closer look at participating whole life insurance
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Advisors and clients are increasingly choosing participating (par) whole life insurance because it provides an alternative asset class that improves overall portfolio efficiency and can maximize estate values. [tweet this]. In turn, investors and professional advisors want to understand why par has historically outperformed fixed income despite having lower volatility. To understand this, first we need to know how Sun Life Financial manages the money it invests to support the Sun par policies.

As President of Sun Life Investment Management, I see the bigger picture of Sun Life’s investment philosophy and can explain how the strength in its approach applies to par.

Sun Life’s general account asset mix: how par fits in

Sun Life Financial is one of the largest Canadian-owned investment managers with close to $1 trillion of assets under management (AUM). The general account represents $163 billion (as of 2017) of the total AUM. These investments back Sun Life’s global products.

General account asset mix – $163 billion

Pie chart showing general account asset mix of $163 billion distribution

Each segment within the general account has a different investment profile. We’ve built the portfolios within the general account to match assets with the liability characteristics of products being sold in each segment. This asset liability matching is critical in optimizing the risk return profile of each segment. On a global scale, the Individual Par Life accounts represent one-quarter of these assets ($38.66B) with about $10 billion supporting the Sun par policies sold in Canada. This size makes par an incredibly important component in Sun Life’s AUM and reflects the strength of Sun Life’s balance sheet. [tweet this].

A strong and experienced investment team

Behind each asset portfolio is a proven investment team with more than 200 people across the globe. Investment teams managing each asset portfolio average 18 years’ experience and their leadership has also been in place for a long time. For instance, investment managers of our private fixed income portfolio have been part of our investment team for 18 years. Investing in par is a long-term decision; as such, both the experience and stability of the investment teams are keys to success.

Investment team

Size of team

Average years of experience

Average tenure of management team

Public fixed income

46

20

14

Portfolio management

16

23

11

Derivatives

17

14

10

Credit research

13

16

8

Private fixed income

55

18

11

Commercial mortgages

45

19

11

Real estate

17

20

14

Asia

36

12

5

Investment strategy

25

21

8

Total

224

18

11

The asset allocation model

The par account is a mix of various asset classes. For each asset class there’s a tactical range and a strategic target for how much we invest.

We determine these ranges by setting the optimum mix of assets needed to align with our liability obligations.

The investment teams closely monitor the tactical ranges of each asset class to make sure they stay within these ranges. If any allocation goes outside the range, the team is notified and they take action to
get back within the range.

Asset Mix Guidelines

Strategic Target %

Tactical Range

Min %

Max %

Cash & short term

0.5

0

4

Fixed Income

Public fixed income

41

33

49

Private fixed income

12.5

5

20

Commercial mortgages

12

4

20

Total Fixed Income

65.5

42

89

Real estate

17

12

22

Public equities

12

7.5

17.5

Private equities

5

2

8

Other assets

0

0

2

Total Non-Fixed Income

34

21.5

49.5

Total Assets

100

Fixed income: quality distribution

The public fixed income component of the Sun par account consists almost entirely of investment-grade bonds. We mix the highest quality AAA- and AA-rated government bonds with A- and BBB-rated corporate bonds. The fixed income investment team feels comfortable in the BBB segment within corporate bonds given the depth and experience of our credit research team.

pie chart showing high yield 1%, AAA 24.31%, AA 35.94%, A 31.25%, BBB 8.5%

Total Return on Corporate Bonds

Rating

Annualized Return

AAA

4.95%

AA

5.08%

A

5.25%

BBB

5.94%

BBB-rated bonds have outperformed more highly rated bonds over time. The table illustrates the annualized return of corporate bonds by risk rating. It demonstrates that it definitely paid off to be in the BBB sector over the last 20 years. By not investing in the BBB sector, you are actually giving up an opportunity.

One recent example:

Sun Life was pleased to lead the deal to finance Ottawa’s light rail transit. In this transaction, the city of Ottawa, AAA-rated, makes payments to the transit system as long as the line is up and running. These payments in turn provide the cash flow, which pays the interest and principal on our bonds. The deal is a win-win for Sun Life and the city’s residents.

We’re asked how liquid these investments are. The reality is that Sun Life never sells any of its private fixed income deals. We buy and hold them for the full duration. These investments are perfect for par since liabilities last for an average of 18–20 years. However, if we ever need to sell these investments, we probably could. These are great investments. Participating whole life insurance is a great way for individuals to gain exposure to this type of institutional investment.

The cornerstone asset: private fixed income

Currently, Sun Life’s competitors don’t use private fixed income to the extent that Sun Life does. In fact, we have the biggest and strongest private fixed income team in Canada. This is a real competitive advantage for Sun Life in the Canadian marketplace.

Private fixed income deals are investment grade that often have long durations. Being in the private market allows Sun Life to take advantage of our capital-rich position in Canada and invest in areas that aren’t well represented in the public market, such as hydroelectric, wind and solar energy, as well as public infrastructures. These are exciting investment opportunities that have paid off well.

Here is the value proposition of private fixed income. In this 10-year chart, the blue line highlights the yield differential of the private fixed income investment vs. corporate bonds with a similar rating and duration. On average, our private fixed income deals have picked up 150 basis points of spread over public bonds of comparable duration and quality. The yellow line represents extra fee return generated by the fixed income deals and the orange line the credit losses. On average, the fee return nearly makes up for all the losses.

Private fixed income: General account

Excess yield to comparable public corporate bonds, absolute credit losses and absolute fee income (bps)

Graph plotted of Basic points vs years from 2007 to 2017 showing Excess yield, Credit loss, Fee income

Performance for Sun Life Financial’s General Account private fixed income portfolio; Sources are Bank of Canada, Sun Life Financial. Spreads are dollar weighted. Past performance does not guarantee future results, which may vary. The returns presented are not those of pooled funds managed by Sun Life Institutional Investments (Canada) Inc. These results are presented for illustrative purposes only and do not represent that which may be achieved by Sun Life Institutional Investments (Canada) Inc. managed funds. Credit losses are dollar weighted and basis points are estimated over the companion year’s average asset base. All private bonds are managed by the private fixed income team for Sun Life Financial’s General Account.

Commercial mortgages

Mortgages are another important asset class for the par account. The mortgage mix of Sun Life is regionally distributed, aligning with the GDP of each province. Therefore, we allocate a heavy weight to Ontario. Our portfolio doesn’t have any residential mortgages, only commercial.

There is not as much yield in mortgages as in private fixed income since it is in a more efficient market. But, mortgage yields compared to Government of Canada bonds have an average spread of 180 basis points. Moreover, the Sun par portfolio of mortgages has experienced almost no losses in the past 10 years, which speaks to the expertise in underwriting these deals.

Province wise regional distribution of commercial mortgage as pie chart

Real estate

Currently we weight Sun Life’s par account portfolio more heavily in real estate compared to the competition. Sun Life doesn’t use real estate investment trusts (REITs), but instead invests in high-quality buildings through construction projects and acquisitions of existing real estate. Real estate is a great asset class for par because of the long duration of the liabilities. This offers Sun Life an attractive return and inflation protection.

What is great about real estate is that the returns can be enhanced over time. If a bond is purchased, it’s going to pay the same amount of coupon year after year. There’s no opportunity to get more money out of that asset. As for real estate, the return can be optimized by increasing rent over time and focusing on high-quality tenants. It’s a long-term play and, therefore, another great fit for the par account.

Real estate historically provided a generous and constant spread over the risk-free rate. Compared to a 10-year Government of Canada bond, the long-term average spread is 351 basis points in favour of real estate. This spread is maintained even as capitalization rates have fallen, because interest rates have also fallen.

Risk Premiums

Graph plotted of risk premiums vs years from 2007 to 2017 as long-term average spread over goverment bonds 3.51% or 351 bps

To sum it up

The par asset portfolio allows an insurance company to differentiate its par product and deliver value to the policy owner. Appreciating the underlying investment philosophy of the par account is a first step in understanding the largest driver of returns to par policyholders. With a proven ability to manage liabilities for the long term, Sun Life’s par accounts present a unique opportunity to benefit from high-quality investments with prudent risk management, pushing out the risk/return frontier for today’s investors.

Contact your Sun Life relationship manager

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This article is intended for information purposes only. Sun Life Assurance Company of Canada has not been engaged for the purpose of providing legal, accounting, taxation, or other professional advice. No one should act upon the examples/information without a thorough examination of the legal/tax situation with their own professional advisor, after the facts of the specific case are considered.

Stephen C. Peacher is President of Sun Life Investment Management. He has more than three decades of investment management and credit experience in North American and international markets. This includes extensive experience managing teams, portfolios and research across a wide range of assets and strategies, including public and private asset classes, derivative markets and liability-driven investing.