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Fixed-income portfolio managers face a challenge known as the “core conundrum”, says Guggenheim Investment’s Chief Investment Officer, Anne Walsh. This is due to the current period of historic low interest rates, which begs the question for investors of where to go to find yield?
In a recently released Clear Path Analysis report, Insurance Asset Management - North America 2022, several market experts from insurance groups including Sunlife, Mercer, Liberty Mutual, and AllianceBernstein, explore issues around good asset management in the post-pandemic world.
"Insurance companies have additional conundrums layered on top."
“Our approach to solving the “core conundrum” is in sourcing, researching, and allocating to sectors which typically are not included in the broad industry benchmark index, the Bloomberg US Aggregate Bond Index,” says Walsh. The Bond Index is commonly known as ‘The Agg’, which is sometimes used as a stand-in for measuring the performance of the US bond market.
In addition to this challenge, insurance companies have additional conundrums layered on top, including unique asset liability challenges, increasingly restrictive accounting requirements, dependency on external ratings, and, most importantly, onerous regulatory requirements, she says. “These problems facing the insurance industry are making it harder for life insurers to operate in the competitive financial marketplace,” Walsh adds.
"Persistent low interest rates are a major threat to life
insurance companies."
The US industry body, the National Association of Insurance Commissioners (NAIC), said in 2021 that “Persistent low interest rates are a major threat to life insurance companies, given their rate-sensitive products, such as whole life insurance and annuities, and investments, the large majority of which are interest-earning bonds.”
Insurance companies have begun to hunt for yield amid tightening regulations over the last decade. The declining insurance portfolio yields have led companies to solve the “core conundrum” by seeking out higher-yielding assets in which they had not historically participated, such as structured credit and private credit.
"There are yield-enhancement techniques, such as increasing duration and lowering credit quality, which may boost total returns in the short term."
At the same time insurers are searching for yield, over the past several years the NAIC, as advised by the Securities Valuation Office (SVO), has become increasingly suspect of certain assets classes in insurance company portfolios and predisposed to increase capital requirements on those investments.
There are solutions, though, she says. Fixed-income markets are underrepresented by The Agg, and there are traditional yield-enhancement techniques, such as increasing duration and lowering credit quality, which may boost total returns in the short term. “But easy financial conditions may be masking the risks associated with potentially damaging long-term effects of reflating the economy through debt accumulation,” she says.
"Insurers must price new products with achievable targets
and margins."
“We believe there is a more sustainable strategy that relies on the ability to uncover value in predominantly investment-grade securities outside of the traditional benchmark-driven framework.”
To truly fix it, Walsh believes, insurers must price new products with achievable targets and margins. There must be clear communication across the various business units from design to sale.
Insurers need to be more active in voicing their concerns about regulation and not wait on a few voices to drive the narratives and they must take advantage of the unique nature of their liabilities. “The illiquidity of their liabilities allows for insurers to similarly take additional illiquidity risk on the asset side of the balance sheet, a strategy that has been successfully deployed with other institutional investors with long-lived liabilities, including endowments and foundations.”
