time, Jamie, Ann, I hope you'll come back and visit with us soon. And thanks to all of you who have joined us for our podcast. If you like what you are hearing, please rate us five stars—it’s how people find out about us. And if you have any questions for Jamie, Ann, or any of our other podcast guests, please send them to MacroMarkets@GuggenheimInvestments.com, and we'll do our best to answer them on a future episode or offline. I'm Jay Diamond and we look forward to gathering again for the next episode of Macro Markets with Guggenheim Investments. In the meantime, for more of our thought leadership, please visit GuggenheimInvestments.com/perspectives. So long.
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