Happy Thanksgiving From All of Us at AQS

We'd like to thank our clients for giving us a chance to serve you. We look forward to much continued success. And our readers. Without you there would be no point to this. And finally, we want to thank teachers everywhere. You make the world a better place.

Reinvestment Rate

We don't typically opine on our reinvestment rate but that's going to change. Credit spreads, the additional yield of a corporate bond above a similar maturity treasury note, are tight (low). Using a 10-year NAIC 2 corporate bond as an example, the credit spread is currently 109 basis points. Over the last 15 years, that spread has only been tighter (lower) once (106 basis points) in June 2021.

While PC insurers may buy corporate bonds, most life and annuity insurers cannot compete on a steady diet of corporate bonds. Even the longest maturities in investment grade issues barely top 6%. Pricing an annuity at 5% offers little if any profit.

How do some companies offer such high crediting rates? Thinking 'outside the box'. To name a few examples:

• Early adaptation of new security structures are rewarded with additional yield. This happens more frequently than you might imagine.
• Asset Backed Securities (ABS) are more complex and that complexity provides yield.
• Derivatives, reinsurance and product design
• Direct and participation mortgage lending - a mainstay of insurer portfolios prior to the 1980s - provide that advantage and are typically secured by a first lien on real property.

AQS has deployed capital in all the above on a limited basis. We publish our reinvestment or 'new money' rate every month. It is updated daily.

AQS Reinvestment Rates as of 11/22/24

The corollary to 'thinking outside the box' is, 'knowing what you don't know'. The Great Financial Crisis is a superb example of NOT knowing what you don't know. Be careful out there!

This Month

• Living On the Edge - Investment Portfolio 'Fails'
• AQS Supports Teachers - November winner
• The usual mashup of issuance, rates and flows.

Living On the Edge - Investment Portfolio 'Fails'

Without naming names, there have been some magnificent 'flame-outs' when it comes to portfolio managers that "didn't know what they didn't know" or in some cases, simply ignored investment discipline.

Over the last 40 years, we at AQS have witnessed:

Novices

A short-term portfolio invested in 10+ year callable agency securities betting that rates would remain low. They didn't. Prices dropped, losses accumulated. Personnel were 'reassigned'.

A long-term portfolio invested in 10+ year callable agency securities that backed life policies (long-term). Rates fell, bonds called, proceeds reinvested at lower (unprofitable) rates locking in losses for decades.

Overly conservative portfolios. High quality and short maturities seem a solid combination. Unless they are funding a specific liability. The hemorrhage is slow but the result is the same - failure. Risk should be managed, not avoided.

Smart Guys

Actually, really smart guys at Long Term Capital Management placed too much faith in the Black-Scholes pricing model which works great when volatility is limited. VOL kicked up, LTCM went down and almost took several primary dealers with them. The book, "When Genius Failed: The Rise and Fall of Long-Term Capital Management" chronicles this nicely.

The runup to the Great Financial Crisis (GFC) circa 2007-2009 produced a new asset class: the Residential Mortgage Backed Security (RMBS) and the Commercial Mortgage Backed Security (CMBS). So new was this asset class that regulators had not yet installed the guardrails that exist today. At the core of the entire structure was the assumption that the collateral supporting these deals would never default at a rate below 3%. But what if they did? "The Big Short" covers this top to bottom.

And Outright Fraud

We were contacted by a client a few years ago. A life and annuity company was dominating domestic annuity business with "above-market" rates. A cursory review of the portfolio showed a collection of securities (loans) to affiliate companies. Regulators saw this too. The indictment that followed read in part, "siphoning vast amounts of money from defendant's insurance companies for his personal use, then lying to regulators to hide their $2 billion scheme."

AQS Supports Teachers - November Winner

Each month, AQS awards a $500 Amazon gift card to a classroom teacher located somewhere in the U.S. In November, our winner is Stephanie who teaches preschool at Dallago Early Childhood Center in Vineland, NJ.

Many teachers selflessly use their own funds for classroom items. AQS wants to help. All the information you can stand as well as the winner announcements can be found at

www.aqssupportsteachers.com

Winner announcements are at the bottom of the page. Know a teacher? Send them our way!

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