{{indexingdisabled}} Best's Review - March 2023 Edition - Asset Management: Economic Headwinds
 
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Post-Pandemic Commercial

Real Estate Investments Shift

Changes in the way people work and shop have prompted insurers
to choose multifamily housing and industrial properties over the
traditional asset classes of retail and office space.
by Terrence Dopp
G
reg Michaud has an admittedly unscientific yet simple way to describe what happened to
the commercial real estate investment market at the end of 2022.
“It just froze,” said Michaud, head of real estate finance at Voya Investment Management.
He said his team did about $3 billion of business in the first six months of
Terrence Dopp
is a senior associate editor. He can be reached
at
terry.dopp@ambest.com
.
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Asset Management
the year, followed by about $500 million in the
second half.
“I’ve never seen a year that’s been that volatile,”
he said. “We were probably signing up or looking
at 12 deals a week, down to zero deals a week for
a couple of months when just nothing was coming
into the office. The market absolutely just froze.”
The COVID-19 pandemic, coupled with rising
interest rates, triggered a fundamental shift in
the market, specifically as to how insurers view
commercial real estate investments and which classes
attract the most interest. Carriers entered 2023
with money to deploy but were waiting for rates to
stabilize before making decisions.
“Ultimately, the returns and expectations
have to be adjusted by the market participants,”
said Bill Petak, chief executive officer of Nassau
CorAmerica, a real estate investment management
firm with insurance clients as a focus. “Until there’s
a recalibration of the wide bid-ask spread, which is
driven by interest rates and the related cost of debt,
the market transition activity will be slow. But at
the same time, funds have to put their money out
and insurance companies have to deploy capital.
Each one picks their safe spot to do it.”
Commercial real estate breaks down along four
broad lines: retail, industrial such as warehouses,
multifamily housing such as large apartment
buildings, and office. While life insurers traditionally
have found steady returns across all four lines, the
industry is seeing a shift in its segments.
“Insurers have been moving away from office
and retail for a number of years now, focused
more on multifamily and industrial,” said Jason
Hopper, AM Best associate director. “The pandemic
exacerbated that. I don’t think, for either of those
types of properties, insurers would suddenly have a
change of heart. The downward trend in appetite is
Key Points
Challenges:
The COVID-19 pandemic shifted work
patterns, making remote work more common and
complicating the office space component of the
commercial real estate investment market.
Shifts:
Insurers now are focused more on multifamily
and industrial properties, said Jason Hopper, AM Best
associate director.
Bright Spots:
Well-located and functional industrial- and
distribution-related assets are growing and will continue in
importance, said Bill Petak of Nassau CorAmerica.
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“I’ve never seen a year that’s been that
volatile. We were probably signing up
or looking at 12 deals a week, down
to zero deals a week for a couple of
months when just nothing was coming
into the office. The market absolutely
just froze.”
Greg Michaud
Voya Investment Management
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going to continue there.”
Hopper said that inflation and interest rates are
the two biggest factors exerting pressure on the
market. He doesn’t see performance of the office
segment making an outsized impact on commercial
real estate as a whole.
Michaud’s take: “It was 100% interest rates. Initially
what you get as interest rates jump is that people
pull back, because all of these owners of property
thought they were going to sell it at a low capital rate.
Buyers are now unsure where rates are going. I don’t
necessarily think interest rates have to drop to make
the market move but they have to stabilize.”
Office space has seen these variations fracture
further along regional and use-based lines. Suburban
office complexes, along with those properties that
feature desirable amenities, have fared well, Michaud
said. For properties without amenities or located
in urban cores, vacancy rates are elevated, he said.
And investors who would overlook a big-city office
tower might seriously ponder financing a medical
office that’s sure to stay occupied.
Meanwhile, less than half, or 44%, of those polled
on the commercial real estate market by J.P. Morgan
Chase for the company’s 2023
Business Leaders
Outlook
survey were optimistic about prospects for
the global economy in 2023. Almost two-thirds, or
65%, said they were optimistic about the asset class
in the coming 12 months. And 54% said they would
meet a downturn by staying the course or even
making strategic acquisitions.
In October of last year Allstate selected Voya
to manage its $850 million commercial mortgage
portfolio. Allstate retained ownership over the
involved assets, which were transferred to Voya
under a separately managed account. Voya was
given responsibility for future originations meeting
BEST’S REVIEW • MARCH 2023
a target allocation in the class.
Voya Investment Management is a full-service
investment management operation with a portfolio
of $15 billion in real estate assets. The company
is involved in two ways: Michaud’s team manages
$4 billion on behalf of the firm. The remainder is
third-party investments primarily for insurance
companies and pension funds.
Economic Headwinds
The commercial real estate investment market
can involve commercial mortgage-backed
securities, direct mortgage lending and numerous
other products that can even include ownership
of properties. The class experienced uncertainty
during the second half of 2022 due to the potential
of a 2023 recession, geopolitical risk and the
Federal Reserve’s interest rate increases.
The broader category of structured securities,
which includes securities backed by both
residential and commercial mortgages, has long
benefited from an influx of money from insurance
carriers. But both residential and commercial
mortgage-backed securities saw issuance drop by
50% through October 2022, AM Best found.
Insurers increased their holdings of CMBS
by 46% since 2011, according to a December
AM Best Special Report,
Insurers’ Structured
Securities Holdings Continue to Rise
. The greatest
concentration was on the life and annuity side,
which collectively held more than $800 billion in
structured securities in 2021. They made up about
a third of portfolios.
If the economy tumbles into a recessionary
period, shop owners, logistics companies and
multifamily leaseholders become strapped and
defaults could increase. In turn, the owners of
Asset Management
those assets would have less money to repay
the loans contained in the original investments.
In that respect, the broader economy creates a
condition that feeds into the commercial real estate
market and causes a very immediate pain point as
leaseholders surrender keys to owners.
“There is an enormous amount of equity sitting
on the sidelines or needing to be invested. But its
returns are only enhanced when the financing
and debt markets are active and transactional, and
enough activity is there to support it,” Petak said.
Fragmentation
At the beginning of the pandemic, retail
appeared dead in the water as lockdowns
hampered stores’ sales and activity and prompted
fears of cascading bankruptcies, which did not
materialize at the rate some had feared. As things
have slowly returned to normal, well-located
community-based neighborhood retail found an
equilibrium, and that corner of the market has
begun to stabilize, Petak said
In a related development, many consumers
turned to online purchasing, which proved to
be a boon for industrial centers. Demand for
warehousing and last-mile facilities proved a strong
tailwind for the segment, Michaud said.
Multifamily housing, which had been gaining
steam as the investment of choice within the asset
class, never experienced the same levels of stress
as retail. Petak cites the need for more affordable
housing in the U.S. as one inherent strength,
along with constant turnover of leases and strong
occupancy figures. This means that even in a soft
market the projects usually retain the ability to pay
lenders.
The demand for office space, however,
decreased as COVID-19 made working remotely
more common. The National Association of Realtors
in its own recent survey of that component of the
commercial real estate market said hybrid work has
become a reality for many people in the workforce,
and “this trend only goes one way.”
Across the United States, the fourth quarter
of 2022 saw inflationary pressures ease. Office
tenants remained guarded as they adjusted to
rising costs of capital and falling valuations,
according to JLL, a professional services firm
that specializes in real estate and investment
management. Leasing activity fell 10.8% in the
“The pandemic exacerbated
that. I don’t think, for either
of those types of properties
[office or retail], insurers would
suddenly have a change of
heart. The downward trend in
appetite is going to continue
there.”
Jason Hopper
AM Best
fourth quarter of last year, and while it rose above
2021 levels, the absorption rate of new office
space was still negative for 2022.
Petak said he sees market sector shifts;
understanding those shifts, along with close
evaluation of individual projects, are key factors
in making good investment decisions. Multifamily
housing projects and well-located functional
industrial- and distribution-related assets have been
growing segments of the commercial real estate
market, he added, and will continue increasing
in importance while office space will see
considerably stricter underwriting.
“The real estate industry will recalibrate; it
always does,” Petak said. “As the market comes
back, and the financing markets come back, which
generally represents a large part of any real estate
asset’s capital stack, you’ll find that 2024 should
start on a positive trend.”
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Death Benefits Reach Record

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Levels in Pandemic Times

Death benefits paid out by life insurers in the United States reached more
than $100 billion in 2021 as higher mortality in the broader population crept
into books of business.
by Terrence Dopp
L
ife insurers paid out record levels of claims
in 2021 as COVID-19 drove mortality levels
higher. Two years later, it’s not clear when—or
if—that trend will abate.
In 2021, the most recent year for which
data is available, the life insurance industry
distributed a record $100.28 billion in total
death benefits, according to AM Best’s BestLink
data. The higher-than-normal payouts began
in 2020, the first year of the pandemic, when
life insurers saw death benefits rise 15.4% in
the largest one-year increase since the 1918
influenza outbreak. The 2021 increase was
10.8%.
Breaking the data down even further, death
benefits for individual life totaled $73.52 billion
Key Points
Record Payouts:
Life insurers paid out more than $100
billion in death benefits during 2021 and another $97 billion in
annuities benefits, according to the American Council of Life
Insurers.
Life Expectancy:
During the pandemic era, the Centers for
Disease Control and Prevention twice lowered life expectancy.
Unknown:
How patterns might shift and whether numbers
will get back to historic levels remain a mystery.
Terrence Dopp
is a senior associate editor. He can be reached
at
terry.dopp@ambest.com
.
BEST’S REVIEW • MARCH 2023
in 2021, up 9.3%, while death benefits for group
life totaled $26.75 billion, up 15.3%, according
to the BestLink data.
“It’s reasonable to assume that in this time
of COVID, part of this [increase] was driven by
COVID,” Andrew Melnyk, ACLI’s vice president
for research and chief economist, said. “It’s very
reasonable to assume that, so we think that has
continued on into 2022.”
Life Insurance
Death benefits did recede to $69.1 billion in
the first nine months of 2022, from $74.27 billion
during the same period in 2021, according to the
BestLink data. Yet that figure remains elevated from
the $59.18 billion paid out during the same period
in 2019 before the pandemic hit.
Continued Hardships
Perhaps the single largest statistical impact of
COVID-19 has been on life expectancy, which
dropped twice in the United States as a result of
a disease that was widespread and led to severe
lockdowns to try to halt its spread.
By early February, 1.1 million people had died
from the virus and more than 102 million people
had been infected, the Centers for Disease Control
and Prevention said. In addition to cases directly
linked to the disease, there were issues such as
complications from long COVID-19 and health care
that was delayed by the pandemic.
Across the United States, life expectancy
dropped in both 2021 and 2022 to 76.1 years,
the lowest since 1996, according to CDC data.
While COVID-19 remained one of the top three
causes of deaths in 2022, heart disease and
cancer surpassed it, according to the Kaiser
Family Foundation.
R. Dale Hall, managing director of research at the
Society of Actuaries, said the big caveat is that all-
population mortality rates don’t always line up with
what life insurers see in their books of business.
The insured population tends to be wealthier and
have better access to health care—two factors that
correlate to better outcomes, he said.
He estimated, however, that COVID-19 is driving
about three-fourths of the increased mortality.
“Even if you took COVID out of the causes
of death and looked at the residual pieces of
information, mortality still would have been up 4%
or 5% in 2020 and a percent or two in 2021,” Hall
said. “We’re starting to see some leveling off.”
Deaths due to chronic conditions such as
diabetes, hypertension and liver disease are all
elevated compared to pre-pandemic years, Hall
said. In fact, cancer deaths among the insured
population have risen slightly, in part due to
deferred health care and delayed detection during
the lockdowns, he said.
“If you’ve got continuous access” to care, he said,
“even slight changes in health can be attended to
Death benefits paid by insurers
will continue to rise due to
higher sales, inflation and the
general cost of claims.
Edward Kohlberg
AM Best
because a doctor notices it and says ‘We really need
to take action.’”
Future Signs
Louis Silvers, a senior financial analyst at AM
Best, said that in 2020, deaths were clustered
among those over 65, while in 2021 they were
concentrated in the working-age population.
Today, companies must decide where to go with
mortality assumptions: Do they stay the course or
raise projections?
“There’s a lot of uncertainty,” Silvers said. “That’s
the biggest takeaway here. Companies are either
waiting to see and leaving it where it is, or taking a
little bit of conservatism with the uncertainty and
saying it could be a little higher and adjusting their
mortality assumptions upward.”
Edward Kohlberg, an AM Best director, said
death benefits paid by insurers will continue to
rise due to higher sales, inflation and the general
cost of claims.
Economies across the globe were shuttered as
lockdowns due to coronavirus began and stanching
the spread became job No. 1.The U.S. economy
shrank to historic lows, then grew swiftly as things
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