Headwinds hitting commercial real estate could be concerning for insurance companies. After all, they had nearly $1 trillion invested in the asset class at the end of last year, the lion’s share held by life insurers, according to Tim Nauheimer, manager of macroprudential supervision in the Capital Markets Bureau of the National Association of Insurance Commissioners.

Nauheimer spoke at the NAIC 2024 Fall National Meeting on a panel in the November 19 session, “Commercial Real Estate: Assessing Insurers’ Short-Term and Long-Term Exposure.”

Where The Risk Is
“The biggest risk right now is in the office space” due to people working remotely, he told conference-goers, stating that insurers hold nearly $130 billion in office mortgages.

These loans accounted for 20% of life carriers’ total commercial mortgage portfolios at the end of 2023, noted the next panelist, Carmi Margalit, a senior director and the life insurance sector lead of North American Financial Services Ratings at S&P Global Ratings.

Beyond the work-from-home trend, higher interest rates at refinancing await maturing commercial mortgages, further weighing on the office category, Margalit said, predicting losses in it.

So far, life insurers’ commercial mortgage portfolios are “holding up well” because these sophisticated institutional investors are conservative loan underwriters, he said. Their percentage of commercial mortgages that were either delinquent by at least 90 days or in foreclosure last New Year’s Eve (0.37%) was a fraction of what it was for banks (1.04%) and commercial mortgage-backed securities (3.25%), the other big lenders in the arena.

At that time, 48% of life carriers’ delinquencies and foreclosures were in office and 35% were in retail, a category representing roughly 17% of life carriers’ total commercial mortgages, Margalit reported.

In terms of industry-level impact, his team’s analysis suggests that a decline of 20% in the market value of all office buildings life insurers have a loan against—a scenario he called “exceedingly remote”—would slice about 0.5% of surplus from the life industry.

At a staggering hypothetical 75% drop in commercial property values, something “nobody is anticipating as a base case,” Margalit reassured, 13.5% of the industry’s surplus would evaporate. For the median life insurer, the surplus loss would be 7.7%; that would not be devastating for the industry, he said.

CMBS
Turning to the approximately $285 billion of commercial mortgage-backed securities held by insurers, about 85% is in the AAA tranche and it’s “fairly well protected” from loss because all lower tranches would have to sustain a complete loss first, he explained. Another 5% of insurer CMBS holdings are AA. It would take “a pretty draconian scenario” for the “vast majority” of these tranches to experience loss, Margalit said.

Diving deeper, he described two types of CMBS, one riskier than the other. Conduits are backed by a portfolio of dozens of commercial mortgages, providing diversification. Single-asset single-borrower CMBS are securitized by one loan, typically on a very large property, and are more risky, even the AAA tranche. Although many insurers own the single-asset single-borrower variety, they underwrite these instruments conservatively, too, according to Margalit.

Overall, the U.S. insurance groups his team rates, primarily the larger ones, generally have very diversified commercial mortgage portfolios, he said.

Another panelist echoed that sentiment.

Robert Kasinow, assistant deputy superintendent at the New York Department of Financial Services, explained that state insurance department actuaries develop cash flow projections under multiple economic scenarios to assess whether insurers’ assets are sufficient to meet their policy obligations.

He conceded that commercial property values are under pressure now and that some categories are facing greater difficulties than others due to low occupancy and potential defaults. But, Kasinow concluded, “life insurers as a whole” are expected to weather the storm with their diversified high-quality portfolios, conservative underwriting and strong liquidity.

Eric Reiner is a freelance writer who also teaches finance and risk management at the University of Colorado Denver Business School.