The BCG Pension Insider

Analysis of Survey Responses

Besides traditional Investment Grade public corporate bonds and municipal bonds, which continue to serve as the backbone of a typical PRT investment portfolio, the next critical asset types for insurers are private credits, structured securities (e.g., RMBS, CMBS, ABS, CLO), and non-fixed income/Schedule BA assets. These asset classes were the focus of this survey while public corporate and municipal bonds were not included.

The insurance industry as a whole has been increasing allocations to these less traditional asset classes to achieve higher returns without taking more credit risk and without consuming much more capital. However, individual PRT insurers have approached these asset classes very differently for their asset allocation decisions while also taking into account their ownership structure, portfolio size, and internal/external asset management capabilities. The benefits of these less traditional asset classes are well known and include the following: excess returns due to illiquidity and/or structural complexity, stronger covenants, and capital efficiency (for senior/mezzanine structured securities and non-fixed income investments up to certain allocation levels), etc. Therefore, we focused the survey on how insurers view the drawbacks and constraints of these asset classes.

As the preceding chart shows, twelve or two-thirds of all respondents viewed Investment Grade Private Credit as the most favored investment strategy among the asset classes surveyed, which makes sense due to the long-dated and relatively predictable cash flows of PRT liabilities. Structured Securities were the next favored strategy, with thirteen #1 and #2 rankings combined. On the other hand, Non-Fixed Income Investments were the least popular investment strategy.

1. Private Credit

As noted above, Investment Grade Private Credit was the most favored investment strategy surveyed. Although this strategy was not further broken down in the survey, this category mostly includes traditional private placement corporate bonds, commercial mortgage loans, and infrastructure debt. It’s possible that some respondents also include privately structured securities backed by private debt in this category.

Non-Investment Grade Credit and Non-Fixed Income Investments were viewed as much less critical, presumably due to high capital consumption, although two respondents ranked Non-Investment Grade Credit as most important among those four strategies.

Among the various constraints of private credit allocations, asset availability ranked as the highest constraint, due to either limited asset class supply or insurers’ own sourcing capability. Lack of duration compared to PRT liabilities was viewed as the next highest constraint. Lack of liquidity was only selected as a primary or important constraint by three respondents, which makes sense given the long-dated, mostly predictable PRT liabilities.

Capital consumption (for Non-Investment Grade Credit) was not selected as a high constraint. This is likely due to small allocations to Non-Investment Grade Credit, not because the respondents are insensitive to capital consumption.

2. Structured Securities

Only three respondents viewed Structured Securities as the most critical investment strategy among the four strategies included in the survey, and ten out of the eighteen respondents viewed Structured Securities as the second most important investment strategy.

The popularity of structured securities is mostly due to their attractive spreads and capital efficiency. On the other hand, short duration (both rate duration and spread duration) was selected in the survey as the highest drawback of structured securities. Cash flow uncertainty was viewed as the next highest drawback.

3. Non-Fixed Income Investments/Schedule BA Assets

Among the seventeen insurer responses to the question, “What is the ideal allocation to Non-Fixed Income Investments in your PRT pricing portfolios?,” two responded Not Applicable, five responded Up to 3%, five responded 3%-5%, three responded 5%-7%, two responded 7%-10%, and none responded Over 10%.

Capital consumption of Non-Fixed Income Investments was selected as the highest drawback. Allocations to Non-Fixed Income Investments seemed to be centered around 5%, as the marginal post-diversification excess capital consumption of Non-Fixed Income Investment allocations above 5% would probably start to overwhelm the excess returns of those assets compared to Investment Grade credits. Accounting and capital volatility was viewed as the next highest drawback for Non-Fixed Income Investments.

Additional Survey Responses

Eight out of the eighteen respondents viewed capital consumption as Very Important to their asset allocations, while another eight viewed capital consumption as Somewhat Important or Important. No respondent viewed capital consumption as Not Important. This is consistent with the drawbacks and constraints cited for individual investment strategies.

For thirteen of the eighteen respondents, U.S. Risk Based Capital was the most important capital measure considered in their PRT asset allocation. The next most important capital measure was internal Economic Capital, which was selected as either the #1 or #2 capital measure by half of the respondents. It’s worth noting that no respondent viewed Rating Agency Capital as the most important capital measure, though Rating Agency Capital was ranked as the second most important capital measure by five respondents.

Conclusion

The survey clearly shows that capital efficiency is critical to the PRT industry and is a primary driver of PRT investment strategies and asset allocation, which are key drivers of PRT annuity pricing. Although we did not include target Return on Capital in the survey due to insurers’ unlikely willingness to disclose this information in a published survey, anecdotal evidence shows insurers typically target Return on Capital of 10%-15%, depending on their costs of capital and the risk profiles of individual PRT cases.

Charting of the full survey aggregate results can be found below.

Charting of Full Survey Aggregate Results¹

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1. What is the overall profile of your life/annuity organization? (n=18)

2. To what extent do you use third party (unaffiliated) asset managers? (n=18)

3. What are the most important investment strategies in your PRT pricing portfolios? (n=18)

4. What is the ideal allocation to non-Fixed Income investments in your PRT pricing portfolios? (n=17)

5. What are the main drawbacks to non-Fixed Income investments in your PRT pricing portfolios? (n=17)

6. What are the main constraints of private credit in your PRT pricing portfolios? (n=18)

7. What are the main drawbacks of structured securities in your PRT pricing portfolios? (n=18)

8. How influential is the amount of capital utilized by these asset classes? (n=18)

9. Which capital measure is considered in your PRT asset allocation? (n=18)