Stewart: Welcome to another edition of The Insurance AUM Journal podcast. My name is Stewart Foley. I’ll be your host standing with you at the corner of insurance and asset management. Today, we’re joined by Mitch He, Chief Investment Officer of Chesapeake Employers’ Insurance. Welcome, Mitch.
Mitch: Good afternoon. Very nice to have me, and very good to join you today. A disclaimer before we get started, everything we discussed today will be my personal opinions, and they do not represent my company’s official view.
Stewart: All right. Good stuff. Thank you. Well, duly noted, and we won’t hold you to any of this.
Stewart: Okay. Let’s get started. Weirdly, you and I have some commonality in that I worked at a place called Missouri Employers Mutual, which was at that time, a mono-line mono state workers’ comp carrier. And that’s the segment that you guys fulfill in Maryland, right?
Mitch: Exactly. Yeah. So you know us well.
Stewart: It’s interesting. It would be hard to find a more specialized insurance company than somebody who’s running one line of business in one state, but I know that nobody does it better than you guys do. Obviously, tough investment markets. In my career, I’ve never ever had anybody say anything different. It’s always tough, but there’s value out there. So, where do you see value in markets today, generally?
Mitch: Yes, definitely. As you mentioned, it’s a tough market, generally, I am cautiously optimistic about both the equity and fixed income markets in this year, but I do favor equities over fixed income a little bit more. With the current Biden Administration’s coordinated efforts in virus protection, vaccine distribution and further stimulus or relief package, the US economy is expected to gradually come out of the COVID-19 pandemic. Most sectors will enjoy gradual, but continued recovery and improvement. Although, the economic recovery process is expected to be slow and last a few years, which actually provides continued earnings growth and support a higher equity marketvaluation. On the fixed income front, most bond sectors have recovered and reached their pre- crisis levels, spread levels.
Mitch: I do believe the treasury yield level will be slightly higher later in the year for the right reason though, as the economy recovers further on, but the yields increase won’t be significant in my opinion. I’m looking for 1.5% on the US treasury 10-year bond at the end of the year. I expect the bond market to generate positive returns based on mostly the carry in 2021. Within the fixed income, I do see value in convertible bonds, CLOs, high yield securities to provide better returns. CLOs are a sector that has been the center of almost every insurance company that’s continued to enjoy some nice risk adjusted yield levels. And high yields should benefit from continued recovery similar to equities with spreads continue to tighten. Convertible bonds, which I want to emphasize, is an asset class that is not widely adopted by insurers, probably for a number of reasons such as limited total market size and possibly negative book yield accounting.
Mitch: However, insurers, for those that do not care too much about their book yield levels or the ones that want to focus on total returns, at least for their reserve portfolio [misspoke, this should be surplus portfolio] should definitely give the asset class a serious consideration given the treatment as bonds, downside protections and equity like potential returns.
Stewart: That’s interesting stuff. I mean, you have just recently put a LinkedIn post out called Market Crash Bitcoin and EVs. What I gathered from that is that as an institutional asset allocator, you’re focused on mega trends. Can you talk a little bit about that?
Mitch: Yes, definitely. I mentioned the market crash, but I don’t think a market crash is imminent. I do think that, as I mentioned earlier, I’m optimistic about both the bond and equity market, at least in this year. So, it makes sense for institutional investors to focus on longer or mega trends for fixed income investments. Insurers generally are buy-and-hold investors, so it’s critical to have the long-term big picture in mind and avoid declining sectors or industries that are on the wrong side of the trend. This is against insurer’s target duration of the portfolio. For example, I mentioned in my LinkedIn post that the fossil fuel industry or traditional internal combustion engine or the ICE car makers are in that group and on the decline for the longer term.
Mitch: On the equity side, to efficiently deploy capital within a limited exposure in these risk assets and with a RBC aware investment approach, it makes sense for insurers to focus their risk exposure on strategies that can either generate income with growth potential or generate significant higher expected total returns, looking at more than 15% annualized. I favor all kinds of technologies, which have been the driver of the global economic development and the equity market growth for the last decade. And I expect it to continue to be the driver for decades to come. I actually believe investors nowadays should have a technology framework in place to guide their sector weighting or even treat technology as an asset class in adiversified portfolio.
Stewart: It’s interesting that at its most basic form, insurance companies get paid to take risk on both sides of the balance sheet. You’re trying tofigure out where that makes sense, where are you getting paid to take risk. So with that as a backdrop, what’s the biggest risk facing insurers today?
Mitch: Yeah. In an increasingly competitive and efficient insurance market, investment income and returns definitely play an importantcomplimentary role in most insurers financial health. As investment professionals, I would say, the biggest risk facing insurers from an investment perspective is prolonged low yields, very narrow credit spreads right now in most bond sectors, combined with an existing regulatory framework or the RBC that essentially require insurance companies to invest predominantly in investment grade fixed income securities, which we know generate little investment income these days. So if rates decline further or stay at the current low levels for longer time, insurers who have relied upon higher book yields from older holdings, will see continued, but a much rapid deterioration on their fixed income book yield and shrinking investment income, or they have to offset that investment income decline by investing even more capital into lower yielding fixed income securities or taking on more duration or credit risks.
Mitch: If rates rise quickly and unexpectedly, insurers, especially public insurance companies will see their fixed income portfolio market value suffer.Additionally, credit loss may develop in their non-core portfolios, such as high yield bonds, and equities would also see market value losses in that case.
Stewart: Given that as a backdrop, how do you see regulation impacting your ability to manage those risks and still achieve your investmentobjective? I don’t have any easy questions today, Mitch. The easy ones come later. These are the hard ones, and then I swear, the next one will not be this awful. Sorry. Go ahead.
Mitch: This is a very good question, I enjoy the dialogue and conversation. We all know regulations and limitations exist for a reason. The heavily regulated insurance industry, we’re financially very sound in the latest COVID-19 pandemic and also the last great financial crisis of 2008. With the exception of AIG, which stepped out of its core insurance into derivative underwriting back then. We also see banks as troublemakers in the 2008 GFC, weathered the currentCOVID-19 crisis very well, and at least the banks as a sector did not become a systematic risk for the market. I attribute that positive performance in the crisis by banks to the improved regulations such as the Dodd-Frank after the 2008 crisis. However, insurance companies, especially those with longer tale liability, such as life annuity insurance or workers’ comp insurance companies in the P&C camp could face a very difficult investment environment in the next few years, given the continued erosion of book yield, and historically low yield level.
Mitch: At the end of last year, about one third of the global investment grade market was in negative yield territory. Although the fed lowered it’s federalfunds rate all the way down to zero at the onset of the crisis, we understand the fed does not want to get into the negative rate territory. However, we know that never say never, as investors, we have to prepare for such a scenario. So I do encourage and welcome regulators and rating agencies to actively plan for and join this kind of discussions when the US interest rates Japanize and dip into negative zones one day, like its counterparts in Japan and Europe. I don’t know what impact it will actually have on the global capital market. Most of risk assets under the modern capital asset pricing model, the CAPM, are priced with positive US risk-free rates.
Mitch: I believe the insurance asset management regulatory framework will need to reform and adapt to the changed investment landscape that we are in today, and we will be facing, especially in the next couple of years. As an industry, insurance investment professionals, including asset owners, asset allocators and investment managers should start to engage more active and constructive dialogues and brainstorming with regulators on how the current RBC framework can be tweaked to reflect the true risks in both fixed income market and equity market, and whether limitations, for example, on foreign exposure should evolve in an increasingly globalized investment market.
Stewart: Right now, we’ve talked a little bit about low rates. We know that’s been the case for a long time, and it’s likely to continue as you mentioned. So, we see fund flows into private markets versus public markets to pick up the spread related to liquidity risk. I guess the question is, what do you see for the future of public versus private markets over the near and I guess the intermediate term?
Mitch: Yeah, definitely, there’s a lot of institutional investors out there, have a capacity to take on additional liquidity risks, such as insurance companies, especially the longer tail liability insurers. So I do think that the private market can continue to offer different kinds of investment opportunities, I see a continued move towards more allocations by institutional investors like insurance companies to private market, including alternatives and other private credit investments, things like that. I do think the private market can continue to grow.
Stewart: You’re right, only worker’s comp insurance. When you and I prepped for this call, we became workers’ compensation insurance geeks together. And I said, “Workers’ comp is a long tail line of business. It has a substantial exposure to medical inflation.” And I said, “Can you hedge it. How do you hedge it?” What was your answer to that question? Are you able to hedge medical cost inflation?
Mitch: Definitely. The insurance company can be proactive and think a little bit out of the box in term of hedging risks embedded in the liability side of their balance sheet. Work’s comp insurance such as ours, Chesapeake Employers, can hedge the medical cost inflation economically, not one-to-one, but economically by investing in equities, focus on healthcare technologies and healthcare solutions. About a dozen years ago, our current CEO, Tom Phelan championed such a strategy actually, which have turned out to be a very nice longterm successful story for us. It generated over 15% annualized returns since inception and returned a 50%, believe it or not, last year, in 2020. This definitely, in my view, is a long-term cornerstone strategy for investors like us that has medical inflation exposure.
Stewart: If Tom Phelan is listening to this podcast, I’d like to give him my best. I’ve known him for many, many moons ago back when I was less gray and the earth was still cooling.
Mitch: Great. Yeah, definitely. I will let him know.
Stewart: So just a quick turn, kind of the back end of this thing, right? You did not have a traditional career path to becoming an insurance asset management professional. What was your career path? How did you get here? Here’s the reason I ask, I teach a lot of younger people listening tothese podcasts. I think they benefit from hearing from people who have been there and done that, and their original plan might not have been exactly how it worked out. So what was your career path?
Mitch: Great. Great. Yeah. Definitely good to know that you’re teaching on the side as well. So actually last year, I also went back to my alma mater University of Illinois and shared some of my experience with the students there. So actually, I believe you can tell, I have a Chinese accent. I was made in China and refurbished in the United States. Actually, I was born and lived in Wuhan, China until I was 23 years old. So in the past, I always joked with my friend before the pandemic, people know about Beijing, Shanghai. They don’t know where’s Wuhan, what is Wuhan. Now, I don’t need to explain much.
Stewart: It’s a good point. Well, don’t worry, I’m from Missouri, so we don’t ever bring up accents on this show.
Mitch: Actually, I had my undergrad study in electronics engineering from a local university in Wuhan. I always think my career path somehowsomewhat reflect the economic development in China. Back then you know, 20, 30 years ago, there was really not a financial market like the public capital market that exists in China, that started to develop while I was in college. So actually, I’ve taken my family advice to study electronics engineering, but I found out that that’s not really my interest. I worked there about three years in different cities in China, in marketing and sales role within the IT and telecommunication sector. While I was working, I developed interest in business and investments, so I decided to come to the US and pursue my masters study in business. I pursued two master degrees focused on both investment and accounting at the University of Illinois, Urbana– Champaign as a graduate of the MBA program in ’03, and another master of accounting in ’04.
Mitch: So my first job on Wall Street was in investment banking, private equity, capital formation, reverse mergers actually, which is the way for blank check companies or SPACs to merge with an operating company, and SPACs have come back in favor these days. That was a boutique merchant bank investment firm for about six years, it was a great experience for me. It was later on acquired by another BDC, and right now, the firm no longer exist.But I kept a very good relationship with the founder and the partners at the firms, so we do chat from time to time over the phone. I stepped into insurance asset management when the reverse merger business went out of favor back then after the great financial crisis. It was a great transition, which taught me a lot about managing investment assets for both life annuity companies and the P&C insurance companies.
Mitch: I worked there for five years as the director of investments for the company Horace Mann insurance Companies, which is a public traded multiline insurance group based in Springfield, Illinois. My wife and I had two kids in Springfield, and when they started to grow a little, we wanted to move to an area that offered more weekend activities. So I fortunately got a nice opportunity to join my current employer in Baltimore, Maryland six years ago. Actually, it’s literally six years because I joined in January, 2015, I believe, as its chief investment officer. I’m really loving it.
Stewart: That’s cool. It’s good to see you’re enjoying it. I know it’s a good group there. Last question, you mentioned you got your two masters at University of Illinois, I’m not going to ask how old you were, but I’m just going to phrase it like this, there you are, you’re walking across the stage on graduation. You’ve got your cap and gown, your mortarboard on, you got your tassel on and you’re looking good. And you go across the stage and the president of the college sticks his or her hand out and they shake your hand, there’s a little quick picture, and off you go and you’re all excited, and you come down the stairs back off the stage and you run in to Mitch He today. What do you tell your newly minted MBA self?
Mitch: Yeah, I would say that be passionate, be curious and proactive, enjoy both work and life, going to need to have some fun in doing things. Read some books and talk to experienced people and learn from them. Maintain your integrity all the time, be a team player and try to help others out actually. There’s a good quote from What It Takes, which is a book written by Steve Schwarzman, the chairman and co-founder of Blackstone, he said that everyone has dreams, do what you can to help others to achieve theirs. So, I think that’s a great quote I want to share with the younger me.
Stewart: That’s good advice, man. Listen, thank you for being on. It’s been a real pleasure. It’s really been great to have you.
Mitch: Great. Nice talking to you.
Stewart: You too. Mitch, thanks for joining us. Mitch He, Chief Investment Officer at Chesapeake Employers Insurance. Thank you for listening. We’d love to hear your ideas for future podcasts. Please email us at firstname.lastname@example.org. My name is Stewart Foley, and this is the Insurance AUM Journal podcast.