Guest Q&A With Ronald P. Joelson
Our editor speaks with the executive vice president and chief investment officer of Northwestern Mutual.
Ron Joelson is a magician in more ways than one. He’s not only the chief investment officer of Northwestern Mutual — the highest rated insurance company in the country — but he can also do mind-boggling card tricks. We’re seated at the conference table in his office overlooking Milwaukee, and we begin by talking about Mark Raffles, the former NM portfolio manager who introduced us. It turns out that Ron is really into magic and got Mark interested as well. Our interview starts with Ron showing me a card trick two feet in front of my eyes, and I still can’t figure out how he did it. That’s when he began discussing the magic required to run NM’s $237 billion General Account investment portfolio.
IAUM: Northwestern Mutual is the highest rated insurance company in the country. How do you maintain that rating over time?
JOELSON: The most interesting thing about our unsurpassed rating is that we actually have more risk assets than our competitors. Our risk asset allocation is north of 17%. That includes high-yield bonds, public equity, private equity and real estate equity.
So why are rating agencies comfortable giving us the AAA rating when we technically take more risk —on average, about 3-4% more than the industry?
A few reasons: 1) we have a lot of surplus — more than $26 billion; 2) the insurance products that we write tend not to have elaborate guarantees or bells and whistles that are difficult to hedge; and, 3) liquidity — we invest approximately $1.6 billion per month after expenses and claims. We also have a career field force that maintains close relationships with clients, helping make our persistency among the best in the industry.
When you look at all of those metrics (and I’ll add to that strong mortality and a low expense ratio — maybe that’s a result of being in Milwaukee and not a global company), the rating agencies say this is a model that deserves their highest credit rating. Another essential factor is the nature of our flagship product, permanent life insurance, which is less risky than some of the offerings sold heavily by our peers and makes up about 85% of our reserves.
Equally important, we pay out a large dividend to our policyowners. This year it will be around $5.6 billion. That’s more than our top three competitors combined. The rating agencies see that as a cushion that makes them more comfortable with the credit rating they assign.
IAUM: You mentioned that you have $1.6 billion per month to invest. I think that sometimes people don’t realize how difficult that is to do. No matter the conditions in the market with regard to interest rates, for example, you have to invest.
JOELSON: That’s right. And, as a matter of fact, when interest rates are low and markets are volatile — as they are today — our business tends to pick up. We’re actually having a very strong sales year, in part because of the uncertainty. As a result, some people view cash value permanent life insurance as highly attractive because cash value only goes in one direction: up.
From my perspective, the difficulty of investing is compounded by the low rate environment. It tends to magnify decisions, with each basis point of value or loss being that much more important.
And, it takes a talented team with breadth and depth to find opportunity in markets that generally have been picked clean.
IAUM: Where do you think the most significant risks are? Rates are very low and the yield curve is inverted. The classic read on this condition is the bond market is forecasting a recession, etc.
JOELSON: I took a look at the leading economic indicators (LEI) right before you came in this morning, and they’re starting to turn a bit.
When I looked at this a couple of months ago, the indicators were pretty solidly green. The LEI components that reflect the consumer still look strong and consumer expectations and credit availability look good. Weekly unemployment claims look strong and new orders for consumer goods are increasing.
What’s causing concern is on the manufacturing side, and it stems from trade uncertainty, which is causing manufacturers to be very cautious about investing. This has triggered nervousness in the market and an inverted yield curve, which, as we all know, is a classic recession indicator.
The other thing we’re seeing is global central banks prepared to continue easing, which will probably bring the short end down further. The bottom line is that we’re likely not yet ready for a full-blown recession, but it’s getting closer. The risks are increasing, although you’re not yet seeing it in credit spreads.
This means you’re not getting paid well to take risk, which in turn means there’s not much point in taking it. Late cycle risk-taking is a concern for the insurance industry because it’s tempting to add risk at what could be the worst time.
IAUM: But it takes a lot of discipline to keep your powder dry in this kind of environment, right?
JOELSON: One of the good qualities of NM is that our investment team doesn’t get second-guessed by other parts of the company, such as Sales saying, “Hey, can you get me an extra 5–10 basis points?” In my old job, I used to say to that, “I can give you whatever yield you want, but you might not like the kind of risk you have to take.”
In contrast, Northwestern Mutual thinks intergenerationally. It’s something I really haven’t seen to the extent we do it here. We’re not just thinking about what could impact results in this or the next quarter. For the investment portfolio, we measure everything on a long-term total return basis. We even think about portfolio positioning in terms of decades. When you take that kind of long-term approach, you don’t feel the same pressure that public companies and even some other mutuals do. Our senior leadership wants management to be fully cognizant of risks that might impact us over the next 5-10 years — not just today. So, if I’m seeing rough seas ahead for the next year or year and a half, I’m not going to feel pressure to add more risk and more yield. That’s the way it should be for a CIO.
We think in terms of what the policyholder would want over a long period of time. As a matter of fact, I can boil almost every investment decision we’ve made down to a tradeoff between paying claims, the financial strength of the company, and paying the highest dividend we possibly can. Paying claims is all about duration. Financial strength requires staying within risk parameters and the rigorous stress testing we do to make sure we can maintain the highest rating even under adverse scenarios.
Finally, paying the highest dividend is a matter of playing within those constraints and maximizing our returns. Higher risk asset allocation and our financial strength has enabled us to outpace our competitors in terms of dividends and overall product value. That’s a play-to-win strategy over the long term.
IAUM: More generally, what developments are you seeing in the industry?
JOELSON: We’re seeing companies exiting the life insurance business, particularly public companies, because it’s not necessarily an optimal return on equity business. The amount of “E” (equity) that you need to support life insurance is higher, particularly in a low-rate environment. Specifically, when you look at the various risks and the desire to have a strong credit rating, your “E” needs to be pretty high. As a result, ROE is less attractive. And ROE drives shareholder value.
That results in companies like Hartford and Allstate getting out of the life business because, essentially, life insurance is a less efficient use of capital than other businesses, such as property and casualty.
I think it’s hard to be a public company in the life industry. So, public companies have diversified toward asset management. They look at property and casualty. They look at risk transfer. All of these have a different risk profile and, presumably, can generate a higher ROE and drive a better share price.
This means fewer players in the life industry, and that worries me a bit. In a low-rate environment, are we going to start to see the fallout of companies that don’t have the wherewithal or desire to withstand it?
I don’t see anything happening right away. But, you should worry about competitors running leaner from a capital perspective. How are they going to survive over the next ten years if rates stay this low? That to me is a very real risk because, well, what’s the impetus for rates to move back to where they were? This is potentially a race to the bottom where the companies that are going to survive are those with the capital to withstand and manage through it.
Here, the makeup of our dividend is revealing. Investment returns make up only about a third of our dividend paid. The remaining two-thirds is from expense and mortality savings. And, remember when I mentioned that our persistency is very high? That helps with mortality because only healthy people lapse their policies. Therefore, if your persistency is high, you generally have a healthier population. This in turn ends up driving more dividend value to the policyholders. In short, you need more than just investment returns to make a life company work well, particularly in a low-rate environment.
IAUM: On a go-forward basis, how do you see the development of the public vs. private markets? Private markets seem to be getting bigger and bigger — do you see that continuing? Do you see private-public partnerships in infrastructure, for example?
JOELSON: There will be some of that, and we’re seeing infrastructure deals that are attractive. But I think the bigger trend in the private market is international, where we’re beginning to see private investments as an entrée to that space. That’s where a healthier public-private premium remains, but of course you have to be able to hedge back to U.S. dollars.
And that accounts in part for the public-private premium in these international deals — not all insurance companies have the power to hedge back to dollars. Their ability to take counterparty risk or put up collateral is limited.
IAUM: What about tech? College kids coming out of school don’t want to work for a bank or insurance company when they can go to work for Google or Amazon, which are flashy and cool. I know you guys are making substantial investments to try and cultivate the talent on your own. How is that working?
JOELSON: Actually, we have a better story than those guys. Think about this for a moment… We’re a mutual company, while Google and Amazon are all about investors. True, they’re very forward looking, but if not profit today, then profit tomorrow. What they’re doing is creating value for investors.
Returning to Northwestern Mutual, we’re a company created and still run to serve the best interests of clients — the people who own it. That’s inherently appealing to today’s young people especially. For those concerned with doing the right thing for society, what we sell has much more meaning than the latest tech gadget you can put in your pocket.
Our mission is to help people achieve financial security at a time when financial anxiety is high. To me, that’s a nobler goal than a lot of other companies can claim. And it’s working. We’re seeing people coming to Milwaukee — and our more recent New York office — who want to work for us. It’s a great story for the future.
IAUM: You’re touching on a very important point that I think many people don’t think about — students coming out of school have a different set of values than students in the past. These students are about the greater good — not all — but a substantial number.
JOELSON: Quick story… One of our products is bank-owned life insurance (BOLI). So, a bank approaches us and says, “You know what? We love your product and want to buy $200 million.” We think that’s great and initiate the deal. But as we’re finalizing the details, they say, “You know what? Rather than $200 million, let’s make it $400 million.” To which we reply, “No, we’re not going to do that.” Wait, why? First, we consider the credit exposure to one entity that might lapse a policy. Second, we worry about diluting policyowner value when rates are low, which we offset somewhat with a dilution charge.
The point is, we’re prepared to limit sales if they’re not in the best interests of the policyowner.
IAUM: It’s a real conundrum in the insurance business: Strong sales and top line growth erode your book yield and can cause a problem for the rest of your book.
JOELSON: Exactly right. We control that because — in the best interests of all our policyowners — we genuinely aim to maximize return. We don’t ever want to reward policyowners today at the expense of policyowners tomorrow.
We do everything in the name of fairness. So, when you reach retirement and have built up several million dollars of cash value, our methodology for calculating dividends isn’t going to change from when you first purchased the policy.
Our senior leadership team does not even get paid on sales. Why? Because we could easily change sales tomorrow — just drop our underwriting standards and sales will increase. But that could trigger a mortality problem ten years down the road, which plainly is not in the best interests of our policyowners.
IAUM: Let’s shift gears a little bit – what about internal vs. external asset management?
JOELSON: We have some externally managed assets. If we want the asset class and don’t feel we have the capability internally, we’re willing to go outside. Bottom line is we do what it takes to maximize return after paying fees.
For example, we might consider outsourcing certain active equity strategies or more esoteric assets (e.g., agricultural loans — we don’t have that capability, so that might be interesting for us).
Emerging market debt is another good example. About a third of our emerging market debt investing is done internally. But we’re certainly not up on every country that’s out there, so we outsource the rest to external managers.
Still, the vast majority of what we do is in house. Why go elsewhere? Our public investment team consistently generates returns above market. Nobody’s got a private equity shop that compares with ours. And, we’ve got six regional real estate offices around the country. We’re not going to outsource that.
IAUM: What about direct lending, development, real estate and these sorts of asset classes?
JOELSON: We’re actually unusual in that we’ll lend and develop a property. We can provide construction loans as well as permanent loans, etc. We have portfolio appetite across the risk spectrum of the real estate market.
Real estate is a significant part of the portfolio — about 5 percent is real estate equity, and about 17 percent of the portfolio is made up of commercial mortgage loans. It’s one of our most successful areas of investing.
IAUM: What advice would you give to new college graduates and those who are early in their careers? Is a tech background helpful?
JOELSON: If they’re looking at Northwestern Mutual, I’d say that you might guess that new technology isn’t a big part of what we do here, but it is. Every industry is transforming, and we’re no exception. Even in the investing we do here, a technology-oriented background is going to help you a lot in many different ways.
A good example is sentiment-type analysis — understanding how markets might impact a particular credit that you’re looking at — just from news and other information that’s out there. You need to understand the disruption possibilities for the industry and how that disruption will likely occur. That’s because it impacts not only the credit but also the term that you might be willing to lend to such a company.
If you have a technology background and an interest in investing, you’re a perfect fit for our world. You’re going to recognize the trends and have an interest in finding value in the markets. That’s what we do every day. It makes this an interesting field to be in, and that doesn’t change.
What changes are the external forces that impact companies. Obviously, there’s also an extremely significant technology component to the business of Northwestern Mutual, how we reach clients and how they interact with us.
Focusing on the investment world, a critical trend for anyone seeking to enter the industry is that fees are on the decline. The business of asset management is becoming extremely competitive and difficult. But this actually makes investing for an insurance company more attractive. Earlier I mentioned that we’re investing $1.6 billion per month. We’re not worried about raising money. Instead, we’re worried about the best place to put it. So, if you’re a young investor looking for a place to hone your skills without worrying whether the business you’re in will even survive, Milwaukee’s looking like a nice place to be.
IAUM: We talked earlier about internally vs. externally managed assets. I’m sure you’ve heard about the large mandates that have been outsourced of late and the fees associated with them. What’s your view on those?
JOELSON: As rates and spreads come down, margins also have to come down. Who wants even lower yields net of fees? So, outsourcing is quickly moving to alternative asset classes where margins are better. It’s still a tough environment to make money and it seems like the same companies are fighting for fewer mandates.
IAUM: Where did you grow up?
JOELSON: I grew up in Westchester County, New York and southern Connecticut, as well.
IAUM: And you went to Hamilton College undergrad and Columbia grad?
JOELSON: That’s right.
IAUM: How long was it between your undergrad and grad school?
JOELSON: I worked for GE for about a year and a half and then went on to graduate school. That was the typical path back then. When I came out of graduate school, I went straight to Prudential on the private side. I started in 1984 and was there for 23 years, serving as their CIO for the last seven.
IAUM: What advice would you give a student coming out of undergraduate school?
JOELSON: Same now as always: Go someplace you can learn a lot. That should be your number one criterion.
It’s not how much they’re going to pay you, because coming out of undergraduate you really know very little. Where can you go to learn something important and make a difference? It’s the same whether it’s investing, finance, technology or whatever. You’re going to spend the first several years learning before you can add real value.
Become the world’s greatest expert at something. Make yourself invaluable — it’s the best way to spend your first couple years out of college.
IAUM: Now for the fun stuff: What’s your favorite sports team?
JOELSON: I’m now a Packers fan, which is tough because of course I was a New York kid born and bred with the Jets. My wife converted me. She became a Packers fan when we moved here. I never thought that would happen. She got so excited about it as part of getting caught up in this city. So now I’m a (Packers) fan because both of us sitting down on Sundays and watching a game is a pretty cool activity for a married couple!
It’s at this part of the interview where Ron demonstrates how dealers trick you playing Three-card Monte. I still don’t know where my ace was — even now. Ron just laughs . . . and as we’re wrapping up there’s one more card trick: Ron pulls out a deck of cards. Taking the top card, he shows it to me: ace of hearts. He says, “This is your card — protect it,” as he places it on my turned-up palm. I put my other hand over that card, covering it completely, protecting it. Then he shows me his card: the six of spades. Ron puts his card face down on the top of the deck. Pointing at his card, he asks, “This is my card, right?” I answer confidently, “Yes.” He then flips the top card over. It’s my card: ace of hearts. “Open your hands,” he said. And what did I see? It was his card: the six of spades. See, I told you he was a magician.