Stress testing factors - what to look for, what to manage, and what is going well - were some of the key discussion points with Amit Agrawal, Head of Fixed Income, AXA XL, who discussed the topic with Victor Palacios, Senior Manager, Investments & Treasury, EY, as well as a representative from United Educators, in a panel.
Their discussion took place at the Insurance Investor Live | North America event in New York with the full write-up featured in the Insurance Asset Management North America 2024 report.
Stress testing has been on the tip of the tongue for the industry over the past six months as regulators and central banks keep an eye on the ‘higher for longer’ interest rate environment and volatile market.
The angle has been discussed by the industry too. “Stress testing of a portfolio is important, as is bringing the assets and the liabilities together,” said Ruth Farrugia, Head of Insurance Asset Management, MetLife Investment Management, in a recent interview with Insurance Investor.
“Liquidity stress testing means having to maintain that ALM discipline – which is bare bones –this is an important discipline when it comes to insurance asset management,” she said.
Agrawal said that the US mortgage market was still a place of interest for them despite the rule changes and areas that are under more stress, largely because of its size and differing areas one can invest in without getting involved in the more ‘stressed’ parts.
He also gave his views on what insurers should be looking at for their investment strategies in this sphere for the next half-decade. This was especially prescient for US companies where the ESG question remained a difficult one to answer considering the politicisation of it.
Read below to see more of Agrawal’s thoughts.
Amit Agrawal: You could argue that the period we have just been through post-Covid-19 is the anti-Goldilocks: either inflation is too high, or the economy is too weak, and it reverses. In this environment, you have to make sure that you have stress testers in the portfolio under multiple scenarios. We also saw, during the summer months, the correlation between bonds and stocks, which were moving in tandem, so you feel as though everything is happening at the same time – which means you want to ensure you have enough liquidity and resources.
We have tweaked some of the metrics for correlations to see whether under stress testing we can access liquidity and that, in the worst-case scenarios, we do have enough resources.
We want to boost our treasury securities and other liquidity but also at the same time we want to bring new tools into our toolkit to enhance liquidities like portfolio financing, repos, and Federal Home Loan Bank (FHLB), amongst others. We are looking at what other tools we can bring into our toolkit to be able to source liquidity when it is acquired.
Most of our portfolios are sitting with losses, so it is hard to go to the portfolio and try to take those losses to meet your claims or payouts. You need to make sure that you have adequate liquidity, and we do spend a lot of time on that aspect.
Amit: In the US, for sure. I was reading that in the end, whatever rule changes happen, they will lend out your agency mortgage-backed securities in those kinds of assets as opposed to more generally. This was its purpose.
Amit: Over the next five years, the biggest change I see is the inflation environment. Post the Great Financial Crisis (GFC), it took 15 years for inflation to finally turn up – so the big thing is whether we can adjust the portfolio to live with the 3% inflation as opposed to 1% and what it would mean for our portfolio.
We are still working to see whether the steady state is going to be 2% or 3%, and the jury is still out, so the debate rages on as to how you adjust your portfolio. You might need more inflation protection to hedge liabilities from an ALM perspective. We are grappling with more of this strategic asset allocation, ALM levels, and what changes need to be made. We are looking at whether cash should be considered as an asset allocation – which is another debate to consider.
There’s also the question of how you incorporate ESG or impact investing as part of your Strategic Asset Allocation (SAA) or ALM. It is hard to forecast what the market is going to bring in five years, so we don’t worry about that too much; we look more at a given year in terms of tactical shifts. Longer-term shifts are more toward ESG and how we measure and monitor the impact we are having from our portfolios. AXA is a French company, and they are focused on this ESG aspect.
A lot of trends like climate, politics, and globalisation are all inflationary, so we need to look at deflationary trends as well so that there is a cross-occurrence. This means that there will be some more inflationary volatility; so, the question is, how do you address that within your portfolio?
Amit: We keep it simple in that we want the carbon intensity in our portfolio to reduce by 50% by 2030 from the current level. This is the direction of travel, and we need to purge a lot of our energy holdings or carbon emitters. We also want to have a target for how many green assets we own.
These targets are easy to measure, and I feel that anything you do has to be measurable, otherwise you don’t know the impact. One of the big arguments in this area is that you can’t know whether the changes you have made are impactful or not. So, measuring and establishing measurements – as well as continuing to find and improve your data in order to report in this area – is important.
