Episode 34

Nitin Chhabra on insurance client considerations and trends

Nitin Chhabra, Managing Director, Head of Insurance Client Relationships & Solutions at SLC Management, discusses how persistent low yields, inflation and regulatory constraints can shift an insurance company’s approach to portfolio allocation.

Steve Peacher: Hi everybody thanks for dialing in to this episode of “Three in Five,” today I’m really pleased to be with Nitin Chhabra who is head of our insurance client relationships and solutions. Nitin thanks for taking a few minutes.

Nitin Chhabra: Great to be here, Steve.

Steve Peacher: One of the big topics on everybody's minds these days is inflation, you can't pick up the newspaper and not read about because of supply chain issues and other issues, how prices are going up. You know you focus on the insurance industry. So how do insurers think about inflation and what are they doing on the investment side to try to mitigate the impacts that inflation may have on their businesses and on their investment portfolios?

Nitin Chhabra: Sure, so your first question there, how does inflation impact insurance companies? Well you know it's been quite a while since we've seen it, but historically higher than expected inflation has been a negative for insurance companies on both sides of the balance sheet. So if we look at property and casualty insurers, on the liability side higher than expected inflation means higher claim costs than what was priced in the policy, so you think about an insurance policy: priced today, but claims against that policy can emerge years into the future, when costs are higher than what was anticipated at the time of policy writing. And then on the asset side, the majority of P&C investment portfolios are invested in bonds, so as inflation drives up interest rates, bond prices fall, and so with the market value of the insurers investment portfolios. You know if we think about the last time that inflation spiked in the 1980s it led to a full-blown liability insurance crisis which was disastrous for the industry. The second part of your question was what can insurance do within their portfolios to hedge against inflation? So within their core bond portfolios outside of making duration bets, you know, insurers can rotate into corporate sub sectors that performed better during inflationary period so think energy, REITs, some of the more defensive sectors like utilities, consumer staples, healthcare, they all hold up fairly well. There's also a number of noncore asset classes, both within and outside of fixed income for which historical returns have been positively correlated with changes in inflation. So I’ll highlight a few – within fixed income, CLOs and leverage loans are two that come to mind. Both of these asset classes come with floating rates. And then outside of fixed income, real estate and infrastructure both offer, you know, good inflation hedges given their exposure to real assets.

Steve Peacher: You know, you mentioned some of the alternative asset classes like real estate, obviously, those are near and dear to our hearts at SLC given some of the capabilities that we have within our portfolio. And that insurers, or some insurers, are moving more toward those asset classes, away from more traditional asset classes like public bonds and equities, you've linked that in part to inflation. But what are some of the other drivers behind that trend toward alternatives from more traditional allocations and asset classes?

Nitin Chhabra: I’d say a couple things, one is market related and one is insurance related. So first, the market related part, looking at the traditional insurance asset classes – core fixed income and equities – we're still seeing relatively low yield on core fixed income. And we're also seeing equity valuations which you could say are stretched. So, to combat those low yields, the first thing that investors and managers are doing is assessing the levers which can be pulled within their core fixed income portfolio, so those levers are duration, credit quality, liquidity. And you know how much is the market compensating them to take on those different types of risk. Core fixed income will, is, and will always continue to be for the foreseeable future, the largest part of insurance company portfolios due to the regulatory and rating agency restrictions on assets backing reserves, but as you stated there's been this growing trend of insurers taking advantage of the higher yields offered by alternative asset classes and we think that trend will continue. On the insurance side, again if we're looking at P&C insurance companies, there's been a number of profitable years we're coming off of, so the industry is very well capitalized following those years of underwriting profits. So, as a result, many companies, they have the capacity and the appetite to take on additional forms of investment risk in order to increase the returns on their portfolio. One other thing I’d add on this topic we've done a lot of strategic asset allocation work for our clients recently and I can tell you that all of the alternative asset classes I mentioned model really well. What I mean by that is even though some of them come with higher volatility on a standalone basis, when you add them to traditional insurance company investment portfolios, you can actually improve yield and expected return while reducing overall risk, and the reason for that is diversification. Historically, the returns of these asset classes have displayed pretty low correlation to the returns of investment grade public bonds.

Steve Peacher: You know you've mentioned in your comments at a there are different types of insurers – you mentioned P&C insurers or life insurance companies. The different types of insurers have different considerations, so when you think about this trend toward higher yielding alternatives, how does that align how do those asset classes align with the different goals that different types of insurers have?

Nitin Chhabra: Yeah, that's a good question. First, if we look at structure, public and private companies have different goals which may dictate investment strategy. So for publicly traded insurance companies the primary goals are one, grow book value per share and two, maximize operating ROE. So they may have more willingness to explore higher returning asset classes not traditionally used utilized by insurers, but you know private companies are also participating, given their excess capital positions. Liquidity is a big consideration. Alternative asset classes generally come with lower liquidity meaning they're harder to sell so ensuring that a company has sufficient cash flow to support its operations is important, you know, so we don't run into a situation where they're trying to sell these less liquid investments to cover potential cash needs. Capital is a key consideration. Alternatives generally come with higher capital charges, as you know, insurers are required to hold certain amount of capital to support the risks inherent in their business, so the greater amount of risk in their investment portfolios, the greater amount of capital they have to hold. Many companies have plenty of excess capital, above and beyond what's required, and so for those companies, they don't have to worry so much about what the capital charge associated with each investment is. For them it's more of an economic exercise of risk versus return, but there are companies that are far more capital constrained and may shy away from asset classes which make economic sense but come with high capital charges. There are ways to optimize capital or minimize charges, for example, if you have a fund investment where the underlying securities are highly rated you can work with the rating agencies and the regulators to get look through treatment to receive less punitive capital charges, and that's something we've done at SLC. And then, lastly, you know one more consideration. ESG is becoming increasingly more of a factor for insurers and I know that's a topic that's been discussed at length on previous episodes of this podcast.

Steve Peacher: Well, you know your answers just highlight how at one level some of these new asset classes are pretty straightforward, but then when you start to figure out how to fit them into the Rubik’s cube of the various considerations of different types of insurance companies, it becomes pretty complex and very interesting and very quickly. Well listen one final question you know where we're having this conversation virtually in the middle of kind of the latest wave of the pandemic. I know that there have been some silver linings, I know you’ve got three little girls at home so you've got to spend more time with them, so how have you how have you used that, how have you been able to enjoy that?

Nitin Chhabra: Yeah definitely. So I have a fifth grader, a third grader and a preschooler and this winner I’m coaching the two older one’s basketball teams, which is something I’m really enjoying. And so that's how I’m spending my Tuesday nights and my Thursday nights. And then on Wednesday nights I play in a men's basketball league, which my wife tells me that I take way too seriously for grown man, you know she might be right about that, but I love the competition it's not something you get on the treadmill or lifting weights.

Steve Peacher: I’m glad to hear that, at least for now they've kept those, your daughter's basketball teams active and haven't postponed those because I think it's so important. Well I’m envious that you're still playing basketball I don't know, I wonder how many things I would break if I got back on the basketball court. Well listen thanks Nitin for taking the time and thanks everybody for listening to this episode of “Three in Five.”

Nitin Chhabra: Thanks for the opportunity, I really enjoyed this.

 

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