< PreviousProfessional investors only. Capital at risk. Where climate research meets economic reality We see opportunity. Because we believe understanding the eff ects of climate change on capital markets leads to better insights, and investment decisions.SPECIAL ADVERTISING SECTIONSPECIAL ADVERTISING SECTION Share this edition at www.bestreview.com/issuesanswersarchive.asp. BEST’S REVIEW • SEPTEMBER 202229 Issues & Answers: Climate Risk Disclosure A Climate of Change As the momentum behind decarbonization and net-zero objectives builds around the world, insurers are increasingly trying to understand and address the investment implications of climate change on investment policy and asset allocation decisions. The need for insurers to take action on climate science just keeps building, says Tim Antonelli, who leads Wellington Management’s global insurance portfolio solutions. Following are excerpts from an interview with Tim. What is the lay of the land as it relates to insurers’ progress on integrating and assessing climate change? At the highest level, real best practices have emerged from who I think are the furthest along on their journey, generally European insurers. Some of the trademarks of that group include a consistent, top-down organizational philosophy, a broken-down silo construction across all functions at the firm. We also see a shift from just exclusionary-based investing to trying to maintain the broadest investable asset universe, and understanding that things such as engagement can become a very valuable tool in this journey. How can insurers evolve their investing approach to tackle these issues? First and foremost, you should ensure that the investment professionals are in line with what your corporate philosophy is. The second thing is establish your baseline exposure. To do that means you should have a full assessment of your exposures, both from the transition risk perspective. Then, third, you should keep your opportunity set for investing as broad as possible. Then, finally, lean into thematic opportunities. Don’t just use climate to avoid risk. How is Wellington helping insurance clients on this journey to better understand and incorporate climate impact? Five years ago, we started partnering with the Woodwell Climate Research Center, who is one of the foremost physical risk climate science centers in the world. We’ve used their research to model heat, wildfire, flooding, hurricanes, etc., to understand what the long-term structural changes could be to our investable asset universe for insurers that are going to be affected by the inevitable climate risk that’s likely to occur. At the beginning of 2022, we partnered with the Joint Program on the Science and Policy of Global Change at the Massachusetts Institute of Technology to work on transition risk specifically. What it will allow us to do is explore a whole host of policy projections as it relates to implementing things such as a carbon tax or shifting sectoral bases as economies move toward a more green, forward-looking state, and will allow us to consider and understand some of those risks, not only through an engagement lens with the portfolio companies we have, but also through some stress testing as well. At the end of last year, we also moved our capital market assumption process to be wholly-ingrained from a climate-aware fashion, meaning we have transition risks and physical risks embedded in all of our asset class returns for the next 10 years. Tim Antonelli, CFA, FRM, SCR Insurance Portfolio Strategist Wellington Management “Don’t just use climate as a risk-off exercise. You should use it as a way to capture alpha sources as well.” Visit the Issues & Answers section at www.bestreview.com to watch an interview with Tim Antonelli.30BEST’S REVIEW • SEPTEMBER 2022 National Flood Insurance Program Republican Senators Offer One-Year NFIP Extension Bill The Biden administration earlier this year gave Congress 17 proposals to reform the NFIP, including measures to end NFIP coverage to properties that repeatedly flood, prohibit new construction in flood-prone areas and require sellers and renters to make full disclosure of a property’s flood history. by Timothy Darragh A group of Republican senators has released a proposal to extend the National Flood Insurance Program by one year. Bill Cassidy and John Kennedy, both of Louisiana, Marco Rubio of Florida and Cindy Hyde-Smith of Mississippi introduced legislation to reauthorize NFIP, which now is authorized through Sept. 30. Florida is home to 1.7 million NFIP policies, more than any other state, Rubio said in a statement. “The National Flood Insurance Program is a lifeline for many Floridians,” he said. “We need to pass this legislation quickly so that no one experiences a lapse in coverage.” Democratic Sen. Robert Menendez of New Jersey already has introduced a bill to extend the program an additional five years. He said his National Flood Insurance Program Reauthorization and Reform bill would put the program back on Timothy Darragh is an associate editor. He can be reached at timothy.darragh@ambest.com. US Private Flood Insurance Purchased by State – 2022 Edition Florida’s residents buy the most private flood coverage. 2021 Direct Premiums Written $166 million 2021 Direct Premiums Written $101 million to $56 million 2021 Direct Premiums Written $34 million to $21 million 2021 Direct Premiums Written $18 million to $1.4 million Source: ILLUMINATE THE DETAILS OF INSURER PERFORMANCE Enhance top-level research and support intelligent decision-making with Best’s Credit Reports, for insight into the financial performance of insurers worldwide, and Best’s Financial Reports, for the latest company information. 22.BCFR002AA Our Insight, Your Advantage ™ Learn More: sales@ambest.com www.ambest.com • (908) 439-2200National Flood Insurance Program 32BEST’S REVIEW • SEPTEMBER 2022 solid fiscal ground and reframes the nation’s entire disaster paradigm to one that focuses more on prevention and mitigation to spare the high cost of rebuilding after flood disasters. Risk Rating 2.0 One thing the Democrat and Republicans have in common: They oppose Risk Rating 2.0. Cassidy called the program “disastrous.” Earlier this year, Cassidy released a statement on the Federal Emergency Management Agency acknowledging an internal study finding that the implementation of Risk Rating 2.0 to the NFIP could cause 20% of policyholders to drop out of the program due to higher premiums. Menendez said he hears from FEMA and special interest groups “who are completely out of touch with disaster victims, that premiums need to be raised sky high on policyholders to bring down costs. But these calls to raise premiums foolishly ignore the fact that FEMA’s huge administrative costs should be reformed to provide premium savings.” The Biden administration earlier this year gave Congress 17 proposals to reform the NFIP, including measures to end NFIP coverage to properties that repeatedly flood, prohibit new construction in flood-prone areas and require sellers and renters to make full disclosure of a property’s flood history. In December, Congress approved a stopgap funding measure to keep the government running past a Dec. 3 deadline as well as a short-term extension of NFIP. The main property/casualty insurance trade groups, the American Property Casualty Insurance Association and the National Association of Mutual Insurance Companies, support long-term extensions of the program. In a position statement, NAMIC said it favors the shift toward risk-based rates, policies designed to increase private-sector involvement in the program and provisions to address affordability, increase mitigation and address repetitive loss properties. At the APCIA, Don Griffin, vice president of policy, research, and international, said flooding is a bipartisan issue, but “strangely enough, there’s still not agreement on how to reform it.” The legislative proposals at least provide a discussion point, but they need study, he said. “While the Biden administration flood insurance proposals have interesting components, we need to evaluate them based on the impact on consumers, communities, insurers, and the financial health of the National Flood Insurance Program,” Griffin said. “However, APCIA has long advocated for no lapse in the NFIP, disclosure of previous losses and showing the true risk costs, and transparency in disclosure.” The administration’s plan would extend NFIP through Sept. 30, 2031, and would ensure FEMA is able to sell and service policies, even during a lapse of appropriations. According to FEMA, the proposals would address four main goals: ensuring more Americans are covered by flood insurance by making it more affordable to low-and-moderate income policyholders; building climate resilience by transforming the communication of risk and providing Americans with tools to manage their flood risk; reducing risk, losses and disaster suffering by strengthening local flood-plain management minimum standards and addressing extreme repetitive loss properties; and instituting a sound and transparent financial framework that allows the NFIP to balance affordability and fiscal soundness. BR Florida is home to 1.7 million NFIP policies, more than any other state. “The National Flood Insurance Program is a lifeline for many Floridians.” Sen. Marco Rubio FloridaUnderwriting courage takes practice. For over 50 years, we’ve built a legacy of expertise and market leadership. From Main Street to Wall Street, we optimize solutions across an array of risks. Let’s talk. lexingtoninsurance.com/2022 The best is PROTECTION EXPERIENCE. Lexington Insurance and Western World, both AIG companies, are U.S.-based surplus lines insurers. AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. For additional information, please visit www.aig.com. Products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Not all products and services are available in every jurisdiction, and insurance coverage is governed by actual policy language. Certain products and services may be provided by independent third parties. Insurance products may be distributed through affiliated or unaffiliated entities. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. INTENDED FOR LICENSED SURPLUS LINES INSURANCE BROKERS ONLY. Copyright © 2022 American International Group, Inc. All rights reserved.National Flood Insurance Program 34BEST’S REVIEW • SEPTEMBER 2022 Best’s Rankings Top 25 Writers - US Private Flood – 2022 Edition Ranked by 2021 direct premiums written. ($ Thousands) 2021 Rank 2020 RankCompany / GroupAMB# 2021 Direct Premiums Written % Change in Premiums Market Share (%)Adjusted Loss Ratios % of Company Premiums 202120202019202120202019 11Zurich Ins US PC Group018549$168,78870.916.113.415.285.2367.034.81.1 23Amer Intl Group 018540156,871108.314.910.39.954.832.928.11.1 32Assurant P&C Group018523107,15110.010.213.316.334.610.116.31.2 44XL Reins America Group01855771,1633.66.89.36.722.234.012.30.9 55Swiss Reins Group00326260,763-9.95.89.212.714.38.056.32.4 68Liberty Mutual Ins Cos00006059,94155.35.75.34.335.0-6.7-48.20.1 77Berkshire Hathaway Ins00081152,11325.85.05.64.314.216.7-86.90.1 86Arch Ins Group01848448,821-1.74.76.86.68.49.25.30.9 912Chubb INA Group01849844,221188.44.22.10.961.90.522.80.2 109Allstate Ins Group00000833,664-5.43.24.83.024.121.614.10.1 1110Allianz US PC Ins Companies01842933,21722.53.23.73.828.0-20.2107.60.6 1239Sompo Hldgs US Group01887833,024999.93.10.00.07.20.00.00.5 1311Alleghany Corp Group01864026,8622.82.63.63.83.1-0.1-0.81.0 1416Munich-Amer Hldg Corp Cos01875323,568196.82.21.11.437.027.131.60.7 1557Transverse Ins Group01893117,3220.01.70.00.096.50.00.07.8 1613MAPFRE North America Group01880115,3675.91.52.02.34.51.710.70.7 1720Trisura US Ins Group01894412,084110.51.20.80.0261.069.359.71.5 1815Palomar Hldgs US Group01895411,65342.51.11.10.936.9-2.334.22.5 1914Progressive Ins Group00078010,1757.71.01.31.33.92.70.20.0 2018United Surety & Indemnity Co0111386,4581.20.60.91.10.21.21.28.3 2119Tokio Marine US PC Group0187335,782-8.60.60.91.386.20.441.00.1 2217Markel Corp Group0184685,267-25.00.51.01.487.652.936.70.1 2321Nationwide Group0059875,24021.30.50.60.684.7132.38.30.0 2425W. R. Berkley Ins Group0182525,078166.40.50.30.0285.70.80.00.1 2522Cincinnati Ins Cos0042944,75423.00.50.50.6152.018.313.00.1 Top 25 Writers$1,019,34741.197.098.399.443.762.822.50.3 Total U.S. P/C Industry$1,050,35242.9100.0100.0100.043.362.022.80.1 Reflects Grand Total (includes Canada and U.S. Territories). Source: - State/Line (P/C Lines) - P/C, US; data as of July 29, 2022. FIND MORE CORPORATE CHANGES IN AM Best’s Powerful, Flexible Online Platform for Best’s Credit Ratings • Financial Data • Credit Analysis 22.BLINK006C2 Our Insight, Your Advantage ™ Learn More: sales@ambest.com www.ambest.com • (908) 439-220035BEST’S REVIEW • SEPTEMBER 2022 Asset Management Private Placements Likely to Remain in US Insurers’ Portfolios Despite Rising Rates Direct lending outside the publicly traded realm of corporate bonds found greater favor amid low interest rates. Don’t look for that to change overnight as the Federal Reserve enacts inflation-fighting increases. Lack of trading opportunities, diversification and investment patterns may make it a crawl rather than a rush for the door. by Terrence Dopp I nsurers stepped up their investments in private placements—direct lending done outside of the public bond market—as interest rates hovered at historic lows for a decade following the 2008 financial crisis. Terrence Dopp is a senior associate editor. He can be reached at terry.dopp@ambest.com. Key Points Instrument: Private placements are essentially corporate loans governed by maturities, yields and covenants that don’t involve public bonds. Market: They took on a greater role in insurers’ portfolios, particularly to back long-tail life and annuities obligations, as the Federal Reserve kept benchmark interest rates at or near zero. Shift: The qualities that made private placements attractive to start with—relative safety and higher yields, as well as longer maturities—mean they’ll stick around even as the Fed inches rates up and bonds become more attractive. PLACE OF INTEREST: The Federal Reserve Bank in New York City’s financial district.Asset Management 36BEST’S REVIEW • SEPTEMBER 2022 Although the Federal Reserve has been increasing those benchmarks on several occasions this year, industry watchers don’t see the asset class losing favor in the near future. Really a broad category rather than one specific investment product, private placements are typically debt instruments in which the borrowers raise money in a debt sale outside of public markets. They allow insurers to obtain yields above those they would see with more traditional bonds, while also featuring in some cases protective covenants more favorable than bonds. “As long as issuers come to market providing that excess spread that is expected by those that are willing to lend to private placement issuers, this market can continue to function very well through volatility, through market changes and spread changes in public markets as long as you’re continuing to provide that excess spread,” said Cindy Beaulieu, a managing director and portfolio manager at investment management firm Conning. “As long as valuations make sense I don’t see a problem for borrowers coming to this market. There’s a natural home in insurance companies for these securities.” Length, Liquidity Also affecting the allocation is the buy-and- hold nature of private placements, which have a higher yield partially because they offer an “illiquidity” premium compared to public investments that are more easily traded. Any shift in investor behavior is likely to take place in new dollar investments rather than a wholesale rejigging of companies’ portfolios. Rob Lund, senior client portfolio manager at Income Research + Management, said the scenarios he sees as most likely, given rising interest rates that have raised the yields on more traditional publicly traded bonds, are either a leveling off of the upward trend toward private placement investing or a slight drop. Think a churn as older investments mature rather than an immediate change in behavior. “Insurance company allocations tend not to be huge moves on day one—they’re gradual shifts,” he said. “It’s more about where that next incremental dollar is getting invested. You might see that next incremental dollar gets invested at the higher rate ultimately bringing up book yields.” Investment money follows yield and rather than a wholesale shift, a more likely case is at most a gradual movement as new money “instead of going into privates in some cases going back into the public markets where we’re seeing some attractive opportunities,” Lund said. Lund’s firm has $88 billion in assets under management. He said he concentrates primarily on public markets in his role and as such keeps an eye on all fixed-income markets in order to watch trends. Upward Trajectory The insurance industry more than doubled private placement investment in the decade from 2009 to 2019, reaching almost $1.4 trillion in the final year, according to a September 2020 Best’s Special Report: Private Placement Assets Double in Decade, Now Face Pandemic Pressure. The growth rate of private placement holdings held by insurers increased by an average 8.4% “As long as issuers come to market providing that excess spread that is expected by those that are wiling to lend to private placement issuers, this market can continue to function very well.” Cindy Beaulieu Conning37BEST’S REVIEW • SEPTEMBER 2022 annually over the final five years of that span. About 84% of that amount was held by the life and annuity sector, according to the research. Beaulieu said the number of Conning’s insurance clients dipping their toes into the asset class has doubled in recent years. The traditional role of private placement investments within an insurance portfolio isn’t likely to shift as interest rates go up, she said. Where she does see movement is in the size of allocations on the part of companies that participate. “It just changes,” Beaulieu said, referring to the investments’ value proposition. “The thing about the private placement market is it always takes some time to change. So one of the things that is very important is to stick with your discipline if you expect to achieve a certain spread over public market.” Also shifting, she said, is the nature of the borrowers themselves. Utilities providers and so-called industrials were early borrowers on the private market with maturities stretching out 15 years or more— making them a strong fit for life insurance and annuities obligations. With longer-term liabilities, the illiquid aspect wasn’t such a factor. Full Decade Interest rates hit an all-time high of 20% in 1980 as inflation spiked in the double digits. It was all downhill from there. Benchmark interest rates effectively hit zero amid the Great Recession in 2008 and stayed there until 2015, a span that coincided with the rise of private placements as a go-to investment as companies sought to push up yields. The Federal Reserve uses a target of between 2% and 5% that is deemed a good level to keep the U.S. economy chugging along but diverges from that figure at times to regulate conditions. And in the near past, the central bank embraced that divergence and for an extended period. After hovering at various levels of low for about a decade after the crisis, benchmark interest rates scratched zero again in March 2020 as the COVID-19 pandemic put a collar on economic activity. With blinking lights warning of recession and inflation again rising as a top- of-mind concern, the Fed raised rates four times during the first eight months of 2022, including a 0.75 percentage point increase in July. Lund, of IRM, said part of the increased interest in private placements had been a pure reaction to the low rates. Now for the first time in recent memory, a high-quality corporate bond with a 5% yield isn’t out of the realm of possibility, he said. “You could make the argument that now might be a time when you could see more start to go up in liquidity, maybe up in quality,” he said. “There’s a lot of uncertainty in the markets. We’ve seen an uptick in conversations around the public markets just given the more attractive yield levels we’re at today.” New Borrowers In recent years, the market also has seen the entrance of financial firms such as business development corporations that borrow directly rather than issue a public bond offering, Beaulieu said. Because these firms often issue medium- duration maturities of as little as three years, the market has seen more interest from property and “Insurance company allocations tend not to be huge moves on day one– they’re gradual shifts.” Rob Lund Income Research + Management Next >