Insurance Requires More than Asset Performance
In the insurance arena, asset-management performance is a necessary, but not sufficient, success factor.
The wave of private capital now flooding into the insurance space is driven by enthusiasm around the long-term opportunity to create value by outperforming underlying liabilities. However, what some market entrants fail to appreciate is that, in insurance, the underlying liabilities themselves are constantly changing and therefore require a flexible approach to matching them with assets.
Like any other allocators, asset managers for insurance companies must meet rigorous performance thresholds, monitored and reinforced by overlapping rules and regulations from clients, ratings agencies and government bodies. These asset managers must also meet the unique challenges of asset-liability matching. Not only do the fluctuations of insurance liabilities require constant portfolio fine-tuning, but the added requirement of information-sharing with counterparties often outstrips the resources of regular-way credit investors.
Indeed, there are important differences between being a good asset manager and being a good asset manager for insurance company portfolios. Insurance solutions providers who recognize these differences will carefully vet asset managers for their abilities to deliver not only performance, but what many in the industry call “service alpha,” a more collaborative model of interaction necessary to meet the ever-evolving needs of insurance clients.
Managers who don’t carefully track the nature of the collateral that supports their investing activity may end up making uneconomic or uninformed decisions. Asset decisions that are not properly informed by the duration of the liabilities, the liquidity of the liabilities, or the capital regime that defines the liabilities may be inconsistent with the needs of an insurer.
Change is an unavoidable feature of insurance company liabilities. For example, capital rules may change or there may be spikes in surrenders before policies mature. “A portfolio of liabilities is sort of a living, breathing organism,” says Raj Krishnan, Partner and Chief Investment Officer of Ares Insurance Solutions (AIS) and Aspida. “You can’t take a set-it-and-forget-it approach.”
A real-world example of uneconomic decisions came in the form of the 2023 collapse of Silicon Valley Bank (SVB), which owed its demise to a mismatch between illiquid, long-term treasury bonds and very liquid customer savings accounts. In the wake of a customer run on the bank, SVB was forced to sell the bonds at a loss, until it became clear the bank would not have funds sufficient to cover the withdrawals, and regulators took over.
While the SVB example may be an outlier event, it illustrates the perils of running an insurance portfolio with a significant asset-liability mismatch.
Excellence in insurance asset management, therefore, requires a deep understanding of the liability profile and the investment universe, including how proprietary origination and sourcing capabilities can help ensure perpetual asset-liability matching. Of particular importance is the ability to source assets in the less-liquid, harder-to-reach corners of the credit market. By widening the allocator’s aperture beyond liquid corporate credit, managers are able to source higher yielding assets without compromising on credit quality.
Among the investment opportunities typically seen as beyond the purview of traditional insurance asset management is structured credit. An asset manager’s ability to source and underwrite structured credit can make the difference between performance, and performance for insurance portfolios. Whether the structured assets in question are mortgage-backed securities (MBS), collateralized loan obligations (CLOs) or asset-backed securities (ABS), a unifying feature is large, diversified pools of portfolios of performing assets that generate durable contractual cash flows and have enhanced structural protection.
As a complement to investment-grade corporate bonds, insurance-focused structured credit teams look to originate or purchase equivalently rated assets that have a similar maturity profile. The resulting structured credit allocation is well diversified by underlying collateral and reflects the manager's comfort in utilizing structure and complexity as tools to earn excess spread, rather than taking on additional credit risk by buying high-yield corporate credit.
A manager’s ability to source and underwrite the right assets, and in a timely manner, is reflected in its record of capital deployment, another important metric that impacts the performance of an insurance investment portfolio. Put simply, a manager unable to invest the required volume of capital contemplated in pricing assumptions at the insurance company might not be the right fit as an insurance investment manager.
For insurance solutions providers, the ability to deploy capital is important because these businesses regularly price products on behalf of clients. These businesses track what a manager is actually deploying from a volume, yield, tenor and rating perspective. An inability to deploy capital in a timely manner might lead to a higher cash balance, which creates a cash drag that negatively impacts performance. And compromised performance may in turn negatively impact that insurance company’s competitiveness in the market.
‘Service Alpha’
Given the asset-origination and proprietary sourcing necessary to match a unique portfolio of liabilities, managers need to resource their investment teams beyond what is required for mere return generation. As a higher level of collaboration, “service alpha" is achieved when a manager not only delivers the investment performance necessary to positively contribute to an insurance business’ profitability, but does so in the context of being a strategic partner with elevated communication, idea-generation, data, analytics and accounting support and a thorough understanding of the liability profile. “Service alpha is very holistic in terms of, is there enough interaction between the manager and AIS for us to really understand what the manager is doing and for the manager to truly understand the goals of the insurance company?” says Molly Sheinberg, Deputy CIO of Ares Insurance Solutions.
A field of communication covered within service alpha includes investment compliance, which outlines whether a manager is staying within required guardrails of target investment and risk policies.
The elevated communication is not exclusively around what to avoid but also underlines which innovative approaches to finding alpha might be worth exploring. For example, in the wake of a market dislocation, an asset manager may identify an attractive but temporary investment opportunity that might not be explicitly included in investment guidelines. In the context of strong, fluid communication, that manager should not hesitate to explain the investment idea to their client and determine whether the client has appetite for the exposure.
Rigorously managed insurance companies don’t succeed by dictating investment ideas, but rather by setting standards and being in the flow of the best ideas from the best managers, who are valued for their deep market knowledge and experience investing over multiple market cycles. "During the fallout of the 2023 regional banking situation, our investment teams were raising their hands with ideas," says Sheinberg. "We sat down with our teams to figure out what the best path forward would be during the short-term market dislocation.”
Ultimately, the best insurance asset managers do not take a buy-and-hold approach, rather a “buy-and-maintain” approach. Maintaining requires more attention than holding, as many insurance asset managers can attest. Buy-and-maintain means meeting liability cash flows, understanding risk tolerances around liquidity, ALM and credit, including credit concerns and idiosyncratic risk and being able to pivot the portfolio in the event of a market sell-off or when unique investment opportunities arise.
One of the downsides of maintaining what Krishnan calls a "sleep-at-night" portfolio is an inability to literally consistently sleep at night. He admits: “We’re always worrying about credit risk.”
What Asset Managers Need to Know About Insurance
Ares Insurance Solutions’ Raj Krishnan and Molly Sheinberg discuss the questions that asset managers often have about the liability-centric mandate of the annuity insurance business, Aspida.
Molly Sheinberg
Krishnan: Does manager idea-sharing also come with an obligation to share data?
Sheinberg: Our business is very data-focused, and having reliable data is imperative. Accurate data is an important component of our definition of service alpha and managing an investment portfolio for an insurance company. My view is, no matter how good the asset is, it almost doesn’t matter unless the data is there to support it. The data may relate to asset cash flows needed by actuaries or investment accountants. It may relate to inputs into pricing policies. It could support discussions with stakeholders including reinsurance counterparties, investors, rating agencies and regulators. Data impacts investment analytics. Data impacts how we calculate net investment income for the portfolio. There are so many ways that data is used across our portfolio, it is vital to get it right and get it timely.
Krishnan: You’ve already noted that there are a lot of insurance asset managers out there. What are the benefits of partnering with AIS?
Sheinberg: Insurance assets are sticky if you build the right platform. Ares has a long history of being a credit manager. The firm has credit underwriting in its DNA. It has a long history of sourcing assets on the private origination side. Within that market, there’s a class of investment-grade securities that worked very well with our predictable liability profile, and Ares’ capability to source and understand those markets is important.
Krishnan: How would you draw a distinction between a buy-and-hold strategy, and AIS’ strategy of “buy and maintain?”
Sheinberg: It’s less about buy-and-hold, because you always need to be paying attention. We tell our managers: when you see something, say something. Obviously, we hire our managers for their expertise and investment experience in a specific sector or sectors. But that doesn’t mean just buying. It means constantly seeking to improve the portfolio, and knowing that credit events do happen, and as these shifts take place, we expect our managers to proactively reach out to us. We never want to be blindsided, and that’s what we’re paying our managers to help us avoid.