Macro Markets Podcast Episode 52: Fixed-Income Investing for Insurance Companies (and Listener Mail)
Jamie Crapanzano, a member of our insurance portfolio management team, joins the podcast to discuss the distinctive aspects of fixed-income management for insurance companies and provide an update on bond market relative value.
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. We have a very exciting guest with us today. We also have some listener mail to answer, which I hope everyone will stick around for, but let's get right to it. Here at Guggenheim, we have insurance company investing in our DNA. Almost 60 percent of our $234 billion in assets under management is for insurance companies. So here to discuss investing for insurance companies is Jamie Crapanzano, a managing director and a leader of our insurance portfolio management team. Welcome, Jamie, and thanks for taking the time to chat with us today.
Jamie Crapanzano: Thank you, Jay. I'm a big fan of the show and I'm very happy to be here with you today.
Jay Diamond: Always good to hear that. Now, I want to begin with what you do here at Guggenheim Investments, where you are a portfolio manager on the team that manages assets for our insurance company clients. Our main questions today are going to revolve around the difference between managing assets for insurance companies as opposed to non-insurance clients, and where they're the same. So to begin, Jamie, tell us about what kinds of insurance companies we have as clients.
Jamie Crapanzano: Sure. Our insurance clients are a mix. We've got clients at each of the major “food groups” of insurance, if you will--life, P & C and health, and each one of these relationships is customized based on the individual client’s needs and where they’re looking to us to add the most value. With that being said, there are some common themes within each client type with regard to how we structure and manage the portfolio to best align with the goals of the investment mandate.
Jay Diamond: So for those listening, P & C is property and casualty. So, what are the goals of an insurance company from an asset management perspective, and how might they differ by the type of insurance company?
Jamie Crapanzano: At a high level, insurance asset management exists to service liabilities, which are the policies that the insurance companies have written to their customers. The profile of those liabilities is what helps determine how the portfolio of assets should be structured and managed on an ongoing basis. Life insurance companies, for example, due to the very long-dated nature of their liabilities, tend to be better suited for longer-duration, income-oriented portfolios, while, in contrast, the liability profile of the P & C and health companies is shorter, given that these policies tend to turn over more frequently and can have payout schedules that are less certain.
Jay Diamond: Now, this might seem like an obvious follow-up, but how do these goals differ from non-insurance company clients?
Jamie Crapanzano: Again, it really comes down to the liabilities. When you are trying to get your assets to match a specific liability profile, in some cases, matching specific cash flows to expected payouts by year, you end up with requirements and constraints that you're less likely to see in clients that don't have that same need. So, it's really that the specificity in there of the liabilities that really kind of differentiates these types of portfolios.
Jay Diamond: So in general, what are you doing in the portfolios for these clients to achieve these goals?
Jamie Crapanzano: For life insurance clients, given the long-duration nature of the liabilities, the goal there is to increase the value of the portfolio over time by maximizing yield while opportunistically realizing gains and mitigating losses along the way. So, rather than engaging in frequent trading, we employ a yield-focused strategy where we invest in assets that have the potential to supply consistent income, and we concentrate on sectors and securities that deliver the best carry for a certain level of risk at any given time. Additionally, the longer nature of the liabilities typically means these portfolios have lower liquidity needs, so that allows us to invest in more structurally complex areas of the market that tend to provide excess yield for a given risk profile due to their relative complexity. On the other end of the spectrum is a strategy that's more total-return focused, which is suitable for clients with shorter liability profiles, like the ones we mentioned, P & C and health. Here, the liabilities are shorter, given that they tend to turn over more frequently, and the investment portfolio has to be more actively managed as a result. These often tend to be benchmark-driven strategies, and, in addition to yield, portfolio return is also comprised of capturing price fluctuations through trading activity. The shorter nature and less-certain payout schedule of the liabilities also translates to a higher need for liquidity in the portfolio, resulting in a smaller allocation to less-liquid sectors.
Jay Diamond: What kinds of choices will you make as a portfolio manager for an insurance company client that you might not make with a non-insurance client?
Jamie Crapanzano: Sure. So, portfolios that that do have those lower liquidity needs – we’re thinking about our life clients there -- we have an ability, again, to focus on these complex areas that do over time really provide excess yield. These are investments like esoteric ABS, private placements, military housing. These are the less-trafficked areas of the market, and these types of investments tend to require more work to kind of evaluate and manage. Here at Guggenheim, we’ve always preferred doing more work rather than taking more risk for a given level of return, and when you have the luxury to hold an asset to maturity, you can really focus on getting paid as much as possible and as safely as possible.
Jay Diamond: And so how would you make a decision for a non-insurance client, so vice versa?
Jamie Crapanzano: So a non-insurance client, depending again on the needs of the portfolio, they may not be able to be in as many of these types of securities. They may have different liquidity needs and they may be run closer to a benchmark. And you’ve got to be in those areas if you’re restricted to a closely benchmark profile. So, in insurance, and again, coming back to life because this is especially in life where we don't have the frequent turnover, it's less about being benchmarked to a public index, and it's more about the idiosyncrasies of what that company needs and their specific liability profile. So it kind of frees you up a bit into getting these more interesting, for lack of a better word, or complex assets into the portfolio that will generate better returns over time.
Jay Diamond: Is the sell discipline different for insurance company portfolios?
Jamie Crapanzano: Yes and no. The sell discipline is consistent across all of our portfolios here at Guggenheim in that sellcandidates can generally be classified in one of two ways: credit-related or relative value. A true credit-related sell is a sell regardless of where it is held. It's a credit that you are concerned about that you want to exit. We're mindful of the fact that we often have loss-constrained portfolios, especially in insurance, right? So, we may work to kind of mitigate the effects of the sell with other activity in the portfolio, such as offsetting it with a gain. But the discipline to arrive at that sell decision is the same across the firm. And that consistency is really something that we pride ourselves on here. In contrast, relative value sells, they can be different across portfolios because their attractiveness is really dependent on the details specific to the portfolio in which they are held. For example, selling a bond that has significantly appreciated in price may be less appealing when it's held in an irreplaceable book yield in an income-oriented portfolio. So, it really just depends on what makes the most sense within the context of the investment mandate and where the asset is held and the details of the portfolio.
Jay Diamond: Now, we've been in a rising rate environment for the past couple of years, but rates have been fairly rangebound recently. So how in general has the higher rate environment affected insurance companies?
Jamie Crapanzano: Generally, higher interest rates are a positive development for the industry. They translate into higher investment income and take some of the pressure off of insurers to reach for yields by having to then invest in riskier assets. Insurers essentially engage in a spread business, meaning they make money from the difference between investment income and the amount that they have to pay out on their liabilities. So, they benefit not only from earning more income from higher yields, but then they can also offer higher crediting rates, which makes their products more competitive and more attractive. While higher interest rates are great for yield on new money, though, they do have a negative effect on the mark-to-market valuations of existing assets and portfolios, and that affects portfolio management decisions on any position that's being contemplated for sale prior to maturity. Given the increase in rates that we saw over the course of 2022 and 2023, investment portfolios can have a significant amount of unrealized losses on the books that insurers are extremely reluctant to crystallize. This is especially true of longer-duration portfolios, which are more sensitive to interest rate changes and will naturally have a higher percentage of assets purchased during different and potentially lower interest rate environments. So, it really presents a portfolio management challenge in that you want to participate in this higher interest rate environment via new purchases, but funding the purchases through sales of existing assets can be unpalatable where outsized losses are involved.
Jay Diamond: And do insurance companies always have inflows of capital from new business, or is the only source of capital for participating in new opportunities coming from the existing portfolio?
Jamie Crapanzano: Yeah, it's a mix. And so clients that are actively writing new policies, yes, in general you can expect some inflows there. But those inflows also can get swept out and used for other operating expenses at the insurance company. Fixed income--great thing about fixed income is there is an income component, so you do get some passive income there via coupons and principal, so that's also available for reinvest, but it depends. Yes, we often will see inflows from policies if they're actively writing policies, but that cash can just as easily come out as it comes in. So, there are times where we do have to kind of fund our own kind of continued purchases.
Jay Diamond: I imagine in the insurance world, there are different regulatory and accounting issues to contend with. Any that you want to share with us right now that are kind of top of mind as you do your job?
Jamie Crapanzano: That could be a subject of an entirely separate podcast, but with regard to insurance companies, there's always lots of regulation involved, and it's really in place to protect the policyholders. People hand their money over to an insurance company expecting to be covered when they need it most, and the regulation is there really to help ensure that that's the case. At Guggenheim here, we're primarily concerned with accounting and regulatory aspects that affect the insurance company’s assets, and accounting and regulation really go hand in hand. Accounting impacts reporting, which is essentially: which schedule an asset ends up on as part of an insurance company’s filing. And that in turn impacts regulatory items like risk-based capital charges, which is the amount of capital that an insurance company has to hold against an asset in order to maintain that risk in the portfolio. So, there’s lots of things to consider when selecting assets for insurance portfolios within that regulatory and accounting space that’s beyond just kind of earning income and returns on your investment.
Jay Diamond: So with risk-based capital, are you suggesting that you might have limits on how much you can hold of a particular risk category because of how it will affect capital?
Jamie Crapanzano: Yeah, that’s exactly right. And the riskier you go, the more capital you have to hold against it at the insurance company level. So, where things are bucketed and where things are rated really becomes an actual capital decision for an insurance company. So, it's very meaningful, and a lot of that is driven by regulation and accounting.
Jay Diamond: Most people are familiar with investment guidelines of a mutual fund or a separate account. This is essentially an investment guideline for insurance companies.
Jamie Crapanzano: So we have investment guidelines—the mandate and the guidelines, and then we have that additional layer of state regulatory--insurance companies are regulated at the state level. And so, we have those additional kind of concerns to think about when we manage these portfolios.
Jay Diamond: Jamie, before you mentioned liquidity and how an insurance company is able to perhaps invest in less liquid securities. Now, we've seen a significant growth in private credit recently, which is a less-liquid sector. Has the insurance industry been stepping into this market?
Jamie Crapanzano: Private credit really started as an investment option for insurance portfolios during lower interest rate environments, when insurers were really struggling to add incremental yield. However, it continued at a pretty steady clip, even as rates and all-in yields in the public markets have risen. So, insurance companies are well accustomed to the tradeoff between liquidity and yield, which makes private credit a natural fit. This trend, however, has been accelerated by the material interest that private equity firms have taken in the insurance sector. Besides the fact that insurance assets are stable, PE firms believe that they can boost investment in yields via capital-efficient private credit investments, and their participation in the sector has been the driving force behind several M&A and reinsurance deals that we've seen lately. This has had the effect of pushing all insurers, even those not affiliated with PE-backed firms, into private credit as a way to keep up, since no one wants to be left behind in terms of the amount of product that they're able to underwrite, so that incremental yield is very important.
Jay Diamond: And where does private credit fit on the risk-based capital spectrum?
Jamie Crapanzano: That really depends, and that is where the art of structuring comes in, and we spend a lot of time thinking about that. And when we contemplate a private credit investment for insurance, we think about how it can be best structured so that it is most accretive from an RBC standpoint, so we spend a lot of time thinking about it and it's really specific to each investment.
Jay Diamond: So, what are some of the areas of concern right now that insurance companies have, or you have as a portfolio manager for insurance companies?
Jamie Crapanzano: Yeah, I think the one that has come up and kind of continues to be a concern is commercial real estate. It's a concern for insurance companies, and rightly so, given the stress that we continue to see in the sector due to elevated interest rates and, really, a changing demand profile, particularly within office. The fact that within CRE, even less-liquid investments like commercial mortgage loans can constitute a meaningful percentage of invested assets for insurers, call it 15 percent or so on average, so it can be a meaningful part of the book. We’ll definitely keep things like Refinancings and individual LTV dynamics of the sector. We expect that to kind of be an ongoing focus for insurers as we see what happens with rates, and see things develop there, office particularly. We think that there's still room to the downside there.
Jay Diamond: Is it merely a question of surveillance of your existing portfolio or stepping back from new investments?
Jamie Crapanzano: I think commercial real estate is a broad area of the market. We have traditionally for quite some time avoided conduit CMBS. That's been an area of focus that we have not been active in a very long time, largely because of the tilt towards office. That hasn't been an area that we've been incredibly interested in, so there's not much different to do there. We've always kind of avoided it. Where we have had interest and continue on a case-by-case basis is CRE-CLO, so that can be more interesting to us. And even within commercial real estate broadly, we definitely still like industrial complexes. We like warehouse deals, things of that nature skewing more industrial rather than office. So, I think like everything in this business, it's a case by case basis, and you really want to be diligent with your underwriting and want to be diligent with the risks in the portfolio. But thankfully we weren't overexposed on CMBS conduit, we weren't overexposed in those areas, and at this point, we're comfortable with what we own.
Jay Diamond: Turning a bit to the market environment, what's the firm's view right now on growth and inflation and monetary policy going forward?
Jamie Crapanzano: We expect growth. We talked about growth measured by real GDP to slow to about 2 percent this year, and 1.5 to 2 percent into 2025. We're seeing a bottoming in manufacturing data, and we expect that that should provide a bit of a cushion to what may potentially be a cooling off in the services sector. It looks like the peak impact of Fed tightening on the economy is behind us, which reduces recession risk, but we remain attentive to sectors of the economy that are really kind of struggling with rates--again, commercial real estate, small businesses. After some good progress in bringing inflation down last year, we've really seen three hot inflation prints to start the year, but we do expect this to be short-lived and expect inflation will fall further, especially as rental inflation continues to decline. That's the big kind of number we're watching. We think once that happens, the fed will have leeway to cut rates and our base case right now sees two rate cuts this year and five cuts next year.
Jay Diamond: And what's your view right now on credit and taking credit risk?
Jamie Crapanzano: Our research team here at Guggenheim spends a lot of time tracking credit spreads and putting them in historical context. At this point, they're seeing credit spreads at historical tights, but of course, that doesn't mean they can't grind tighter as they have been doing, which is reflective of the strong risk sentiment that we saw in Q4 and has continued through Q1 of this year. However, while spreads are tight, all-in yields are still relatively high, which means that it can still be attractive to deploy capital at these levels. But given that a higher percentage of all-in yield is coming from rates rather than spreads, we just want to be mindful of the fact that we aren't necessarily being paid right now to kind of push the envelope in credit. So, we think skewing to higher quality paper makes sense here. Agency-related paper, high quality corporates--that can be the move as there may be better opportunities to invest at wider spreads down the road.
Jay Diamond: Well, Jamie, you've been incredibly generous with your time today. I really appreciate it. Before I let you go, I noted at the top of our conversation today that you are portfolio manager on our insurance portfolio management team, which is a separate specialized unit within our investment team. So why has Guggenheim created the structure in this way, and why do you think it's better for servicing insurance clients?
Jamie Crapanzano: Our goal is really to create optimized solutions that take into account all of the nuances of insurance portfolios. Every asset that is contemplated for our insurance portfolios is viewed through the insurance asset management lens. Does it fit the liabilities? Is the structure capital efficient? How will it be perceived from a rating agency perspective? Because the strategies are specific and unique and the regulatory environment is constantly evolving, we think it deserves a dedicated team.
Jay Diamond: Well, great. Thanks very much. Before we say goodbye, any final takeaways you might have for our listeners?
Jamie Crapanzano: We spoke about broad themes today with regard to investment strategy. In general, we think this is a good time to opportunistically deploy capital. We're seeing yields like we haven't seen in quite some time, and it's exciting–we have this running joke about putting the “income” back into fixed income, and here we are. And being thoughtful about how you deploy that to take advantage of these higher yields is definitely something that is attractive. Specific to Guggenheim and what we're doing here, our important takeaway is that we really kind of consider each of our insurance relationships as a true partnership. None of what we do is out of the box. It's highly customized. It's driven by what our clients need. No two clients are the same, and we really want to be a partner in delivering the solutions that are going to mean the most to our clients.
Jay Diamond: Thanks again for your time, Jamie. I hope you'll come back again and visit with us soon.
Jamie Crapanzano: Yes, thank you so much for having me. Thank you to everyone who was listening. It's really been a pleasure and thank you again.
Jay Diamond: Now, before we wrap up, we do have a question from a listener that was addressed to Karthik Narayanan, who is our Head of Structured Credit and a guest most recently on Episode 48 of Macro Markets. Now the listener asked the following: how much coverage does a BBB CLO tranche typically have? How large would the losses have to be before such a tranche is negatively impacted? Which is a great question. Now, Karthik's answer is as follows. Most BBB tranches we see for newly broadly syndicated issues today have 12 percent credit enhancement. At this level, this means the tranche could withstand an immediate default of 24 percent of the pool, with a 50 percent recovery for a 12 percent loss before the tranche is impaired. Now, nichier and smaller deals might have more credit enhancement, say on the order of 18 percent, but don't forget, for all of this, there is about 2 to 4 percent per year of excess interest that is additional credit protection. Now it's very good question, a very lengthy answer, but I appreciate Karthik taking the time to answer. So, thank you, Karthik, and thanks to all of you who have joined us for our podcast today. If you like what you are hearing, please rate us five stars. If you have any questions for Jamie or any of our other podcast guests, please send them to macromarkets@guggenheiminvestments.com, and we will do our best to answer them on a future episode or offline. I'm Jay Diamond. 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, including our Quarterly Macro Themes, which is just out, please visit guggenheiminvestments.com/perspectives. So long!
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