Eric Kirsch is the executive vice president and global chief investment officer at Aflac, where he oversees the $100 billion-plus investment portfolio and investment teams based in New York and Tokyo. In part one of this interview, he discusses the nuances of leading the investment office at an insurance firm and an endowment; prepping for a turn in the U.S. credit cycle; how the new tax code positively impacts Aflac; and dealing with the fiscal and monetary headwinds in Japan.
Eric Kirsch was named on Trusted Insight's 2018 Top 30 Insurance Chief Investment Officers. He graciously spoke with us on May 30, 2018.
Trusted Insight: You've had a wealth of experience at various institutions in your career. How do risk appetite and internal policies differ at an insurance corporation versus endowment or foundation?
Eric Kirsch: I can give you a first-hand view of that, as I am also the co-CIO of the Baruch College Fund investment committee overseeing its endowment. I can see both worlds side by side.
In the endowment or pension world, first, your liabilities are completely different than a set of insurance products. Most U.S.-based endowments have an investment objective of CPI plus 2-3 percent.
There is a safety of principle involved, because donors have given funds to the institution to be used for education, student grants and more. The objective of CPI plus 3 percent usually gets an organization to about a 5 percent type of total return with moderate risk. You don't have to worry about book yields, book income, or public financial statements and stock price.
Regarding asset allocation for an endowment, fixed income is typically the smallest portion of the allocation. Whereas with an insurance company, the asset allocation is almost predominantly fixed income. For an endowment to get the CPI plus 5 percent, the asset allocation requires a healthy dose of both global and domestic public equities and what we call “flexible capital.” This could be hedge funds, distressed funds or a variety of absolute return funds.
Now, let's shift to the insurance world. The major nuance at the outset is that we have policyholders. The 100 percent promise that we make to our policyholders is that we will be there for them in their time of need, which means we must have money to pay our policyholders when they make claims. That money resides in the investment portfolio I am responsible for managing.
The second nuance is that we are highly regulated as an insurance company. Endowments have some rules around them, but not to the same degree as the insurance industry. U.S. insurers may have both the state regulators and international regulators. In Aflac’s case, because we are global and more than 70 percent of our business comes out of Aflac Japan, we also work with regulators in Japan. The regulations say, "You're there to protect policyholders and earn a good return. Your primary objective is to be safe and assure policyholders return of principle." That is why insurance companies predominantly have fixed income securities, whose characteristics include return of principal at maturity and a competitive yield.
Ultimately, the economics matter in the context of asset liability management in our investment portfolio. Those policyholder claims are our liabilities. We also have capital considerations because the insurance company has to provide capital to support investment activities and other activities of the company. That is a major differentiation.
In the world of insurance, the investment strategy is much more focused and precise with a concentration in fixed income. We aim to make sure policyholder funds are secure and safe while hopefully earning a return above and beyond what policyholders and shareholders have been promised. That excess return can be considered part of the profit pool for the insurance company and added value for shareholders for public companies. For endowments and pensions, there is much greater flexibility on the investment strategy and more focus on total return.
Trusted Insight: Are there other interesting insights that you can provide in terms of how diversification policies were decided at each of the firms that you were at?
Eric Kirsch: At Aflac, diversification at multiple levels is critical. One approach we practice at Aflac is “strategic asset allocation.” And at a high level, we use “quantitative-based” models to look at the volatility of our liabilities, and the duration of those liabilities.
We also look at capital Aflac has to support investment functions and the amount of capital at risk the company is comfortable maintaining. We then look at factors like regulations and earnings volatility. We match all of those factors with traditional mean-variance analysis around asset classes, whether it’s fixed income, equities or alternatives. The strategic asset allocation basically answers the question, “To achieve the company's objectives, what is the optimal portfolio mixture of these assets that also reduces our surplus risk?” That is our capital risk.
We go through that exercise every three years and that is the first level of diversification. That output shows what is optimal. For instance, X percent in Japanese government bonds for Japan, X percent in investment grade bonds or X percent in commercial mortgage loans. We do this for a variety of different asset classes within fixed income, as well as a smaller allocation to alternative investments like private equity and real estate.
The importance of this strategic approach is that it is calibrated to the company's objectives. From there, we bring it down to the security and industry level and look at factors like financials, industrials and technology to help manage credit and country risk. It is a very quantitative process to set the diversification limits and guidelines.
On a day-to-day basis from a portfolio management standpoint, our portfolio managers around the globe, in Japan and the U.S., run the individual positions and asset classes we buy and sell by those risk limits. Diversification comes top-down, but then it comes bottom-up by individual research, credit companies, asset class and properties depending on the asset class. So, diversification is critical.
As you know, markets go in cycles. We have been in a nearly 10-year bull market now. Everything is holding up and it has done very well. At some point, the credit cycle will turn, however.
When the credit cycle turns, we want to make sure our predetermined diversification standards keep us safe and minimize any losses. We are exposed to credit markets, and whenever credit cycles turn, there may be some challenges. Though with the good risk management and credit work that we do, they should be minimal and not disruptive to our operation.
Trusted Insight: What is your opinion on where Japan is heading and how that will affect the credit markets there?
Eric Kirsch: As you know, the U.S. has the largest credit market in the world, but Japan's fixed income market is primarily Japan government bonds. There is a credit market, but it is very small in comparison to the U.S. It is difficult to actually buy credit-denominated yen assets. There are some cases, but a fraction of what we have in the U.S.
We have a positive view of the future for Japan, but there are certainly headwinds that they need to deal with. The headwind in Japan that everybody is familiar with is the aging demographics and how that will pose a challenge from a fiscal and monetary perspective. The Japanese population is getting older, and they do not have a robust immigration policy, which poses challenges in terms of the size of the basket of wealth. The impact of fiscal and monetary policy becomes more important. Any company doing business in Japan needs to consider those demographic changes.
The other headwind is Japan has a high degree of debt. If you have a robust society that looks like it is going to grow for a long time, then you have a good chance of being able to manage your fiscal imbalances and your debt. This is where Japan’s aging society concerns many investors.
The tailwinds over the last three years under Japan Prime Minister Shinzo Abe’s administration has really brought Japan far along in terms of fiscal expansionary, monetary policy and social changes. In the past, Japan has had difficulty with gender diversification in the workplace. Now, with Prime Minister Abe’s goal of growing female participation in the workplace and his call for Japanese corporations to fill at least 30 percent of their leadership positions with women by 2020, Japan has a much more robust acceptance. Aflac has won commendations in Japan, such as the Japan Women’s Innovative Network’s J-WIN Diversity Award, for creating an environment where women can succeed.
On the monetary side over the last few years, Haruhiko Kuroda, governor of the Bank of Japan, has had a focus on creating inflation in Japan. By creating inflation, economic growth is created. He has not been 100 percent successful, but he has had a policy of extreme monetary easing in Japan, which is why interest rates have been so low. The fact is, Japan's economy has been growing the last two to three years, much more than it did prior to being stuck in deflation.
When we add all of these factors together, we see more tailwinds than headwinds, but Japan certainly has its challenges in front of it. Ultimately, we see good prospects for Japan when we look out at the next few years because of the good policies that have been put in place.
Something worth noting is that unlike other countries that rely on outside investors to buy their sovereign debt, Japan is mostly internally invested. Meaning 90+ percent of their Japanese government bonds are owned by Japanese financial institutions and the government. So, it is unlikely they would face a situation like Greece, for instance, where foreigners owned Greek debt. Japan is somewhat immune from that activity.
Trusted Insight: Moving back to the U.S., are there any Trump administration policies that have affected the way you execute decisions? Are there any pending or upcoming policies that you're particularly paying attention to?
Eric Kirsch: The tax code changes were very positive for Aflac in terms of lowering our tax rate. That was an extremely positive change for the business, our employees, and the future strategy of Aflac in terms of being able to reinvest in our business and our shareholders. We were able to give some excellent benefits to our employees, as well, including increases in company contributions to employee 401(k) programs and additional training programs.
On the investment side, the tax code changes have some impact on our Aflac U.S. business, more so than our Aflac Japan business. This has made municipal securities an attractive investment for Aflac U.S. We have actually implemented some muni-strategies, which prior to the tax code changes, would not have made sense for us on an after-tax basis. With the new tax code and how municipals are treated, we get a tax advantage by having a certain allocation to municipalities over taxable investments. That has been a profound change that we did not expect, but is a very positive outcome for the investment portfolio and strategy.
View our full catalog of interviews with here.
The complete list of 2018 Top 30 Insurance Chief Investment Officers can be found here.
Eric Kirsch was named on Trusted Insight's 2018 Top 30 Insurance Chief Investment Officers. He graciously spoke with us on May 30, 2018.
Trusted Insight: You've had a wealth of experience at various institutions in your career. How do risk appetite and internal policies differ at an insurance corporation versus endowment or foundation?
Eric Kirsch: I can give you a first-hand view of that, as I am also the co-CIO of the Baruch College Fund investment committee overseeing its endowment. I can see both worlds side by side.
In the endowment or pension world, first, your liabilities are completely different than a set of insurance products. Most U.S.-based endowments have an investment objective of CPI plus 2-3 percent.
There is a safety of principle involved, because donors have given funds to the institution to be used for education, student grants and more. The objective of CPI plus 3 percent usually gets an organization to about a 5 percent type of total return with moderate risk. You don't have to worry about book yields, book income, or public financial statements and stock price.
"In the world of insurance, the investment strategy is much more focused and precise with a concentration in fixed income... For endowments and pensions, there is much greater flexibility on the investment strategy and more focus on total return."
Regarding asset allocation for an endowment, fixed income is typically the smallest portion of the allocation. Whereas with an insurance company, the asset allocation is almost predominantly fixed income. For an endowment to get the CPI plus 5 percent, the asset allocation requires a healthy dose of both global and domestic public equities and what we call “flexible capital.” This could be hedge funds, distressed funds or a variety of absolute return funds.
Now, let's shift to the insurance world. The major nuance at the outset is that we have policyholders. The 100 percent promise that we make to our policyholders is that we will be there for them in their time of need, which means we must have money to pay our policyholders when they make claims. That money resides in the investment portfolio I am responsible for managing.
The second nuance is that we are highly regulated as an insurance company. Endowments have some rules around them, but not to the same degree as the insurance industry. U.S. insurers may have both the state regulators and international regulators. In Aflac’s case, because we are global and more than 70 percent of our business comes out of Aflac Japan, we also work with regulators in Japan. The regulations say, "You're there to protect policyholders and earn a good return. Your primary objective is to be safe and assure policyholders return of principle." That is why insurance companies predominantly have fixed income securities, whose characteristics include return of principal at maturity and a competitive yield.
"We have a positive view of the future for Japan, but there are certainly headwinds that they need to deal with. The headwind in Japan that everybody is familiar with is the aging demographics and how that will pose a challenge from a fiscal and monetary perspective."
Ultimately, the economics matter in the context of asset liability management in our investment portfolio. Those policyholder claims are our liabilities. We also have capital considerations because the insurance company has to provide capital to support investment activities and other activities of the company. That is a major differentiation.
In the world of insurance, the investment strategy is much more focused and precise with a concentration in fixed income. We aim to make sure policyholder funds are secure and safe while hopefully earning a return above and beyond what policyholders and shareholders have been promised. That excess return can be considered part of the profit pool for the insurance company and added value for shareholders for public companies. For endowments and pensions, there is much greater flexibility on the investment strategy and more focus on total return.
Trusted Insight: Are there other interesting insights that you can provide in terms of how diversification policies were decided at each of the firms that you were at?
Eric Kirsch: At Aflac, diversification at multiple levels is critical. One approach we practice at Aflac is “strategic asset allocation.” And at a high level, we use “quantitative-based” models to look at the volatility of our liabilities, and the duration of those liabilities.
We also look at capital Aflac has to support investment functions and the amount of capital at risk the company is comfortable maintaining. We then look at factors like regulations and earnings volatility. We match all of those factors with traditional mean-variance analysis around asset classes, whether it’s fixed income, equities or alternatives. The strategic asset allocation basically answers the question, “To achieve the company's objectives, what is the optimal portfolio mixture of these assets that also reduces our surplus risk?” That is our capital risk.
"When the credit cycle turns, we want to make sure our predetermined diversification standards keep us safe and minimize any losses. Though with the good risk management and credit work that we do, they should be minimal and not disruptive to our operation."
We go through that exercise every three years and that is the first level of diversification. That output shows what is optimal. For instance, X percent in Japanese government bonds for Japan, X percent in investment grade bonds or X percent in commercial mortgage loans. We do this for a variety of different asset classes within fixed income, as well as a smaller allocation to alternative investments like private equity and real estate.
The importance of this strategic approach is that it is calibrated to the company's objectives. From there, we bring it down to the security and industry level and look at factors like financials, industrials and technology to help manage credit and country risk. It is a very quantitative process to set the diversification limits and guidelines.
On a day-to-day basis from a portfolio management standpoint, our portfolio managers around the globe, in Japan and the U.S., run the individual positions and asset classes we buy and sell by those risk limits. Diversification comes top-down, but then it comes bottom-up by individual research, credit companies, asset class and properties depending on the asset class. So, diversification is critical.
As you know, markets go in cycles. We have been in a nearly 10-year bull market now. Everything is holding up and it has done very well. At some point, the credit cycle will turn, however.
When the credit cycle turns, we want to make sure our predetermined diversification standards keep us safe and minimize any losses. We are exposed to credit markets, and whenever credit cycles turn, there may be some challenges. Though with the good risk management and credit work that we do, they should be minimal and not disruptive to our operation.
Trusted Insight: What is your opinion on where Japan is heading and how that will affect the credit markets there?
Eric Kirsch: As you know, the U.S. has the largest credit market in the world, but Japan's fixed income market is primarily Japan government bonds. There is a credit market, but it is very small in comparison to the U.S. It is difficult to actually buy credit-denominated yen assets. There are some cases, but a fraction of what we have in the U.S.
We have a positive view of the future for Japan, but there are certainly headwinds that they need to deal with. The headwind in Japan that everybody is familiar with is the aging demographics and how that will pose a challenge from a fiscal and monetary perspective. The Japanese population is getting older, and they do not have a robust immigration policy, which poses challenges in terms of the size of the basket of wealth. The impact of fiscal and monetary policy becomes more important. Any company doing business in Japan needs to consider those demographic changes.
The other headwind is Japan has a high degree of debt. If you have a robust society that looks like it is going to grow for a long time, then you have a good chance of being able to manage your fiscal imbalances and your debt. This is where Japan’s aging society concerns many investors.
The tailwinds over the last three years under Japan Prime Minister Shinzo Abe’s administration has really brought Japan far along in terms of fiscal expansionary, monetary policy and social changes. In the past, Japan has had difficulty with gender diversification in the workplace. Now, with Prime Minister Abe’s goal of growing female participation in the workplace and his call for Japanese corporations to fill at least 30 percent of their leadership positions with women by 2020, Japan has a much more robust acceptance. Aflac has won commendations in Japan, such as the Japan Women’s Innovative Network’s J-WIN Diversity Award, for creating an environment where women can succeed.
On the monetary side over the last few years, Haruhiko Kuroda, governor of the Bank of Japan, has had a focus on creating inflation in Japan. By creating inflation, economic growth is created. He has not been 100 percent successful, but he has had a policy of extreme monetary easing in Japan, which is why interest rates have been so low. The fact is, Japan's economy has been growing the last two to three years, much more than it did prior to being stuck in deflation.
When we add all of these factors together, we see more tailwinds than headwinds, but Japan certainly has its challenges in front of it. Ultimately, we see good prospects for Japan when we look out at the next few years because of the good policies that have been put in place.
Something worth noting is that unlike other countries that rely on outside investors to buy their sovereign debt, Japan is mostly internally invested. Meaning 90+ percent of their Japanese government bonds are owned by Japanese financial institutions and the government. So, it is unlikely they would face a situation like Greece, for instance, where foreigners owned Greek debt. Japan is somewhat immune from that activity.
Trusted Insight: Moving back to the U.S., are there any Trump administration policies that have affected the way you execute decisions? Are there any pending or upcoming policies that you're particularly paying attention to?
Eric Kirsch: The tax code changes were very positive for Aflac in terms of lowering our tax rate. That was an extremely positive change for the business, our employees, and the future strategy of Aflac in terms of being able to reinvest in our business and our shareholders. We were able to give some excellent benefits to our employees, as well, including increases in company contributions to employee 401(k) programs and additional training programs.
On the investment side, the tax code changes have some impact on our Aflac U.S. business, more so than our Aflac Japan business. This has made municipal securities an attractive investment for Aflac U.S. We have actually implemented some muni-strategies, which prior to the tax code changes, would not have made sense for us on an after-tax basis. With the new tax code and how municipals are treated, we get a tax advantage by having a certain allocation to municipalities over taxable investments. That has been a profound change that we did not expect, but is a very positive outcome for the investment portfolio and strategy.
View our full catalog of interviews with here.
The complete list of 2018 Top 30 Insurance Chief Investment Officers can be found here.