Stewart: If you know anything about insurance asset management, you know that regulation is a major factor in everything insurance investment professionals do. We are joined by a true expert in insurance asset management regulation, and we're going to learn a lot today. So, Amnon Levy of Bridgeway Analytics, welcome.
Amnon: Oh, thank you, Stew.
Stewart: It's great to have you. You and I are friends, so this should be a good casual conversation. Let me start off with this one, the way we start them all. What was your hometown, your first job ever, and a fun fact?
Amnon: Stew, I just love how you bring individuality into your podcast. If you'll allow for it, I'll combine my response to those questions. My hometown straddled New York City and the Yemenite Quarter of Tel Aviv, Israel. Fun fact, the Tel Aviv home was built in the end of World War I when my grandfather, who had migrated from Yemen, crossed the Saudi Arabian Peninsula by foot in 1906.
Stewart: Oh, my goodness.
Amnon: Yeah. It was one of the first houses that was later to become part of Tel Aviv in 1923. That's after the British took over from the Ottomans.
Stewart: Wow. There you go.
Amnon: Yeah, yeah. Lots of history.
Stewart: And first job?
Amnon: First job, I was a dishwasher at a restaurant across the street from the house that I grew up in in the Yemenite Quarter.
Stewart: That's fantastic. My first job was McDonald's, so it's neck and neck for our futures.
Amnon: Yes.
Stewart: For those people, our listeners, who are not familiar with you, you have a very deep background in regulation of a variety of types. Can you just go over at a high level some of your background so that our listeners sort of know where you're coming from?
Amnon: Absolutely, Stew. I've had the honor of working on regulations going back to the early 90s when I was at the Federal Reserve. The group I was in was responsible in part to engage with the Basel committee in the design of Basel II. My first commercial job after graduate school, we wound up developing credit models. This was at a company called KMV. It was later acquired by Moody's, but the credit models that we developed were later embedded into the Basel II framework that governed banks credit holdings.
Over the years, I had the honor of working with the fed on CCAR, working on models related to IFRS 9 and CECL in reserving. Over the years, my engagement with the insurance industry and regulators on the insurance side had my group get pulled into the redesign of the C1 bond factors that governed three trillion in credit holdings for US life companies. That was an incredible opportunity to support the community. It was a challenge that the regulators and the industry were trying to see eye to eye on for almost a decade.
We were pulled in the end of 2020 to review what was being proposed. In the end, what we had designed was voted for adoption in 2021 with support from the industry and the regulators and the NAIC. That was quite gratifying to see that go through.
More recently, we've been engaging with regulators, the NAIC, and the industry, having conversations around possible future changes, refinements to how different credit assets are treated, recognizing differentiated risks that are embedded in different credit assets, whether corporate or muni or structured assets that all get treated the same under the C1 framework.
Stewart: You have the richest background in regulation. I didn't know all of those aspects. You also have a call into a lot of people. You have an impressive list of folks who you speak with and interact with as well. But at a high level, can you give us an overview? I know that we all know a rough version of this. What is an overview of how investments for insurance companies are governed?
Amnon: Yeah, that's a really interesting area to explore. The US is fairly unique in how insurance is regulated when you compare it to other countries. Insurance is regulated at the state level, not at the national level. While you have the NAIC design RBC and statutory guidelines through their various committees, the NAIC is not a regulator. The NAIC provides guidance through what they reference as model law for the states to use effectively as a template in designing the rules.
The way that the rules are structured in the United States, there's an enormous amount of variation in how states design their rules. The limits to investments in, say, real estate or equity or foreign entities is incredibly broad. One asset class that often gets notable reference is Yankee Bond, foreign entities that are issuing dollar-denominated assets in the US. The limits in Florida are 5% of admitted assets. California, it's 20%. Some states don't have any limit.
The list goes on in terms of how the different states have structured their guidelines and language that's used and the like, and the governance that each state has in terms of how the laws are structured. You have the laws that the legislature passes that the governor signs off on, you have the administrative code that Department of Insurance structures that has the rule of law, you have circular letters, you have bulletins and opinions, all of which, in effect, govern insurers differently in different states.
Stewart: That is a lot to keep track of. I mean, I think by anyone's measure, that is a tremendously complicated labyrinth of rules. I know, our listeners are insurance investors, but for the sake of it, we talked about RBC, which stands for risk-based capital. Banks and insurance companies are required to hold a certain amount of capital. The insurance word is 'surplus', but it's the assets minus the liabilities. That capital is a haircut based on the holdings of the company. Can you just give us, at the highest level, a little bit on RBC?
Amnon: Absolutely. As you described, banks and insurance companies have to have a buffer to be able to handle losses at a particular level. Depending on how risky a particular asset is viewed to be, the requirements are going to be either higher or lower.
A triple A asset requires just over 10 basis points of a buffer, say, to absorb future possible losses. If you're talking about equity, then you're talking about generally something in the order of, say, 30%. Companies have to demonstrate that that buffer is sufficient, that it's effectively multiples of whatever the minimum requirements are. State rules indicate that if those buffers are insufficient by some set of measures, the state regulator effectively has to step in.
Stewart: I think one of the big misconceptions is that insurance companies are dumb money because they've got all this money in bonds, but the reality is that the regulatory framework somewhat forces them into a big allocation to fixed income because of the favorable capital treatment, right? I mean, that's in rough numbers. The RBC, those levels are set by the NAIC. Is that right?
Amnon: Yeah. The RBC, the risk-based capital associated with each asset class is set by the NAIC committees. Those are voted on. What the state rules do is limit how much could actually be invested in a particular asset class or how a particular asset class is classified.
For example, ETFs, Stew. You've had many folks come on your program to explore the role and evolution of ETF use in the insurance industry. Incredibly important asset class that's grown tremendously, very efficient. ETFs that are primarily invested in bonds could get a special SVO designation allowing them to be treated as a bond, whereas an ETF in its genetics is an equity asset. That favorable regulatory and accounting treatment is differentiated across different states. Some states might allow an ETF to be treated as a bond, others might not. And so, you get very different strategies as a result in terms of that asset class, as an example.
Stewart: The term for that is 'look through', right? Whether you look at an ETF... Some states look at an ETF as one thing, and then if the NAIC says grace over it, it gets a look through to the underlying holdings, right?
Amnon: Yeah.
Stewart: That's some of the big difference.
Amnon: For the bonds effectively, for the bond ETFs or preferred stock ETFs, the SVO effectively looks through the structure, sees what the weighted average rating is, effectively, and then assigns a designation based off of that, and you wind up getting much more favorable regulatory capital treatment.
Stewart: I was just going to say, you use the term SVO. That stands for Securities Valuation Office, which is part of the NAIC. Is that right?
Amnon: That's right. The way that the NAIC is structured, and here we're getting really to the weeds, which I love.
Stewart: That's where this audience lives, man. I've had some people, I was at the CFA Chicago event and somebody goes, "I like your podcast." I'm like, "God, don't say that out loud again. Your social life will suffer." So, yeah, no, we need to be in the weeds, man. This is good.
Amnon: Yeah. The NAIC is comprised of committees that are populated by regulators, by state regulators that rotate effectively across the states, and then you have full-time NAIC staff in offices. The Securities Valuation Office is full-time NAIC stuff. They have 30 some odd capital markets professionals that manage the process, among other things, of assigning NAIC designations to each of the credit holdings across the insurance industry.
Stewart: And they publish too, right? They also do some publishing.
Amnon: Exactly. They have a Capital Markets Bureau that publishes research, that explores dynamics in the evolution of market trends whether it's the investment in certain types of assets like structured assets or other trends that help the regulators understand how the industry's evolving.
Stewart: So, the regulatory landscape, there's been a fair amount of change recently. Why so much change now?
Amnon: Stew, on numerous podcasts that you've posted, you've highlighted the rate of change in the industry is spectacular. The last two years have just been, in insurance years it's been centuries.
Stewart: Yeah. I mean, we're like on the Starship Enterprise, right? The part where the ship just blasts into space and it just disappears behind a beam of light.
Amnon: Exactly. Yeah.
Stewart: Somebody said to me the other day that the life insurance industry has changed more in the last two years than it has in the last fifty. So, what's going on?
Amnon: I think there are multiple catalysts at play here. The industry was forced to change effectively over the last decade or so given the low-yield environment. It was forced to look for alternative investment models that would support the life business. That's part of it. There are other parts, though, that are reinforcing that, which includes... The C1 factors, for example, were 10 years in making. The change to the commercial real estate factors, those are longtime coming changes that have substantial impact on investment strategy.
Other aspects include, Dodd Frank changed how credit for reinsurance is governed. That's actually a very underappreciated change that is going into effect now that's going to, I think, really have an impact on the industry.
Now, with all these changes, insurance regulators have to adapt. By and large, regulators are not going to regulate hypotheticals. They're going to wait until they understand how the landscape is evolving, and if they see something that needs to be regulated or they see something that they don't understand, they're going to react.
What we've seen is substantial shift in investment strategies, going into structured assets, a shift in business strategy related to, say, private equity-owned companies, and we're seeing the regulators react. We're seeing them explore changes to how affiliate investments are reported. They've changed how RMBS and CMBS are regulated, and now looking at CLOs.
Stewart: Yeah. I mean, it's interesting. I've said this in the past, but at the end of the day, regulators are there to protect the consumer, right? Same for banks. You put your money in the bank, you go to get it out, you get it out and the regulator, that's the purpose. In insurance regulation, the idea is: you have an accident with your car, and the insurance company's check clears to fix it.
And so, prior to this very low-interest rate environment, that was a very long time. The regulator's concern, first and foremost, about the fault risk, and that risk really shifted to earning enough investment income to survive. And the regulator has responded, if I've got this right, with some changes. So, what's the challenge right now with the dynamic landscape? You had mentioned this just a moment ago, but navigating changes in the NAIC guidelines, I'm sure there's things going on at the state level. It's not on my radar screen, but I know that's in the center of the fairway for you. Could you talk a little bit about that?
Amnon: Absolutely. First of all, Stew, I really appreciate how you've articulated the concerns that the regulators have in terms of the industry being able to generate enough income.
Regulations should aspire to promote competition and fair practice. The industry is struggling in many areas to survive in terms of certain business models. Unfortunately, the complexities often limit the extent to which insurers can compete in certain areas. Just the overwhelming burden of navigating and keeping track of the various state repositories for the regulation on the investment side and the change in NAIC, often the insurers wind up just taking vanilla strategies that are unfortunate, because these days, with the yields being where they are, if you're taking vanilla strategy, you really have to question how viable that business model is. That's certainly something that the regulatory community is aware of and has their eye on. So, something that, Stew, I wanted to really reinforce in the terms of the point that you made.
Now, coming back to the question, with as much change as there has been, the burden of keeping track of where things might go, recognizing that life companies focus on long-term investments and when you have things on your books for 10, 20, 30 years, you really need to think about how viable that investment is if the rules are going to shift or if the capital charges are going to shift in a rated bond, for example. Life companies don't move quickly. They don't. And so, all of these factors just have the burden. It's incredibly expensive.
I shared with you our effort at Bridgeway to design a tool that keeps track of the different rules across the states and provides a level set articulation along with technology to monitor potential changes to the rules at the NAIC and the state level. That's something that we're finding is incredibly effective and efficient in helping insurers navigate the dynamic environment.
What I found really, again, gratifying, whenever I think about policy is that many regulators are finding the tool to be incredibly valuable in how they approach the regulatory process including the design of new rules, given how they themselves are challenged with whether it's onboarding new regulators or whether it's in assessing the solvency of a company from another state. It's a problem that the whole community faces.
Stewart: I love how you use the term community. That's how I view it too, it is a community. I want to go to what you're working on at Bridgeway, but I want to go to another place first. You mentioned life insurance, the low yield, there have been some major transactions taking place where Allstate, for example, AIG another, where they sold their life business. The only thing I can come away with there is because they can't make money at it. They're selling it to private equity that has the ability to invest in a different set of assets with a higher expected rates of return. Are those transactions noticed by the regulatory community? How do they view it? Are they concerned? You're the only person I know to ask that I think might know the answer.
Amnon: Those deals are absolutely noticed by the regulators, there's no question about it. Now, are they concerned? I think the blanket response is whenever you see a lot of change, especially in an industry that's known to move as slowly as life, there's going to be red flags. It's going to take regulators time to get their head around the materiality of the potential risks associated with these shifts.
The examples that you just gave are related to items that are all on the table right now at the NAIC in terms of possible refinements with the regulation. Whether you're talking about treatment of private equity backed insurers, whether you're talking about credit for reinsurance, whether you're talking about how affiliate investments are being treated and possible changes to how things are documented and disclosed, as well as the investment that private equity companies are known to focus on, namely the private placed debt as well as structured credit, CLOs. And so, there are a lot of question marks.
The issues that the regulators struggle with often is in understanding how material those risks are because it's very hypothetical until something blows up, right? Very hypothetical. In different economic environments, things might be fine or they might not be fine. I like to point to, just a fun little factoid here to give you a sense of how challenging some of these issues are, not just to regulators, but to capital markets more broadly.
Stewart: Amnon, if you can bring something fun in regulation, man, this is the holy grail. Come on.
Amnon: Let me share some fun facts. Over the last 50 years, the cumulative 10-year Moody's investment grade rated muni bond default rate has been 10 basis points. In other words, since being rated investment grade over the subsequent 10 years, only 10 basis points of munis have defaulted, measured over the last 50 years. That's a pretty established asset class. Meanwhile, the cumulative 10-year investment grade rate for corporates is 225 basis points, 2.25%. That's, what is it, 22 times higher over the same period.
Now, what's going on here? It's really hard to measure these things. You're talking about default remote events where... The fun fact is since 1970, there were six corporate defaults within 10 years of being rated triple A. Six.
Stewart: That's incredible.
Amnon: So, how do you measure? You're going to use that data to differentiate risk somehow? And, fun fact, three of them were Icelandic banks, so I don't know if that was three events or one, and two of them were Texaco and Getty whose default was driven by a botched corporate takeover attempt. Michael Douglas won an Oscar for best actor when playing ‘greed is good’ character, Gordon Gekko, which was inspired by a composite of the personalities involved in that deal. That really just leaves Macy's as the only triple A, in the US at least, to have defaulted within 10 years of being rated triple A in the US since 1970. So, how are you really describing these risks and differentiating them and helping the regulators understand what they should really be concerned about?
Stewart: I think it's a great point that a single A-rated muni and a single A-rated corporate, the risk is not the same. Everything rated single A is not comparable across asset classes. Is that fair?
Amnon: Yeah. Absolutely. Absolutely. The muni default rates is about one-tenth that of corporates over a 10-year period.
Stewart: Here's my fun fact.
Amnon: Yeah.
Stewart: I was the treasurer of the City of Columbia, Missouri, which at the time, and I don't know the rating today, was a standalone double A. I always that said the City of Fort Worth isn't going to lever up and try and take over Dallas. It just doesn't work that way. When you're issuing muni bonds, holy smokes, the voter approval and the rigmarole that you've got to go through to get something financed is amazing. It's such a process to get that done, and I'm not surprised. I just didn't know the numbers, right? The numbers are really interesting from my perspective.
When I was running muni, every now and then someone would say, "Hey, would you look at our portfolio and let us know if we're in compliance with all the state regulations?" And ‘no’ couldn't come out of anybody's mouth fast enough. I don't know if you're familiar with this term, but when the check comes, everybody has what's known as alligator arms where they pull their hands back. That's what happens when they say, "Oh, can you tell me if I'm incompliant?"
Now, you and Bridgeway Analytics, you have built, in my mind, the ultimate regulatory mouse trap that can tell you that. And you made this point, as complicated as it is for the investment community to figure out all these different regulatory regimes, domiciles, and so forth, it's also very complicated for the regulator. Your company has seen interest in what you've built from both sides of the equation. Can you talk a little bit about what Bridgeway has done and what you're doing? I find it just remarkable and I think it's important for people to know that it's out there.
Amnon: Thank you, Stew. The objective that we have is really to allow the industry and regulators to more effectively and efficiently understand, navigate the rules. What we've done is built out a taxonomy of rules at the state and NAIC level and codify the rules on the investment side, allowing one to understand in a level-set manner how limits and the treatment for various assets are structured in the different states. That level set articulation really has us effectively rebuild the rules using a common language that by that very nature abstracts from the actual rules and it allows users to navigate, understand how we interpret the rules. It's our opinion of the rules, right?
Rules are written often in an open-ended manner intentionally so they can't be gained too easily. We have our interpretation of the rules and then the user could go and dive into the actual rules and see what the language is and how the rules are actually written.
The state rules are written using language that is incredibly varied. From Pennsylvania, for example, we were just going through reviewing that. Those rules were written in partly 1922, very different from some of the Iowa rules that were written last year. Being able to level set that, it provides an incredibly efficient mechanism of knowing how compliant an organization is, knowing what rules are most relevant and knowing how one might want to structure their investment policy in a way that the regulators are comfortable with.
On the regulatory side, the regulators themselves often are struggling to understand what the rules are in another state. If you're familiar with the way that states allow different insurers to conduct business, foreign insurers, those domiciled, and states outside are allowed to conduct business and provide a certification from their domiciled commissioner. That leaves the state often wondering, well, how solvent is that structure?
Stewart: Just from a terminology perspective, because this has always confused me, the regulator talks about a foreign insurer in a company, not in their state, and someone that's not from the US, they call... Is it alien? Is that right?
Amnon: That's right. Absolutely. To give you a sense of how confusing it is, often the rules are written where they'll reference domestic and foreign as referencing insurers or investments outside of the US or inside the US. In other parts of the code, it'll reference domestic and foreign as within the state and outside the state but still within the US. So, the rules are just incredibly painful to navigate and understand.
Stewart: I'm just super impressed with what you guys have done. I mean, it is impressive. Anybody who's run muni and dealt with these regulations, it is really challenging, particularly those changes. What about looking forward? Are you optimistic? What do you see out the front window? We've talked a little bit about what's out the back window. It would be great to just get your view of the go-forward.
Amnon: I am optimistic, Stew. I find that the NAIC and the regulators are giving, especially on the investment side, a lot more energy that they have historically. They are realizing how critical the investment process is to the business of insurance.
Historically, often, the focus was really on the policy side, which is incredibly important, but the investment side was not considered part of the business of insurance, which is something that cannot be dismissed at this point given your observation, Stew, of how policy blocks are being sold off in ways that make it clear that certain business models just aren't going to survive without the proper investment supporting that policy block.
Stewart: Yeah. I mean, a mutual friend of ours, Bill Pacheco, shared a slide with me from St. John's that went back and showed the sources of profitability over the last 20 years, and it's overwhelmingly on the investment side. I mean, the insurance operation is providing cash flow and assets for investment, and the investment income and returns, that's going to drive the profitability. So, it's interesting that... I don't know. I hate to say like this, but that the regulator is just focused on it at this point, right?
Amnon: Yeah. I think that's something that really evolved out of necessity. Prior to the financial crisis, yields were not problematically low and the insurers generally took much simpler investment strategies. It's only the last 15 years, 20 years maybe that they really started to really push the envelope.
What we're seeing is really a ramp-up in terms of their awareness of capital markets and the differentiated risks across investments. As they're doing that, I think it's also coupled with other aspects to technological advancements, whether we're talking about what we've done at Bridgeway to support the regulators, but also advancements with some of the InsurTech and the RegTech space to help provide transparency and efficiency in navigating regulation.
I'm actually quite optimistic that in the next five years or so and beyond, we're really going to see a much more efficient and effective system that will ultimately benefit policyholders in the end of the day. That's what we care about.
Stewart: I just want to go back to this for a second. Bridgeway, you've undertaken what I would call a seemingly impossible task of figuring out the NAIC and state rules. You are using some advanced techniques including machine learning. You are front and center in the RegTech area. Is that a fair statement?
Amnon: I would like to think so, Stew. That's what we're told, so...
Stewart: But you've gotten a lot of traction, right? I mean, a lot of traction.
Amnon: Yeah. Yeah, we've gotten some really good feedback from... As I mentioned, we're grateful that the very positive feedback is not only coming from the industry, but from the regulators, which is great. Because if the regulators, if that community's using the tool and they feel comfortable with our interpretation of the rules and they're using it, then that ultimately provides comfort that what we've done makes sense. Like you said, you pointed to the term community, it is a community, right? We're all struggling with the same problem, and by having a standard like this, everyone benefits.
Stewart: Hundred percent, so I appreciate it. I learned so much. I always learn so much on these podcasts, and I know that our listeners do as well. I want to thank you very, very sincerely for being on. I've just got one more question for you. Looking back over your career, what would you tell your 21-year-old self?
Amnon: That's a really wonderful question. Stew, I was a former academic. I was a professor at a number of business schools, the Haas and Stern, and wound up joining a startup, KMV, 20 years ago. It was a FinTech before FinTechs existed. We were bought out eventually by Moody's Corporation. I worked at Moody's for 20 years and eventually left in August.
I couldn't be more grateful for what Moody's allowed me to do, engage with industry and regulators; but when I left, I didn't know that I was going to start Bridgeway. In fact, it was probably the furthest thing for my mind. I never thought I'd start my own company. I felt like I may have been programmed over the years to really think about staying in lane and focusing on, maybe, a narrow set of issues and having kind of stepped out of it and evaluate the landscape and take a few months to really think through what's going on out there.
Maybe I should have done that earlier in my career. Even though I'm so grateful for the opportunities that I had, I do wonder how things would have changed had I jumped in the deep end and tried to do my own thing earlier on in my life.
Stewart: You have done it beautifully. I don't think anybody has got more street cred on this than you. I mean that sincerely. If anybody talks to you and you and I have had the opportunity, and it's been my pleasure to get to know you and understand what your skill set is, it is impressive. I want to thank you for being on. Amnon Levy, Bridgeway Analytics, have a look. I think you'll be impressed. Amnon, thanks for being on.
Amnon: Stew, thank you. I listen to your podcast religiously. I learn a ton, so keep doing what you're doing. I love it.
Stewart: I appreciate that very much. Listen, thanks for listening. If you have ideas for a podcast, email me at stewart@insuranceaum.com. My name's Stuart Foley and this is the InsuranceAUM.com Podcast.
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