Opportunities In Structured Products for Insurance Companies

We spoke with Conning to discuss the role of Structured Products within insurers' investment portfolios, including how insurers have viewed the space historically, an update on today's environment, as well as trends they are monitoring in the Structured Product space.

Samantha Andreoli | Director | Business Development | Conning
samantha.andreoli@conning.com | www.conning.com/

SAA: Historically, why have insurance companies considered Structured Products as part of their portfolio?

Conning: Structured products can be an extremely useful asset class for insurers, typically because they offer a number of differentiating features that many fixed income sectors do not: structural protections through credit enhancement, amortizing structures, and exposure away from corporations.

Historically, insurance companies have invested in traditional agency mortgage-backed securities (MBS) or credit card-backed asset-backed securities (ABS). However, we find that non-agency RMBS, esoteric ABS (non-traditional collateral), and commercial mortgage-backed securities (CMBS) provide value in insurance company portfolios. These securities typically offer attractive spreads and yields over and above traditional corporate debt and other similar-duration fixed income instruments.

Structured products have structural protections through subordination and overcollateralization which provide investors with comfort knowing that they are protected against some level of defined delinquency and loss metrics on the underlying collateral. Even if a given deal experiences losses within the underlying collateral, not all the tranches of the ABS will be affected. The benefits of credit enhancement include but are not limited to reduced credit risk, higher probability of ratings upgrades over time as deals age, and increased liquidity in the secondary market.

Amortizing structures provide investors with returned principal throughout the life of the transaction as underlying loans are paid down. This is particularly useful for insurers if they need cash for claim payments, operational needs, etc. Typical corporate bonds do not have this feature, with investors getting principal returned upon maturity.

Diversification away from corporate bonds is one of the biggest attractions for insurers to structured products. The asset class offers investors opportunities to invest in the U.S. consumer, housing market, commercial real estate market, construction and travel industries, and more without having to buy a bond from any one company that may have idiosyncratic risks within that sector. For example, rather than buying the bond of one airline manufacturer, we can buy several deals backed by aircraft leases and get broader exposure to the industry and the consumers within it.

SAA: In today’s environment, where do you see opportunities in structured products for insurers?

Conning: With the U.S. Federal Reserve seeing data suggesting an improving inflation environment, we may be heading toward a fine-tuning of interest rate cuts rather than additional hikes. This should help reduce rate volatility, which is a boon to Agency MBS. This sector has been very cheap – especially compared to investment grade corporates – over the last two years and falling rate volatility should help return Agency MBS toward more historical spread levels.

Commercial real estate has been a subject of much consternation for some time, especially with respect to the office sector within major metropolitan areas, and many properties have struggled to fill vacancies. However, with the post-COVID issuance market regaining footing in 2024, we feel as though there are some green shoots in this sector and new underwriting and appraisals provide us with a level of comfort to take advantage of dislocations in pricing.

Esoteric ABS is another sector that we’ve long favored due to its shorter average duration and position on the yield curve. Even though we may see the Fed cut interest rates, the treasury curve remains inverted and taking advantage of higher front-end rates is still an attractive proposition. The structural protections and amortizing nature of many deals make esoteric ABS an asset we can comfortably consider down to single-A and potentially BBB, allowing us to access higher spreads and yields at a fraction of the duration of longer-dated corporate bonds.

SAA: How do you stress test portfolios and what market trends are you monitoring?

Conning: We have a robust modeling and surveillance process from both a macro top-down and bottom-up perspective. Every month, our Investment Risk Committee meets to discuss and highlight key metrics about overall firm positioning. We also flag any outsized risks in the portfolio that surface based on economic and market scenario modeling.

On a more micro basis, we run an automated monthly process that takes data from several inputs for each deal (and tranche) we own. The system consolidates the data and important up-to-date deal metrics into a view where we can see changes in deal performance month-over-month. This will give us an early view into how delinquencies, defaults, loss coverage ratios, and overall subsector health are evolving. We can know on a tranche-by-tranche basis where the potholes might emerge or conversely where we should focus more capital.

Amng the many trends we monitor, three stand out to us currently:

• Over the last 12 months or so, the rise in subprime borrower delinquencies has been more rapid than those of prime consumers, although we have seen a levelling off as of late. But we are watching this very closely.
• We are seeing strong commercial collateral deal performance: container deals are delivering nicely and building credit enhancement, and small and medium-sized ticket equipment performance is stable with very low losses - less than 1%.
• There has been a meteoric rise of digital infrastructure issuance, including data center and fiber network ABS deals. This sector has grown exponentially over the last two years as cloud computing and AI have expanded into our everyday vernacular.

Disclaimer: This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different than that discussed here.

Source: Strategic Asset Alliance, AAM. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.