Episode 266: Wellington Management’s 2025 Insurance Outlook

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley. I'll be your host. Hey, welcome back. We've got a great podcast for you today. We've got a 2025 outlook for insurers, and we're joined by what I believe to be the record holder for podcast appearances on our air. In fact, I think you did actually our first one, Tim Antonelli, who has got, so here we go, CAIA, CFA, FRM, SCR, head of Insurance, Multi-Asset Strategy and portfolio manager. What else could you possibly do? Mr. Antonelli, welcome back. Thanks for being on again,

Tim: Stew, it's a pleasure. Fifth time, a testament to what you've built. And it's always exciting to be on.

Stewart: I appreciate it. We've got a really good team. And Lynde O'Brien, one of our key person that's running the operations, actually listens to a lot of these podcasts, and she's on today. So, shout out to her and her contributions, too.

Wellington is one of the OGs in this business. And I think it's worth pointing out that you have to have a very dedicated effort in the insurance investment management arena to have someone of your seniority and capabilities as a strategist. And I just think it's important to point out that just if you could just give us... You've been on a bunch of times and we've heard the... I do have an icebreaker question for you, but before we go there, can you just talk a little bit about what your role actually is at Wellington?

Tim: Yeah. So, it says the head of Multi-Asset Strategy for Insurance and portfolio manager, and I've really been able to distill that into three buckets, basically. The first is content generation. I want to be reviewing, understanding, thinking about implications of investments for our insurance clients, and forming an opinion that'll help them navigate what's to come in the future. We want to be the first voice before they even have to think about things on their own. So, we put a lot of value in being a proactive thought partner. There's also an internal element to the content, to make sure that everybody that touches insurance assets within the firm understands the latest, the greatest rules and regulations, understands accounting changes that could impact portfolio management, and then also understands the broader trends in the industry.

In addition to that, I do manage bespoke portfolios for surplus solutions for our clients that go across either multi-asset or multi-manager investment classes. And oftentimes, we're doing that through either a capital consumption lens or a focus on surplus volatility and drawdown potential.

And then, the last thing I'd say is really being out in the market and talking with the rating agencies, talking with the regulators, talking with the big four accounting firms. And just getting a sense of what's to come, and trying to anticipate what that means with the capital markets.

Stewart: It's super helpful. So, if you were starting out today, this business, I started back when the earth was cooling, but you've been at this a long time, too. And this business has changed a lot. Even the last five years, it's changed a lot. Ownerships changed, asset classes have changed, people have changed, the required skills have changed. If you were going to start out today, out of school, where would you go in this business?

Tim: So, maybe I'm biased because it was my own career path, but I think when you are an analyst within an insurance company, in my case a reinsurance group that was part of an investment bank, you have to learn the industry from the ground up. You're doing everything from understanding security valuation to knowing how to fill out an AM Best SRQ, to being able to talk with DOIs and regulators and understand accounting and compliance rules.

All of that stuff, getting that type of foundation, to me, is essential to building out the lens and the insurance-specific knowledge that you need to then layer on understanding the capital markets. I think it's very challenging to be a generalist and have insurance clients. I always tell new-hired colleagues, or folks that maybe aren't familiar with the channel, you can't fake insurance. If you know-

Stewart: That's still true.

Tim: ... any insurance company, yeah, if you meet with an insurance company and you start spouting off generic investment terms and they ask you a question about IMR or AVR and you don't know the answer, well, you're not going to be invited back. So, it's a very difficult thing to do part-time. And I think the duration of our client relationships, being as long as it is, is a testament to how much that industry-specific knowledge matters. But I think having the foundation from their side at the actual insurance company is what I would recommend to folks just graduating.

Stewart: Truer words were never spoken than you can't fake insurance. It's the truth. People know. They know whether you know what you're talking about or not.

Tim: Yeah, exactly.

Stewart: It's true, and it's interesting the timing of this podcast. Because we're coming up on the retirement of one of the folks who have meant the most to a lot of people in this business, Rich Kaufman, who is the real OG in the insurance asset management business. And so, shout out to Rich, and kudos to everything you guys have been able to accomplish at Wellington. It's terrific. So, really, hats off to you guys, really.

Tim: Yeah. I would just say, Rich has been a mentor to me and a friend, and I call him the godfather of insurance asset management. It's like you said, he's been pretty much one of the founding pioneers of that industry. And I would just note from our firm perspective, I believe next year will mark 50 years of Wellington working with insurance clients. So, it's clearly something that's part of our DNA and will be for years to come.

Stewart: Yeah, I think he is the godfather. You're right. I think that's right. So, before we got on today, you mentioned having nearly 150 meetings with insurance companies across the globe in 2024. What are some of the broad observations you've had as insurance companies began to plan for 2025?

Tim: I think you mentioned it a few moments ago about the industry evolving and changing substantially over the last five years. And I can tell you, from my seat, it's actually been really interesting to see the sea change in terms of what insurance companies are open to doing with their portfolios. I think there's been a willingness to be more dynamic. There's been a willingness to review historical assumptions more frequently. Even in my 20-year career, SAAs, strategic asset allocations, went from a once-every-three-to-five-year occurrence to an annual or sometimes entry-year exercise.

So, I think that underneath all of this, there's a desire to always be asking questions about how they can modify the portfolio. And the one thing that I've encouraged our clients around the world to really focus on is fighting recency bias. So, I know that you, as an insurer, are thinking about managing different tail risks as it relates to your portfolio across the capital market spectrum. But I think the one, and an observation that I make in the outlook, is that actually looking in the mirror and saying, "Okay, are you questioning yourself enough in terms of what you're doing with a portfolio, or are there ways you can change your approach to be better suited for what lies ahead?"

And for me, that really comes down to three themes that are consistent around the world. One, we say it yields today, gone tomorrow. So, a play on that phrase. And for that, it's really about locking in structural income. Obviously, interest rates are expected to be a little bit higher for longer, and we've certainly seen them go back up post-election, but they're not going to be this way forever. And so, I think it's important to not get too caught up in the yields of today, and look for where on the margin you can lock in incremental income for when rates normalize.

The second theme is Swiss-Army-Knife your surplus. So, as a side note, my mother actually wrote a few episodes of the show MacGyver, of which she used the Swiss Army knife quite a bit. So, as part of that, it's an all-in utility device that's really able to be nimble and work in a lot of different situations. They need to think about their surplus with that holistic, multifaceted mindset.

And then, the last thing, which I think is becoming even a larger focus when we're having clients around the world begin to operate under new risk-based capital regimes, whether it's in Japan or South Korea or Hong Kong, it's, don't let the economic case for an asset class be dominated by the capital charge. I think one of the things that I want to point out to folks is that should be part of your mosaic for sure, but it shouldn't be what you're making your primary allocation decisions on.

Stewart: Yeah, I think it's a great point. So, just to unpack some stuff there, and I'm always thinking about people who may be listening to this for the first time, or close. So, when you're talking about surplus, which is an insurance-centric term, is essentially the assets minus liabilities. It is what the industry refers to as surplus, but it is essentially shareholder's equity, or the policyholder equity. And then, a lot of insurers think in terms of my reserve assets, which are set aside and used to defuse future claims, known claims payments or projected claims payments. And then, the surplus assets really can be used more toward higher returns strategies. Is that a fair assessment? Where would you tweak that?

Tim: No, so that is a fair assessment, and I love how you just worded that. Because one of the observations that I make is that I really want to carry over some of the rigor that goes into the reserve-backing assets and how they're thinking about those holistically, and carry that over to how they're thinking about the surplus.

So, I can tell you, and I'm sure in your career experience, you've had these conversations as well, it's not uncommon for you to be meeting with an insurance prospect or a client and you're understanding the different components in their surplus assets. And it's, "Well, that investment was here before I got here," or, "This person on the investment committee had a relationship with that asset manager," or, "There was a Wall Street Journal article which made this sector look really compelling, so we invested in a fund."

And so, there's a lot of dart throwing at the dartboard with a lot of surplus, and there's very little thought about thinking about the sum of the parts and how the interplay works together. Is there a diversification benefit there? Are they offsetting strategies so that really, depending on the market, you might not be getting any sort of alpha? And then, also, how is the context of the rest of your business impacting what you're doing in the surplus?

So, things like capital adequacy, or things like underwriting volatility, or cash flow expectations. I don't think that there's enough structure, at least today, about how surplus allocations are designed relative to all of the stuff that goes into ALM in thinking about the reserves.

Stewart: I think that's fair. And I also think that one of the reasons that there's been a dam break, if you will, is the ownership structure. And there's a pretty significant percentage of life assets that are owned by private equity. And I think that there are some folks who maybe didn't have their pencil sharpened quite as sharp as it ought to be and are now being asked, "Hey, why are we not doing those strategies as well?" or, "What are we missing?" Do you think that this shift in the industry has driven some of that change, or do you think that there are other factors?

Tim: I think that's definitely played a role, and that's played a larger role, I think, in the reserve side. Because a lot of what the PE-backed insurers have been investing in have been things where either the structure or the vehicle itself, or the underlying asset class, has a relatively high rating, comes with some amount of duration and it's capital efficient. I think that what we've seen less of has been influence with those companies in terms of getting over to the surplus assets.
I do think that there is some overlap and there's asset classes that straddle the investment grade in high-yield space. So, whether that be asset-based finance, which is one of my top ideas for next year, or whether that be direct lending, which is now getting more allocations at the expense of traditional public market high yield. I think some of those on the margin have become a larger emphasis now that private equity has been playing in the insurance market more, but I think the majority of the change has been on the reserve side and not the surplus.

Stewart: Interesting. So, you mentioned this concept of Swiss-Army-knifing your surplus assets. Have you covered that adequately, or were there other things that you wanted to bring in?

Tim: No. I think, for me, there's a couple different things that I would factor into how to judge that. And so, when you're thinking about your surplus in the context of the business, and in our outlook, we outline a little bit of a decision framework where you use a simple scale of one to five, ranging from income generation to capital appreciation. And then, you check off where you are as an organization based on a variety of operating considerations, from revenue declining or growing to tax sensitivity, to your net margins either deteriorating or improving, and then your surplus and rating agency oversight and the like.

And then, you see, okay, what do I really need to get out of my risk assets? Because when we talk to insurance companies, it's not uncommon for them to want as much total return as possible. But oh, I also want an income component because I have to hit my NAI target every year as part of my compensation or my management goals. So, for me, I think marrying that understanding of the business, what do you need out of it income-wise, liquidity-wise, and then capital appreciation-wise. And then, coming up with a core satellite structure, where again, you're thinking about these pieces together, not just individually.

And you're able to do that in a way that allows you to maybe have a separately managed account, where you can focus on the tax sensitivity of realized gains and losses as the core, and then supplement that with satellite approaches with higher conviction alpha opportunities. And whether that's a small cap strategy or a hedge fund or private equity, but you're thinking about the universe of those assets in isolation in terms of their economic contribution, but holistically in terms of what the interplay is.

You think about the world that we're going into, which is a market that will be marked by a lot more dispersion around macro results, both from an interest rate environment, a fiscal spending, and an inflation environment. More volatility there means more market noise, which should mean more opportunity if you're allocated the right way. So, I think establishing these risk-return parameters and thinking through how it fits with your broader business is essential to getting it right.

Stewart: So, Tim, that's super helpful, and we've been at this for a minute. I just look a lot older than you, which is a little disconcerting, but nevertheless. When we always hear insurers are looking for yield, and it's always the case in this business that folks are looking for yield. So, can you focus in there and give our audience some ideas of where they should be looking for yield in 2025?

Tim: Yeah. So, I think core reserve portfolios, at this point, at least in the United States, are very well-diversified across what I would call the standards sectors and security types. So, this means that we've seen in recent years secure ties become a larger portion of the pie, municipal bonds we know are in the universe, and obviously corporate credit. So, that's being done very well by core portfolio managers. So, as I thought about the next year, I said, "On the margin, where could you make plus allocations ideally as part of what's backing your reserves, and lock in some additional spread ahead of interest rates normalizing to whatever the neutral rate ends up being when the Fed's done cutting?"

And there was a couple areas that really shown... Well, the first is capital securities. So, these are your hybrids or your preferreds. Now, this used to be something that insurance companies did quite a bit of. But in recent years, for whatever reason, they fell to the wayside. And I know in one of our previous podcasts, we talked about convertible bonds, and those are part of this universe, too. But there are some really yieldy parts of this market that actually are well or highly rated. So, as of June 30th of this year, for example, 66% of the weighted average yield and 53% of the option-adjusted spread of this universe of securities came from issuers rated BBB or higher.

And if you compare that to the similar metrics of the high-yield market, for example, only 56% of the yield and 70% of the spread comes from rated B or lower issuers. So, there really is a nice credit quality, positive credit quality skew in a part of the market that has been underappreciated. If you couple that with the fact that in the majority of risk capital calculations, whether it be rating agency or regulatory, they model pretty favorably from a capital consumption perspective. And I think you could make the case that this is an interesting area in the public market to play in in the new year.

The second one I'd say is this idea of asset-based finance. So, this is a very broad market and to me, this is going to be the focus of the year for insurance companies looking in the illiquid space. So, this has a lot of great tailwinds behind it. I think what you're going to see is the ability to source exposure to a tenor of your choosing, to a credit quality of your choosing, diversified across a lot of different collateral types. This is built for insurance companies. And whether that's directly sourcing some of these, or working with a bank in terms of synthetic risk transfers, these assets should be on everybody's radar coming into the new year because there's still a considerable spread to publics.

And then, the other area, which again, I've been saying for a while, I think we've talked about it in the past, private placement debt shouldn't just be a life insurance phenomenon. This is something that should continue to make up a meaningful part of insurers of all durations moving forward. And we've seen incremental increases in the P&C and health markets in the US. And now we're seeing a ton of interest outside the US because of the duration and the income and the ability to get IG or up paper. And the one note of caution that I make to a lot of our clients here is that this is not a homogenous asset class. So, you see yield spreads quoted a lot that aren't all that compelling, but those are typically the agency deals.

If you look at some of the club deals or the directly-originated deals, the spread to publics gets a lot more compelling. So, make sure you're working with a manager that's getting you that exposure outside of just the agency market.

Stewart: Those are great tips. I want to go back to something you said a little bit earlier, which is, "Don't let the capital charge drive the decision." There's a lot of folks in the market with rated note feeders and other capital-efficient vehicles, but I tend to agree with you that it... I was always, when I ran money, it was not the last basis point. It was whether or not you own the right assets. So, the economics will win out, ultimately. So, can you talk a little bit, expand on what you meant when you say, "Don't let the capital charge drive the decision?"

Tim: So, part of this comes from the new regimes that are starting globally, where maybe a country didn't even have an insurance company operating under some sort of capital test that was anything more complex than just your surplus coverage versus what your liabilities would be. Now that there's more detailed and robust capital calculations, we have a lot of discussions globally with clients who say, "What's the return on risk capital of this investment?"

And yes, I think it should be something you look at as part of your decision-making process, but I always encourage folks to get the capital model from their finance team, or their accounting team, and plug in what these changes will be. Because if you think about, and this is in every case, but what we're talking about are these smaller allocations of a surplus that if you net it all in and you factor in the diversification adjustments across market risk, and then across the aggregated risk, it could become a rounding error when you're looking at your aggregate RBC.

And so, I always point out to people, just to level set, the rule of thumb when it comes to risk capital consumption, and this generally holds true across the industry, is for the life industry, about two-thirds of their risk capital is made up of asset risk. So, that matters a lot to them. If you're a non-life insurer, the inverse is actually true. Only about one-third of your capital consumption is reflected by asset risk. So, if you're having a decision, and this is conversations that we have a lot of, "Oh, that's a schedule BA asset," and you're a P&C insurer, the differential between owning equities directly at 15%, or being in a more dynamic fund that can achieve a better economic objective and incurring 20%, should not be the reason you were not in or in that fund.

Now, there's obviously circumstances and external considerations around making sure that your net capital ratio isn't dragged down. And that could trigger things on reinsurance agreements, that can trigger regulatory reviews, that can trigger downgrades. So, I'm not saying “Don't understand how the implications will work.” But what I am saying is, really make sure that the economic case is the first thing you're thinking about, and then troubleshoot the capital charge on the back end.

Stewart: I love that. I've got another great education from you, and I appreciate that. What are a couple, three takeaways our audience should be taking with them as they go into 2025?

Tim: Yeah. So, I think it really all rolls up under this idea of fighting recency bias and trying to challenge what you've done historically, and figure out if it's really the best way for a path forward. I think that means getting more creative, both in terms of broadening your potential investment asset universe. So, this could be an increase in frequency of your SAA. It could be using near-term or shorter-term capital market assumptions to reflect more recent relative value. And it could mean just thinking about things outside of what you've done historically.

The other element is, bring some of that reserve asset liability management-type discipline to how you're allocating your risk assets and your surplus. Think about how those pieces will work together, and even think about the interplay between your reserve-backing assets and your risk assets. Because I think there's a good story to tell with uncorrelated assets and diversification.

And then, finally, be aware of the business considerations before you make an investment, but don't let the business considerations dominate the investment case before you make a decision.

Stewart: Yeah, I love that. That's great advice. Final one for you on the way out. You can have lunch or dinner, and you can have up to three guests. It doesn't have to be three, but it can be up to three. Who would you like to have lunch with, or dinner with, alive or dead?

Tim: Well, so Leo Messi is my favorite soccer player ever.

Stewart: There you go.

Tim: Football. So, he would definitely be there.

Stewart: I like this.

Tim: This is going to be pretty obscure, but one of my favorite comedic actors of all time was Leslie Nielsen, so I would actually include him as well. So, we've got a very strange dynamic there.

Stewart: Okay, here's a weird question for you. Was he in Airplane!?

Tim: He was.

Stewart: And wasn't Kareem Abdul-Jabbar there as well?

Tim: He was.

Stewart: Played opposite-

Tim: He was.

Stewart: Okay.

Tim: So, yeah, exactly.

Stewart: Just keeping it, make sure we got this reel. Okay, go ahead. Keep going. You got two. All right.

Tim: Yeah. Sure, so those are two. And then, I guess the final one would be my great-grandfather. Because I heard so many great stories about him, and I never had the pleasure of meeting him. And he was old school Italian, and I think he would bring some fire to the conversation.

Stewart: Wow. Just the interplay between Leslie... I don't know your grandfather, your great-grandfather, but the interplay between Leslie Nielsen and Messi, that'll-

Tim: Oh, it would be classic.

Stewart: ... that would be classic. I can't thank you enough for the education, Tim. It's been a great one. So, thanks so much.

Tim: Thanks for having me back. It's always a pleasure.

Stewart: Thank you. We've been joined today by Tim Antonelli, CAIA, CFA, FRM, SCR, head of Insurance, Multi-Asset Strategy and portfolio manager at Wellington Management. Thanks for listening. If you have ideas for podcast, please shoot me a note at Stewart@InsuranceAUM.com. Please rate us, like us and review us on Apple Podcasts, Spotify, wherever you listen to your favorite shows. My name's Stewart Foley. We'll see you again next time on the InsuranceAUM.com podcast.