Stewart: Welcome to another edition of the InsuranceAUM.com podcast. I’m Stewart Foley. I’ll be your host. We’re very happy to be joined today by Ken McCullum, Executive Vice President and Chief Risk Officer of Principal Financial Group. Ken, thanks for being on.
Ken McCullum: Thank you, Stewart. Really appreciate you having me and I look forward to the discussion today.
Stewart: We are responding to our listeners’ inquiries who ask us, “Why don’t you put on some CROs? You’ve got CIOs on all the time, and it would be great to hear from a CRO.” And so you are the first of, hopefully, more to come, and we’re thrilled to have you. I want to start this the way we start them all, which is I want to ask you where you grew up, what was your first job, and what makes insurance asset management so cool?
Ken McCullum: Hey, well, I appreciate all of that. I moved around as a kid, but I’ll claim Bloomfield Hills, which is a suburb of Detroit, as my deepest roots and my hometown. And I still pull for the Detroit sports teams, painful though that can be. My first job is one that I’m glad to be behind and would never do again. That was at a Dairy Queen, and it got me really motivated to want to get an education and do something different with my life than that.
So what we do, cool, is what we do for our customers. Individuals and families need to save and prepare for retirement and they don’t get a chance to do it over if they screw it up. So they rely on companies like ours to provide them with the investment advice, the investment products, the guaranteed streams of income, and the protection products that have them confidently go through the working years providing for their families and into their golden years and the retirement years, confident that they’re well positioned to enjoy them.
Stewart: That’s fantastic. And the Principal, I always refer to the Principal Financial Group as the Principal, the same way that I do the Hartford, the Travelers. Your company has been around for a long time. You’re a bedrock insurance company in this space, and maybe not everybody knows that you also offer third party asset management services to insurance companies. So one of the first questions I guess I have, Ken, is can you talk a little bit about the perspective that being an insurer brings to your role as an asset management firm?
Ken McCullum: Yeah, absolutely, Stewart and you’re right, we have a long history doing this. We just had our 144th birthday on July 1st. We think a lot about how we can be most competitive for our customers by investing the premium dollars that they give us today to pay the claims and the benefits that they count on us for in the future. Those time horizons can be uncertain and they can be fairly long and they require you to be able to invest in a way that is going to generate a lot of accumulation and growth, while managing through a variety of economic cycles and making sure that you have a risk profile that’s suitable for those goals and objectives of your insurance company clients.
So, we’ve built a strong heritage obviously in fixed income and especially real estate in doing that. The other thing was we were one of the first companies to get into the retirement market in the defined contribution space with 401(k)s, and had to take a similar mindset of investing for the customer’s needs with the products that were most suitable for them. And so we’re an innovator with target date funds and things like that to make sure that we can help those customers as well.
Stewart: One of the things I think would be helpful, what does a CRO do, at 40,000 or 50,000 feet?
Ken McCullum: Yeah, no, great question. Fundamentally, my job is to make sure that we understand all the risks that we’re exposed to as a company and that we’ve properly not only identified them, but assessed them and managed them, and that we’re constantly reacting and identifying new and emerging risks. We have an obligation to share this with investors in our company, so our stock and bond holders. We have an obligation to report it to senior management and to the board of directors and to our regulators and to the rating agencies. And we have an obligation to also make our customers aware of how we manage risk for them and the investment products that they buy from us and from the company’s perspective, and the insurance products that they trust us with.
So it’s a great job. It’s a lot of responsibility that I’m very fortunate to have a team of 19,000 colleagues around the world who take very seriously, who are very responsible, very astute, and making sure that we do understand the risk in our business, and we are positioned to work through the uncertainties and be there for our customers when they’re counting on us.
Stewart: And when you look out the horizon today, what are the top risks the insurers face? You get a chance to have a multi-part question right off the bat. How has that changed from prior years, and how does that impact an asset manager versus other industries?
Ken McCullum: Yeah, it’s a great question and I have to think about it both macro from the enterprise perspective, and business by business that we’re in, and the businesses sometimes that our customers are in to make sure we have that well-rounded perspective. We all face, to varying degrees, sensitivity to the macroeconomic environment. When the economy’s strong, tends to be a tide that lifts a lot of boats, and when it’s going the other way, it tends to be tough sailing for all of us. As an insurer, interest rates and credit markets probably dominate how we think about macroeconomic sensitivity. But as a full financial services company, I also look at credit or currency markets and equity markets and so forth to make sure that we have that complete understanding.
I fundamentally believe that when you’re 144 years old, you’ve learned how to weather all those cycles. So we’ve seen the Great Depression, we’ve seen the financial crisis of 2008 and everything in between. Good, bad, or indifferent, our customers count on us to be able to get through those market environments with confidence and a steady hand on the rudder.
Unique to being a life insurance company, we focus a lot on mortality and morbidity, and that had been a fairly stable and predictable thing until this global pandemic came along. And with COVID-19, there were a lot of effects, both the immediate effects of the loss of life and the illnesses that folks suffered from it, but the uncertain ongoing effects of things like long COVID, of people that postponed getting detective and preventative care during the pandemic, and of the rapid advance in medical technology with the vaccines that were developed. All of that can be a positive or a negative.
Then we see significant changes in lifestyle over the last several years, and we see trends in obesity that are alarming. We see trends in mental health that are alarming as well. So there’s a lot happening in the world right now that makes the management of mortality and morbidity risk a little bit more uncertain than it’s ever been.
So those are things that are unique to an insurance company. I think, then, we all think about strategic risk and are we innovating enough with our products? Are we keeping current enough with our technology to serve and meet our customers in the ways that they expect us to be able to do? We all worry about cyber risk, we all worry about regulatory uncertainty, geopolitical risk and so forth. So there’s a broad array of risks, some unique to insurance, some unique to asset management. Some more global than that. One of the neat things about my job is I get to meet risk managers from other insurance companies, from other asset managers and from manufacturing companies and goods and services companies, and even from government agencies, and get a wide range of perspectives that I try to bring back to how we think about our business here.
Stewart: It’s interesting, I’ve taught insurance and have run portfolios and all of that. Insurance companies are basically paid to take risk on both sides of the ledger. The vocabulary for what we call those risks differs. Rate online versus yield spread, it’s the same difference. It’s what you’re getting paid to bear a particular risk. And given where we are today with interest rates, spreads, inflation, all of that, where do you think that you’re getting paid to take risk and are there areas where you think insurers should take a more conservative approach?
Ken McCullum: That’s another great question, Stewart. And you’re right. In order to succeed in our market, we need to take risk. So my job is not to prevent us from taking risk, it’s to make sure that we’re taking risks that we understand and that we’ve appropriately provisioned for and that we know what could go wrong. As we think about investment risk in the market cycles, we believe strongly, and I think Silicon Valley Bank was a good reminder of this, that disciplined asset liability management is critical throughout, that if you lose your way with that, you’ll hit a cycle where you’ll regret it and hopefully be able to survive it. But depending on how far misaligned the cash flows of your assets and your liabilities get, you may or may not.
So that’s one that we’re sort of all weather on that, that you want to have good alignment there and you always want to be testing the future uncertainties against that to see how you keep in alignment.
We have seen over time that market calls. So a conviction as to which way you think the market’s about to head. Are we about to enter into a recession? Are we about to see interest rates go down? Whatever it might be, have a bad track record of being able to add value. You can find individuals who won, just like you can find people who had the right team in the game last night that will want to tell you it was their expertise, that they knew how it was going to go. And you tend to remember the winners more than the losers. But we just fundamentally believe, and I fundamentally believe that market calls are a tough way to create value over time.
On the other side of it, credit underwriting and the ability, something in that class, particularly like real estate, to really understand the property and the governance and the situation that it’s in is a great way to create value over time.
So we believe the fundamentals of strong underwriting of the asset properties in markets like this where people might get nervous is a great opportunity to create value. We believe in staying disciplined in ALM and staying humble in knowing what you’re expert in and what you’re not, and knowing what you might be wrong about and being prepared for if it goes the wrong way, what that could mean are all key. It’s complicated and it takes a team and it takes healthy debate over the pros and cons to make the right decisions in that. Back to your premise, I couldn’t agree more, you have to take risk to create value.
Stewart: So we moved to the topic of liquidity and measuring liquidity. Now, this is front and center for a lot of people right now, as you know, Ken. Insurers are trying to figure out. Too much liquidity… I can get paid to take on illiquidity risk. The question is how much? Because there’s a cost to being too liquid, but there’s a potentially catastrophic cost, as we’ve learned recently, being not liquid enough. Particularly I think it was Warren Buffet who used the phrase, “You can’t tell who’s swimming naked until the tide goes out.’ So how are you measuring liquidity in your portfolios, and how should insurers determine how much liquidity they need as there has been a fairly significant and seems to be continuing march to private markets?
Ken McCullum: Yeah, it’s another great question and a timely one, Stewart. And you’re right. Most of the time, in normal conditions, we’re all going to feel like we have more liquidity than we need. But there’s that rainy day to come and you need to make sure that you’re always poised and positioned for that. We believe for our insurance company that you have to stress test the assets and the liabilities. You have to look at both short and medium term stresses on those to really understand how well your liquidity can weather those storms.
We believe, and we’ve seen, that having a diversified portfolio of assets and liabilities is very, very helpful. That having contingency resources is very, very helpful, and that you have a real keen understanding of how the liabilities are designed, that there not be a carelessness of having insurance products that provide liquidity to the customer that you can’t really support from your end, so you just hope that they never use it. You think that’s a bad design and one that you have to be careful about.
So that’s what we’ve done and that’s how we’ve managed our book of business, and when we work with others, those are the kinds of things that we talk about. But it is one that most of the time it’s pretty easy to pass the test, and some of the time it’s pretty hard. And my job is to make sure we’re focused on that some of the time when it’s pretty hard.
Stewart: Absolutely. And the next item on the agenda here is also challenging. So I’ve heard this phrased a number of different ways, and I’ll go back to my friend and fellow podcast guest, Nazar Alobaidat, when he talked about what is the right period to look at returns and correlations for SAA models.
Now, the context comes from this as to saying, and Howard Marks actually, it was a podcast, he came up with this idea of sea change, and are we in a different market environment and does that require different assumptions or whatever? And then I’ve heard a retort to that that says, actually the 10 years or so from GFC to 2021 were the anomaly and that’s the part that you should leave out. So when you think about SAA, strategic asset allocation, what’s the right period for returns and correlations and what’s the right time period?
Ken McCullum: Again, it’s a great question and to some of what you were starting to get into with the environment that we’ve been through, there’s a lot of judgment involved and there’s no substitute for good judgment. And we will occasionally see things that we’ve never seen before that will distort any ability to look at history, whether it’s government intervention in the markets, whether it’s an explosion. You mentioned private markets of new and different asset classes. We saw proliferation of mortgage-backed securities prior to the financial crisis. All of those things will have effects. It will make a model that’s solely based on historical experience incomplete, because we’ve thrown in market conditions that have never been represented in history. So that judgment overlay and that ability to think about what’s fundamentally different than I need to imagine in a broader way is always part of it.
Having said that, to be more precise on the specific question, we do tend to look over the course of a market cycle or over the life of a liability. And that probably boils down to, in most cases, we’re looking over 5 and 10 years. But it’s not just math. The math is important. It’s part of the process, but the judgment is ultimately where you really distinguish yourself. Anybody can do the math, but the ability to have that balance and thoughtful judgment is, I think, where you distinguish yourself.
Stewart: That’s really helpful. We’re kind of getting down to the closing out a little bit here. What issues are top of mind for you and other CROs as we move into the second half of 2023 here?
Ken McCullum: Yeah, again, super question. I always try to start thinking about our customers first. And when I think about fundamentally that we’re trying to help them save, invest those savings dollars and protect against the uncertainties in life, I see that opportunity and that need as steady and only growing. When I think about what’s changing with them, their demand for simple, customized, and transparent solutions in the world we’re now operating in is extraordinary. And so how are we adapting our processes, our capabilities, our products to meet that, is a very interesting challenge.
As I think about the second half of the year, the macroeconomic conditions are going to be uncertain, but as I’ve mentioned before, I think that’s always going to be the case. And a company like ours needs to be built to get through whatever those conditions will be. There will be good days and bad days ahead, and I’m not smart enough to know which ones are going to be immediately ahead, but I want to be prepared to thrive in the good times and survive in the bad ones.
When I think about the world we’re in, the geopolitical uncertainty is growing, in my view, and I think it is important to develop contingency plans for what that might lead to, to make sure that you’re diverse supplier-fied, whether that’s supply chains or markets that you operate in, and that you have contingency plans if things do go the wrong way.
We always think about talent. We always think about technology. We always think about our culture, and we always think about the competitiveness of our capabilities, and really try to hold ourselves to a high bar on all of those. But at the end of the day, and I’m thrilled to hear the way you characterized us earlier, our reputation and our brand is essential to our success. So making sure that we have good stewardship of that, that our employees understand that every day in the market, they represent that and our expectations are high, and that we have no tolerance for people that wouldn’t look to uphold that is critical.
So that’s really what’s on my mind. Those wouldn’t be unique to the fact that it’s the second half of ’23. Those would be on my mind pretty much all of the time. As we sit here right now, we’re waiting for clarity in the Chilean markets with their constitutional reform, for example. We do have a house view that a recession’s more likely than not, but we’re uncertain of that, and we are recognizing, as you mentioned earlier, the hard shift to private asset classes and thinking about all of that.
Stewart: I think that talent acquisition is so big in our industry right now. I do all I can do to let people know that this is a very interesting industry with a lot of complexity and smart money running these assets, whether it’s internal within the insurance companies themselves or in the asset management community that serves the folks who’ve decided to outsource some of those capabilities. I take every chance I get to beat the drum and wave the flag of the insurance asset management industry. I think it’s a great industry and one that offers a lot of opportunities for the right folks.
I’ll toot our one. We have IWIN. The Insurance Women’s Investment Network sponsors a job board on our website. We’ve tried to make that available to the industry, free of charge, so that people can see the opportunities that are out there. So I think the talent acquisition is such a big deal right now.
I’ve got one fun question for you before we go. You can have your choice. You can take both of these questions. You can take one or either one or both. Who would you most like to have lunch with, alive or dead, or what’s the best piece of advice you ever got?
Ken McCullum: Wow, there are so many people I’d love to have lunch with. Warren Buffet, who you mentioned earlier, would be on that list. I don’t quite have the funds to pay up for that one. On the personal, just sort of fun level, Jack Nicklaus would be one that I’d love to talk to.
On the best advice, I’ve had so many good pieces of advice I don’t know that I can boil it down to a single one. The thing that I think I would take the most pride in is that I’ve always, I think, been comfortable taking risk as long as we’ve done the work to make sure we understand what could go wrong and how would we get through it if it did. So, as a CRO, a car can only go fast if it has good brakes, and I feel my job is to be the brakes, and I feel like I’m kind of wired to enable the car to go fast, and the businesses to thrive by knowing that the brakes work too.
Stewart: That’s great stuff. I do want to tell you on a personal note that I feel your pain with the Dairy Queen thing. I owned a place called Bob’s Drive-In when I was in my 20s. I was working at Merrill Lynch and I ended up, I would drive after work and come home and work the ice cream stand at night and cleaning out the… I’ve been in dress shirts, cleaning out those ice cream machines. Oh, man, there’s a unique smell to that mix and I get it, man. So I feel you with that. So I really appreciate you being on taking the time and joining us today. And thanks for a great education from the CRO seat.
Ken McCullum: Thank you, Stewart. Really appreciate the time.
Stewart: We’ve been joined today by Ken McCullum, Executive Vice President and Chief Risk Officer of the Principal Financial Group. Thanks for listening. If you have ideas for a podcast, we do listen, as you can tell by this podcast. Please shoot me a note at insuranceaum.com. Please rate us, like us, and review us on Apple Podcast or wherever you get your podcast contact. My name’s Stewart Foley, and this is the InsuranceAUM.com podcast.
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