For insurance companies, today’s turbulent markets are presenting both tough investment choices and significant opportunities. That was the sense of a panel of investment officers at Standard & Poor’s Ratings Services’ Insurance 2008 “Operating Within A Global Economy” conference in New York City on June 1. Navigating credit, market, and interest rate risks has become increasingly complex with heightened market volatility, constrained credit, and lower market liquidity. “If you’re looking for an uplifting message, you might not get it in this panel discussion,” said moderator Gregory Gaskel, a Standard & Poor’s director.
All three panelists agreed that threatening clouds would continue to hover over the U.S. economy as the fallout from the housing market settles. “We think the economy is in for an extended period of slow to anemic growth,” said Joel Strauch, senior vice president at PIMCO. “The key is going to be housing. The consumer has really been stretched.” His fellow panelists were Scott Sleyster, domestic chief investment officer of Prudential Financial; and Tom Sorell, chief investment officer for Guardian Insurance.
If the current market conditions have any upside, panelists agreed that it’s that credit spreads have widened for new money invested. Indeed, repricing of risk is very attractive right now, and the corporate credit area is still reasonably strong, according to Strauch. “We see rates at levels where they are today or slightly higher over the next two to three years,” he said, noting that spreads are “much more attractive.” On the other hand, he has greater concern for inflation.
Attractive asset buys exist in this distressed market if investors conduct thorough due diligence, said Sorell. This is especially true in the structured finance area, with distressed mortgage credit, or in the leveraged loan market. Guardian has also been opportunistic in tactically taking advantage of attractive investments in large money center banks and brokers, he said, and is also focused on investing in higher quality commercial mortgages and private placement debt. Guardian is avoiding regional banks and cyclical consumer sectors.
Emerging and foreign markets are areas where Strauch sees opportunity and growth, in part because they benefit from sustained exports and foreign demand. “Now we’re in a position where there is enough momentum and size in these international economies, especially in these large emerging market countries, that they will bring along total world demand,” he said.
To be sure, Sleyster notes that Prudential Financial’s core portfolio treads lightly in terms of interest rate risk positions. He would prefer to take diversifiable risk such as credit risk and run his asset liability matching pretty tight. “The challenge for this cycle for classic spread businesses has really been the cost of funding,” he said. On balance, however, the widening of credit spreads is a positive. “Fundamentally, we think we’re getting paid,” he added, noting the wider spreads. “If you wander through the commercial mortgage and private placement organizations right now, you see some pretty happy folks who were quite miserable for two or three years.”
Sleyster, however, was less excited at this stage about alternative investments (anything that’s not fixed income), of which he has a modest amount in his portfolio. He noted that equity analysts following public companies and even the investor base tend to look for more predictable earnings than the more volatile returns of alternative investments such as private equity. “It does drive you toward a very heavy proportion of fixed income,” he said. “Looking at the various proposed accounting changes, I think you’re going to end up with more mark to market on your liabilities.” When you get to that state, he believes public insurance companies will be more likely to invest in a broader array of asset classes, such as alternative investments to match their long-dated liabilities.
The whole loan commercial mortgage market has once again become more attractive to insurers as the past practices of aggressive underwriting and pricing have become less prevalent in the market. As far as the commercial mortgage-backed securities (CMBS) market is concerned, Sorell doesn’t expect a significant increase in near-term CMBS delinquencies, but their typically high leverage and interest-only structures with limited amortization could have a negative effect, including near-term market values.
While liquidity has been coming back into the market, the panelists stressed that this is not the time to get complacent. Rather, it’s a time to be positioned for shocks in the marketplace. Said Sleyster: “[Liquidity is] one more scarce resource that you need to be thinking about, whether you’re commercializing it, protecting your rating, or protecting your capital.”
Source: Standard & Poor’s,
www.standardandpoors.com
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