I have been busy with finals, but will post more cool articles like an analysis on the evolving problematic monetization schemes in video games soon for the few people that read this blog 😄. In the meantime, this is an article on insurance, which I like learning about, that I read on Apollo Global Management
https://www.bloomberg.com/opinion/articles/2024-04-30/apollo-had-some-death-bets
For why so many retirees have anxiety about their post-retirement life, it is important to understand trends that have had profound impacts on longevity risk. The first one is that people are living a lot longer than in the past, largely due to advancements in healthcare technology and medicine. For recent developments that are improving life expectancy, gene editing like CRISPR therapy has been approved to help with sickle cell disease and the drug Leqembi got FDA approval that helps slow Alzheimer’s disease, which affects 6.7 million Americans age 65 and older. These are a few of the many works of those working in life sciences that have allowed people to live longer, presenting a challenge to those planning for retirement. In the United States, the average life expectancy for males and females was 73.5 and 79.3 in 2021, far higher than what it was even just 10 years ago. Below depicts a 2021 table from the United States Life Tables.
It can be observed that for every 100,000 people, there is a 29.50% and 44.24% chance a male and female live to 85; for those male and females, there is a 14.62% chance and 26.10% chance. Given that the average person retires at 63 in the United States, there are serious financial implications that concern individuals who may live past what they may have originally planned or did not plan for. Especially for wealthier individuals that can obtain access to private health insurance and pay for the high costs of certain drugs, they tend to live past the average life expectancy.
The second trend is the uncertainty surrounding public markets and capital preservation utilizing conventional strategies like the 60/40 allocation to equities and fixed income. For a long time, a relatively stable, low interest rate environment has supported strong stock and bond performance, which make up a large percentage of many retirees’ portfolios. Now, higher interest rates have not only decreased the value of bonds but caused a huge rise in inflation, which has decreased consumer spending power. Risk-parity strategies that may be deployed have struggled over the past few years, especially as the correlation between stocks and bonds has been the highest since 1998. For equities, which have seen significant returns for investors over the past few decades, there are questions of whether these returns can be replicated again amidst a more volatile stock market, according to DataTrek. All of this has caused some to allocate more capital into private markets in the forms of private credit and multi-strategy hedge funds recently, but these can only be accessed by retirees with high net worths that can make the initial investment. While it is true that these market conditions are transitory and may return to being more calm, such spikes in volatility and concerns about investment returns from stocks and bonds put pressure on retirees’ non-guaranteed income.
Finally, guaranteed income streams that retirees may rely on can not be relied on as heavily to supplement one’s retirement income as in the past, with some examples being a pension or Social Security. Up until the 1980s, defined-benefit plans like pensions were extremely popular within the private sector, but there has been a shift to defined-contribution plans like Roth or Traditional IRAs for a few reasons. For employers, accurately projecting pension liabilities is very difficult so rather than taking on the longevity and investment risk, they transfer those to the employee to figure out. Furthermore, it is easier to manage defined-benefit plans as the costs are more predictable and employers know how much to set aside without accumulating losses from people retiring early or dying late. There are still corporations that offer pensions, but there is no guarantee the money will be paid out if corporations decide to cut the pension -- look at General Motors in the past as an example. For the Social Security Trust Fund, while it may never fully run out of money, there are predictions that the fund will start reducing total benefits in as early as 2034. This will cause many retirees to rethink how to supplement this shortfall in Social Security with additional streams of retirement income, with about 40% of retirees solely relying on Social Security. This does not even take into account if politicians make cuts to Social Security or other government-backed programs like Medicare, which would increase expenses that may not have been planned for by retirees. As Larry Fink said in his most recent Investors Letter, these factors have caused people to realize “a shift from financial certainty to financial uncertainty,” evidence that no income stream is guaranteed.
Benefits of Longevity Insurance
There are a wide range of answers when asked how much one will need to retire comfortably. Some may say $1 million, others will say $2 million, and some may even say $5 million. Whatever that number is, there is a 4% rule that states for a 30-year retirement period, a 4% withdrawal from a portfolio for the first year followed by withdrawal rates adjusted for inflation should keep one’s portfolio safe from being depleted. But how well does this rule apply to today? For one, it makes the assumption that people actually follow the 4% rule strictly and do not withdraw beyond that. In addition, it makes the assumption that there are no significant life events that deplete one’s portfolio. Whether that is helping one’s kids who have lost their jobs, covering sudden cancer treatment expenses, or divorce, these things will cause one to either cut spending or take on more investment risk by placing more weight in a portfolio on assets like stocks, which are known to be more volatile than treasuries or money market funds. Especially if these events happen early on in one’s retirement, it can have devastating effects on the 4% rule if followed. For example, pretend we have a $2 million dollar portfolio along a 30-year time horizon and returns on average 5% annually, in line with what experts say a balanced retirement portfolio of stocks and bonds should be. The first table will show strong, positive returns in the start and then negative returns at the end, while the second table will show negative returns in the start and then strong, positive returns at the end. Below are the two tables.
In the first scenario, the portfolio value increased, whereas the portfolio value turned negative in the second scenario. While there are many unrealistic assumptions being made here and factors that I am not accounting for, I wanted to show that following the 4% rule is not a useful guideline when looking at negative shocks to one’s portfolio. Tackling investment risk and longevity risk at the same time makes retirement planning one of the toughest things to do. Therefore, what can retirees do to have more peace of mind over their retirement life?
Longevity insurance may be the key to this problem. It is a deferred annuity that a retiree buys from an insurance company, which guarantees income for life at a predetermined date of usually around 80-85. The retiree only needs to make a one-time payment and the amount of income will depend on how long the annuity is deferred for; the longer the deferral, the more annual income a retiree will receive. In addition, if one dies before the deferral period, the payments are not received. For longevity insurance policies, the insurer will take the money from policyholders and put it into assets like IG corporate bonds, making sure that it makes a consistent return to have enough to pay for the longevity annuities if policyholders are still alive and any potential losses due to longevity risk for itself. For insurers, they make sure they price the premiums and payouts to a point where they can still gain profit because they still need to make money from this. For retirees, those who live a long enough life will not only have the guaranteed protection of a recurring income but also an income that returns more than what one would receive from one’s investment portfolio. Below is a simple graph of what it is.
The whole purpose of longevity insurance is that it helps cover expenses that were not planned for due to living longer, something that can be difficult to predict. When we are young, we buy life insurance as we tend to value the future income we will make in years to come. When we get older, as our expected future income decreases, so does the value of buying life insurance and subsequently increases the value of buying longevity insurance. For those who best fit the need for longevity insurance, it is important to understand one’s risk tolerance and financial situation. If someone is risk-averse, longevity insurance makes sense as the whole purpose of the policy is to create income protection for the individual in the case that one lives longer than expected. In terms of financial situation, it should be recommended to retirees who lie in between those with a lot of assets to cover expected and unexpected retirement expenses and those with not enough assets. If one has enough assets, there is no need for income protection as the individual can withstand any market volatility and take on longevity risk. If one does not have enough assets, then capital accumulation should be the main focus. Therefore, it requires a thorough assessment of one’s finances before purchasing the policy.
Psychological Barriers Behind Purchasing Longevity Insurance
As noted, it makes sense to buy longevity insurance for a multitude of reasons. It gives individuals financial freedom, reduces stress over running out of money, and reduces any financial burden individuals close to you may feel as you grow old. However, longevity insurance is not a popular product that people are buying. According to Limra, out of the $385.4 billion in annuity sales in 2023, only about $4.2 billion of that was in deferred income annuities (DIAs) -- from my knowledge, longevity insurance is a type of DIA, which means longevity insurance sales were even smaller than the DIA sales amount. While the sales of these DIAs nearly doubled from 2022-2023, they make up only a little more than 1% of the sales. There are some possible explanations for why they are not as popular as they should be.
One reason can be explained through the concept of hyperbolic discounting or the tendency to value small rewards in the short-term over large rewards in the long-term. The longevity insurance policy premium can be a six-figure amount and some retirees do not want to forgo that much money that they do not know will yield a benefit in the future. They would rather use that money to travel the world, use it as a downpayment for a vacation home, or set up a college fund for their grandchildren. So the potential loss due to dying early has far greater weight than the gain in future benefit from the longevity insurance, creating a sense of loss aversion for many. Another reason is that some may be worried about one’s insurance company becoming insolvent, meaning that payments technically are not guaranteed at a certain start date. While one should entrust their insurance policy with a large insurer with a strong balance sheet like a New York Life or MetLife, that does not mean that a bankruptcy is an impossibility. Therefore, for someone thinking about buying longevity insurance that will payout a few decades into the future, there is counterparty risk that a person may not want to take on from a potential insurer’s bankruptcy. Finally, there are concerns about inflation eroding the value of any annuity payments that may come. During the deferral period, individuals bear the inflation risk and while people can pay a premium for inflation-adjusted annual payments, it still does not fully protect against inflation. In all, these are some highlights for why people are wary of making the purchase of longevity insurance.
As stated by wealth management professor Michael Finke, the longevity annuity is “probably the most difficult financial product to sell.” But given the benefits they provide, I believe that they should be purchased more often than they actually are and marketed better to people. The best way to do this is through financial advisors; however, according to a survey, the majority of financial advisors do not recommend annuity products and even when they do, most clients do not listen to their recommendations. For the latter part, individuals may not know how to value annuities and think about longevity risk; therefore, a lack of financial literacy causes individuals to not buy these annuities. But in addition, some financial advisors are compensated on AUM, meaning that selling annuities as a financial advisor does not directly tie easily to compensation. Selling longevity insurance would require a client to sell assets to purchase the policy, reducing the AUM of the financial advisor, which would not be in their best interest. Also, it is noted in a paper how advisors will advise clients to roll over their 401k plans to IRAs instead of annuitize them because of the recurring advisory fees they would receive as opposed to a one-time fee. Therefore, an advisor’s compensation structure creates a mismatch of incentives between financial advisors and their clients, which should not be the case as the financial advisors should solely act in the client’s best interest as a fiduciary. While development within the wealth management industry may change to encourage better marketing for longevity insurance to clients, there are still some headwinds that are currently being faced.
I believe longevity insurance is truly the best way for people to live their best retirement life and the concept of longevity risk needs to be talked about more online. There is so much more that can be covered, but hope you enjoyed this article!
Word Cited
Arapakis, Karolos, and Gal Wettstein. “Do Financial Professionals Recommend Annuities?” Center for Retirement Research, 19 Dec. 2023, crr.bc.edu/do-financial-professionals-recommend-annuities/.
Clancy, Luke. “Can Risk Parity Ride out the Storm of Correlated Asset Chaos?” Risk.Net, 5 Feb. 2024, www.risk.net/investing/7958954/can-risk-parity-ride-out-the-storm-of-correlated-asset-chaos.
Dave Strausfeld, J.D. “Longevity Annuities: Why Clients Should Consider Them.” Journal of Accountancy, Journal of Accountancy, 30 May 2023, www.journalofaccountancy.com/news/2023/may/longevity-annuities-why-clients-should-consider-them.html.
Passenger Vehicles and Electric Vehicles in Cities
To start, it is important to understand electric vehicles compared to internal combustion engine (ICE) cars on a basic level. For most electric vehicles, the motor runs on a lithium-ion battery because it has the highest energy density for weight as well as being able to charge faster and longer compared to other materials like cobalt -- not going to get too much into the science of how the battery works. With that being said, the range of an electric vehicle is not as long as an ICE, especially when you factor in cold temperature levels that limit the battery’s range even further. This is one of the biggest reasons why major automotive companies like Toyota have been able to succeed with its hybrid electric cars as customers are hesitant to buy EVs due to limited range concerns. Though when talking about the efficiency of energy usage between EVs and ICEs, EVs are a lot better. When stationary, an EV does not need to consume energy and is able to also offer regenerative braking to increase fuel efficiency. In addition, electric vehicles are ideal for those who want a quiet vehicle to drive in.
Finally, the big question that you are probably wondering and may already be considering as a buyer of one: which costs less? To answer this simply, it really depends on a wide range of factors, which a study that was published in the Journal of Industrial Ecology actually explores. For EVs, the battery is the largest upfront cost that comes with purchasing an EV, which is why ICE cars tend to be cheaper; through economies of scale, these EV battery prices should drop. In addition, it depends where the consumer is located and how he or she is charging the EV. For a city like Detroit, car insurance costs are extremely high, with them being at an average of $5,687 for annual coverage; this does not even take into account the 20% premium that EV owners must pay for insurance relative to an ICE owner due to higher purchasing cost and repair. In this scenario, it does not make economical sense to buy an EV, especially if located in an area of Detroit that does not provide lots of cheap charging. In addition, for someone who has the capability to build out home EV charging, the study reported lower lifetime charging costs of up to $26,000. Coupling that with being in a city that also offers low overnight charging rates should provide another tailwind for choosing an EV. Finally, there are the regulatory incentives for purchasing an EV that may help slightly decrease the cost of ownership, with the $7,500 EV credit from the IRA being the most well-known -- the number of EV models that apply for this tax credit has decreased over time, with it being about 18 now. While I can keep on going on and talk even more about the differences between ICEs and EVs, this is just a surface-level comparison of how to compare the two.
For large metropolitan areas that are trying to spur EV adoption like San Francisco and New York City, there are various things consumers consider that affect this, with what I may have mentioned already. For one, many consumers may see driving an EV in a city as more fuel efficient in a city, especially with the fact that there is regenerative braking (lots of stop-and-go traffic) and that energy is not being lost due to friction and heat as opposed to an ICE. In addition, EVs help with keeping city air cleaner and can be a quieter option for those who do want to contribute to the noise pollution that highly dense cities bring. While I am only familiar with NYC emissions law called Local Law 145 passed back in 2013, I would assume that other cities or states have similar laws in place and that more stringent measures could help with EV adoption. However, there is still a charging dilemma where even if there are enough accessible chargers to the public at a cost-effective rate in cities, the chargers may just be extremely slow. For example, there are three levels of charging speeds: level 1, level 2, and level 3. Below is one of the best infographics to explain the differences.
Level 1 chargers are included with EVs upon purchase, but can basically be rendered useless unless one has a hybrid car, at least in my point of view. Level 2 chargers are more practical for EV owners and cities like New York City have curbside Level 2 charging on public streets. Finally, level 3 or DC charging is the fastest type of charging, with its ability to charge an EV in under an hour. Other startups like Gravity have opened even faster charging, with it recently creating 24 EV charger systems in New York City, charging an EV 200 miles in five minutes. However, one problem with creating a citywide fast charging network is that you must create stations that have the different types of EV charging plugs; Level 3 plugs are not standardized for all EVS unlike the lower-level chargers. As an example, Hyundai IONIQ 5 and Kia EV6 are examples of cars that are unable to connect to Tesla Level 3 superchargers. In addition, the buildout of charging in garages in cities for individuals can prove to be difficult. If someone is at home or at the office, he or she wants to make sure the EV is charging while away. For families that live in a private residence, this is no problem. However, for others living in apartment complexes in Manhattan or driving in to work, it may be difficult. Private garages tend to be expensive with the parking fees and then some of the chargers may not have regular maintenance on them. It is far easier to install the charging during the construction of new garages or parking and even if the infrastructure is installed, this will cause finding parking a lot more difficult unless Level 3 chargers are all being installed at these sites. These are a few things to touch on when looking at what cities are thinking about when spurring EV adoption -- it really is a chicken-and-egg problem where there is hesitancy to switch to an EV due to the lack of charging and because of the lack of charging, there is very little EV ownership.
Quick Overview of Revel and Thoughts from CEO Frank Reig
Now that I have talked about electric vehicles, I want to dive into Revel. Started in 2018 by a previous chef at Gramercy Tavern -- you read that right -- and later on as a consultant at GLG, Frank Reig created Revel that has now become the largest rideshare startup in the New York City Metropolitan area. At first, it started out as an electric moped startup with 68 mopeds; however, the threat of new, safer entrants into the New York City transportation ecosystem like Citibikes as well as the costs of moped charging infrastructure caused Revel to switch to electric vehicles. The switch has been so far successful, with Revel having more than 500 taxis and numerous fast charging stations throughout New York City; in fact, Revel plans to have more than 300 chargers by the end of 2024, which would represent 90% of the city’s fast-charging capacity. For its rideshare business, all employees are full-time employees with hourly pay and benefits; therefore, Revel can not be classified within the gig economy like some of its competitors. In addition, it has 24/7 supercharging stations that claim to charge vehicles 100 miles in under 20 minutes of charge. Most recently in the news, Revel partnered with Uber to allow Uber drivers to charge at any of Revel’s fast charging stations at a discounted price, a big boost to not just its brand image but its attempt at bringing charging demand to its stations. Given that the company is supposedly supposed to be profitable by the end of this year and that Eric Adams recently announced that New York City’s rideshare fleet must all be EVs by 2030, it seems clear that Revel is on a strong trajectory for growth.
During a club meeting from one of the entrepreneurship clubs at my university, Frank Reig gave a lot of insight into startup culture, how he thinks about the electric vehicle industry, and what makes a great company. In the beginning, he talked about how he came up with the idea of Revel by just googling the space of shared mopeds. Seeing the growth that has occurred in Europe and Asia, he saw an opportunity to bring it to the United States, more specifically New York City as it is where he was born and raised. As he was creating Revel, it was interesting to note that it was not technological or regulatory barriers that hindered scale, but actually finding a warehouse that could build the charging infrastructure for the mopeds. He mentioned a plethora of problems such as finding rational landlords to give him good terms, zoning laws, land development and environmental regulations (ex. the charging wires built underground can not touch the soil), and finding buildings hooked to an electrical grid that can obtain 2-5 MW of electrical power as some of the barriers. This was quite a surprise to me and really showed the nuances behind building out fast charging hubs in large cities as opposed to areas with more lenient regulations.
Later on, he talked more about building startups. When talking about finding the best mentors, he said that the first 30 seconds are key when pitching to investors; therefore, making sure you instill confidence from the beginning and explain your unique story of why you created the business is foundational. In addition, he talked about the negative side of raising debt as a business and suggests to always opt for issuing equity early on as a company until you have the financial luxury of being able to pay off over the long-run. He made an interesting remark on the dangers of venture debt specifically, talking about how financial covenants may screw a startup early on, which is why to be wary of who you decide to receive funding from. Finally, there was a question asked by someone in the room about the effects of the Inflation Reduction Act (IRA) on Revel and Frank said that while there is a lot of upside for Revel because of it, it is hard to have foresight and be optimistic of these types of regulatory tailwinds. The reason being is that the IRA can easily be repelled by a new administration in the federal government as an election looms and hinging a business's success based on regulatory drivers exposes the business model to too much systematic risk. Overall, I could tell the passion he showed for Revel as he was not only very knowledgeable of how to go about startup funding, the politics of management, and the electric vehicle space, but also how well-spoken he was when asked questions. It was definitely one of the most insightful events I have been to in recent memory and will be interesting to see how Revel does in the near future.
Thank you for taking the time to read my article on electric vehicles and Revel!
Sources
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Detroit, Scripps News. “This City Still Has the Highest Car Insurance Rates in the Country.” Scripps News, Scripps News, 9 Feb. 2024, scrippsnews.com/stories/this-city-still-has-the-highest-car-insurance-rates-in-the-country/.
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Garza, Alejandro de la. “Revel’s CEO Wants to Solve the Urban EV Charging Challenge.” Time, Time, 26 July 2023, time.com/6298181/revel-frank-reig-city-ev-charging/#:~:text=Over%20the%20past%20two%20years%2C%20the%20company%20has%20built%2040,by%20the%20end%20of%202024.
“How Lithium-Ion Batteries Work.” Energy.Gov, 28 Feb. 2023, www.energy.gov/energysaver/articles/how-lithium-ion-batteries-work.
Hu, Winnie. “Why Revel Shut down Its Moped Service in New York.” The New York Times, The New York Times, 18 Nov. 2023, www.nytimes.com/2023/11/18/nyregion/revel-mopeds-nyc-e-scooter.html.
Lewis, Michelle. “New York Is Now the World’s First City to Mandate EV Rideshare Fleets by 2030.” Electrek, 16 Aug. 2023, electrek.co/2023/08/16/new-york-ev-rideshare-fleets-2030/.
“Venture Capital, Private Equity and M&A Database | Pitchbook.” Pitchbook, pitchbook.com/. Accessed 22 Mar. 2024.
As a college student in New York City, I feel grateful to be in one of the best cities to experience the world of art. With some of the most famous art museums in the world and a plethora of pop-up galleries year-round, it can be quite overwhelming to choose where to visit in my finite amount of time juggling classes, friends, and other endeavors. I am always enamored of art and decided to write an article on it. I want to dive into what makes art investing extremely attractive and how we should understand the valuations of certain art pieces. While I am not going to be diving into the unregulated nature of art transactions, fakes, NFTs, and a lot of other components that revolve around art investing, these are all things interesting developments I am following.
Introduction to Art Investing
Pioneered by the British Rail Pension Fund, art investing is an investment opportunity that can be quite interesting for some investors with the money and right knowledge on the subject. For art investing, there is a primary and a secondary market. In the primary market, this is when the artist first sells the artwork, whether it is out of a gallery, museum, or own art studio. In the secondary market, this is where art is being exchanged between buyers, which is the focus of this article. Typically, buyers will sell artwork for three main reasons, though not limited to just these three: to pay off debt, divorce, or death. With that being said, artwork may sometimes not sell at the seller’s expected value due to condition, prestige of the art piece, or provenance. In addition, understanding the motivations for why certain groups of people buy certain pieces of art plays a huge role. This is why finding the “correct” value of an art piece is incredibly important yet very difficult -- I will go into this in more detail later.
For many retail and institutional investors, there are many reasons for not seeing art as an investable asset class. One, it is extremely illiquid and has a thinly traded market. Given that art is generally seen as a collectible to keep for years, there are not many buyers and sellers constantly making transactions with each other on a daily basis. In addition, it is not the type of asset that your typical retail investor can afford to make. Art can be extremely expensive and when you factor in additional costs such as transaction costs, storage, and the purchasing of insurance, many people do not want to go through that whole process. For those who lack enough capital to build a physical art portfolio, Masterworks is the only alternative investing platform that gives investors the ability to buy fractional shares of certain art pieces. Even then, one may not be a believer that the art that Masterworks selects on its platform may generate sufficient returns, so there are selection issues that arise. Therefore, ways to invest in art is very limited and I compare this to investing in sports franchises where the only way to gain exposure is through private equity or ETFs to my knowledge. Finally, as mentioned before, with art sales reaching an estimated $65 billion in 2023, the biggest reason across generations for buying art was for enjoyment. While some do art as an attractive investment, it is generally just seen as one to fulfill one's happiness. A graph below from a 2023 Survey by UBS shows the breakdown.
The Thesis behind Art Investing
With all this being said, those that want to invest in art are fortunate enough to take advantage of the many drivers that can make this asset extremely compelling for years to come, if one does take the time to do the research. The first are the huge age demographic changes happening across the world. Within the U.S., we are experiencing “The Great Wealth Transfer, where in the next quarter of a century, approximately $73 trillion dollars will be passed down from Boomers to Gen X, Gen Z, and Millennials. This is important due to the fact that each generation has a different taste in art. In Asia, it was noted that millennials prefer photography and installations, while Gen Z like digital art and prints. In addition, it was indicated in a CNBC article that 40% of Christie’s buyers in Asia Pacific were millennials, an important note on tracking consumer purchasing power across generations. While there is a lot of nuance that goes with understanding conspicuous consumption across generations and different regions of the world, this huge transfer of wealth from generation to generation can help investors interested in art to find the best pieces that will appreciate in value. Later in the article, I will talk about those who do enough research and have large data sets on art prices can potentially do hedonic pricing for art to help determine which pieces are most valuable as younger generations start to buy different art than their parents. The second reason is that a lot of art buying is now going digital via online art auctions, which allows for greater and easier accessibility. While some may prefer the in-person experience of bidding at an art auction, that has not stopped the online art market from growing, with CNBC reporting that it will grow to $17.76 billion by 2030, up from $9.72 billion in 2022. With more online auctions allowing for a wider audience to participate, this can potentially pump more money into the art marketplace from investors like family offices or institutional investors who may otherwise have not participated, growing the secondary market. However, online art auctions may be susceptible to trust and authenticity issues, though more research will need to be done on this to truly understand the degree to which these effects are affecting art purchase frequency.
The third reason for driving art as an asset class is the rise of credit and collateral used to help finance the purchase of new art. While high interest rates have raised the cost of using credit at the moment and most people try to use current income for spending on luxury items, it was noted by UBS that 40% of high-net worth clients have used credit or collateral to help finance these art investments. Because consumers are receptive to using these means for financing these transactions, credit expansion from banks will likely continue to stimulate and grow consumer spending into this segment. Finally, which I believe is the biggest driver, art is an asset class that has a finite amount of supply. As an example, many contemporary artists from the second half of 20th century are either dead or very old that they are retired. Therefore, their famous art collections are not growing any more. But what is growing is the huge concentration of wealth being held with the top 1% of the world -- lots of economic data to showcase this. And for art, it is a type of collectible that can cater to all generations and all types of people regardless of gender or cultural background. Below is a graph that displays the annualized returns and volatility of certain collectables.
It is very interesting to see some breakdown between different pieces of art, which supports the idea that art as a whole may not be a great investment unless you try to figure out which pieces are most valuable. Therefore, I believe certain pieces of art returns will only grow as time goes on and easily outperform the overall market. But how can we tell which ones?
Finding the “Correct” Valuations of Art Work
For those who work at art auctions, their jobs are to sell the art, not value the art. It is really up to the buyers for understanding what is the “fair value” of a certain piece of art. But what ways can we use to determine what “fair value” really looks like? After all, there is no public valuation methodology for understanding art prices.
First, you can look at the artistic movement from when the art was created. Is it Romanticism or Impressionism? Neoclassicism or Contemporary? This should be a great indicator of at least starting to narrow down ways to group pieces together. Then, you can do it by artist. A Picasso painting and a Banksy painting will fetch totally different prices as it not only just attracts certain types of buyers, but one is dead while the other one is still alive (hopefully) creating more art that can be purchased on the secondary market. Finally, looking at the type of art is a crucial factor, one that is possibly more relevant for anything created during the Contemporary Art period, which started late 20th century. Today, more modern artwork does not just consist of sculptures and portraits, but also digital installations, photography, and installations that people want to buy. From here, hedonic pricing will need to be used to find the fair market value, just like what is done in real estate via the Case-Shiller index. All of these factors are just a baseline for how to look at the various ways of starting to create some valuation methodology. This will allow an art investor to figure out who is investing in what and to get ahead of trends before certain art pieces spike. Creating a database of all this data may take time, but definitely may be worthwhile for those with enough capital to seriously consider investing in art.
However, even if you can create an art database of sales that span across time periods, geographical locations, and other factors mentioned, there are still some things to consider that can affect valuations beyond what I said. One is the liquidity of the art market at a given time, which can cause deviations from expected estimates art auctions may have calculated. After all, since auctions are very infrequent, it can be hard to access the market of potential buyers. Therefore, while there are macroeconomic factors that can be used as prediction tools for whether there is a strong buyers market for art, there is still some idiosyncratic risk that comes with art transactions that can be random. Another factor is that certain art buyers may have asymmetric information sets when it comes to understanding the values of art pieces, which affects the purchase price of certain art pieces. More profit-driven art investors will do their research and fully understand the art piece before giving an offer. A more casual art investor or collector may just buy an art piece because of pure enjoyment, with the purchase price being an insignificant factor. Therefore, some types of art collectors that are not just in it for profit; some do it for identity, some feel connected to a piece due to a cultural significance, some may just be addicted to art collecting. This is why even if you can do hedonic pricing for artwork, it is important to understand art trends and consumer behavior when it comes to buying certain art pieces to fully capture the potential appreciation in value. With this being said, I do believe art as an asset class will grow in the future and see it as one of the most interesting collectables to look at.
Thank you for reading my article on art investing!
Updated as of March 14, 2024
Highly recommend people read The Art Basel & UBS Global Art Market Report 2024 for more information, which I did not cover.
Sources
Ann, Quek Jie. “Asia’s Young and Wealthy Are Fueling Demand for Art - What Are They Collecting?” CNBC, CNBC, 7 Jan. 2024, www.cnbc.com/2024/01/08/asias-young-and-rich-are-fueling-art-demand-what-are-they-collecting.html.
The Art Basel and UBS Survey of Global Collecting in 2023, theartmarket.artbasel.com/download/The-Art-Basel-and-UBS-Survey-of-Global-Collecting-in-2023.pdf. Accessed 2 Mar. 2024.
Belinchón, Fernando. “Investing in Art: A Profitable Activity Just for a Select Few?” EL PAÍS English, 12 Nov. 2023, english.elpais.com/economy-and-business/2023-11-12/investing-in-art-a-profitable-activity-just-for-a-select-few.html%C2%A0.
Masterworks. “A Short History of Art Investing.” Masterworks, 29 June 2022, insights.masterworks.com/alternative-investments/art-investing/a-short-history-of-art-investing/%C2%A0.
Mattei, Shanti Escalante-De. “The Great Wealth Transfer Is Encouraging Older Collectors to Sell off Their Art Collections.” ARTnews.Com, ARTnews.com, 22 Aug. 2022, www.artnews.com/art-news/news/great-wealth-transfer-art-collecting-1234637068/%C2%A0.
Wagstyl, Stefan. “The Market for Collectibles Can Be Volatile but Rewarding.” Financial Times, Financial Times, 2 Sept. 2022, www.ft.com/content/72b8a3ee-d6fe-4736-89e5-793377f1db88.
Reinsurance is insurance for insurance companies and plays a huge role in keeping the insurance industry afloat in the scenarios of large losses. But just like an insurance company, it must take care of its balance sheet and creditworthiness as it is highly sensitive to large events like climate disasters. Over the past five years, Moody’s stated that there has been on average $100 billion worth of global insured natural catastrophe losses. This has caused insurance and reinsurance companies to limit coverage or exit certain markets, with examples in the U.S being floods in Florida and wildfires in California. In addition, when costly climate disasters occur, property catastrophe reinsurance rates will substantially rise, with reinsurance companies taking on higher attachment points and aggregate covers becoming less. This will decrease the capacity of reinsurance companies as there becomes an asset-liability mismatch with perhaps their assets side being unable to cover for the large liabilities losses. Therefore, CAT bonds have been great instruments to help transfer some of this risk that reinsurance is supposed to take on to the capital markets. Below is a simple diagram from Man Group of how a CAT Bond works.
To start, the sponsor will enter a reinsurance agreement with a SPV to collect capital from investors. This capital will then be used to issue the bond into the secondary market, where investors will be able to purchase it. A collateral account will be used to help collect the proceeds from investors and be invested in securities that have high-credit rating to ensure “guaranteed” payments. Because of this, CAT bonds do not carry any credit risk, which is attractive to insurers to know that there will never be an instance of non-payment on a claim. Now, a CAT bond can be triggered through generally two ways: indemnity or parametric. Indemnity is the most common trigger and just looks at aggregate damages done, while parametric looks into weather factors like wind speed or total amount of rainfall as the trigger. If the trigger occurs, the sponsor will be able to get the funds initially invested by investors, whether partial or full. If not, the investor gets all its principal back at the maturity of the CAT bond plus the coupon payments that come with it.
With large climate catastrophe events being very low frequency, it is important that reinsurance companies take on a long-term view of their balance sheets. If there are so few players in the space, rates will be driven down as these companies will start underwriting short-term reinsurance. But if a major event occurs, it may affect the industry’s capacity to provide sufficient coverage. This is what makes CAT bonds so interesting. Because property and casualty (P&C) insurance will inevitably grow with the frequency of climate events and the need for capacity, my thesis is that this instrument will have to grow as balance sheets of these insurance companies are constrained from a risk perspective. Sure, they may have the capacity to underwrite more, but they may have reached their max risk exposure. So far, the market growth is set to soar for CAT bonds, with an estimated $20 billion of insurance being forecasted by GAM Investments in 2024, which would be greater than the phenomenal 2023 year of Cat bond issuance. Below is a better visualization of Cat bond issuance and amount outstanding.
As I have been following CAT bonds since freshman year, it was a surprise to see them starting to make headlines and become more discussed within financial markets by the end of last year. For some of the top hedge funds that specialize in ILS investing like Fermat Capital Management and Leadenhall Capital Partners, it was a fantastic 2023 year for them and was spurred due to some factors like extreme weather events and high costs of rebuilding after natural disasters. Below is a graph to showcase hedge funds returns and the dominance of ILS and Cat Bonds for 2023.
This should be illustrative of the opportunity that CAT bonds present for investors seeking alternative sources for returns -- as an investor, you can also do pro quota treaties as well but I will not be getting into that. Not only hedge funds, but family offices and PE firms like KKR have also been catching on to how the insurance sector can provide interesting diversified, low-correlated returns relative to the overall market for its investors. If high spread levels that were seen in 2023 can be sustained, I do not see a reason for why it should not be incorporated more into investors’ portfolios. As mentioned before, has a low correlation to the overall market and compared to other fixed income products, it has very little interest rate duration risk. It will be interesting to see what occurs for the year 2024.
NYC ILS Conference Overview
Being at the conference was quite weird, especially since I was one of only two people there who was an undergraduate student, let alone under the age of 30. However, it was definitely worth my time and I wanted to share some informative insights of what industry experts are thinking about regarding ILS securities.
To start with Cat bonds, there were many strong remarks about the exceptional performance of the asset class in 2023, with them mentioning huge inflows of money into this instrument by opportunistic investors amidst rising interest rates. However, that is not to say that all headwinds have vanished. Many of the speakers noted that normal allocations for investors into these ILS securities are a modest amount of 1-3%, largely due to the illiquidity and scalability that comes with such a strategy. This means that despite the outperformance of many large market indices, CAT bonds will still need more than one year evidence that it can be part of investors’ portfolios. There was also recognition that ILS investors have also become more sophisticated over the years, especially given the fact that many have been following the asset class for at least a decade. Therefore, better climate risk modeling will be needed to provide evidence that capital should be given to CAT funds over pure capital strategies like equities or fixed income. So as interest rates start to fall and spreads tighten, it will be important to build transparency with investors in terms of pricing and predictability of interest-payments. Also, large left tail risk events are a reason why investors may be wary of allocating capital into these strategies, with them skeptical of climate risk modeling being done. In addition, poor asset-liability management from reinsurance companies that we saw more occur starting with the rise in the Fed Funds rate in March 2022 showed decreasing book values of these companies, meaning less underwriting and hurting the inflow of capital into CAT bonds. The final thing to note is that CAT bonds have largely been only open to institutional investors’ capital, so it will be important in the future to help retail investors obtain exposure to this growing asset class to help fill in demand.
Despite my fascination towards Cat bonds, the most interesting topic of the conference was the Cyber bond, which is an extremely new instrument that was only introduced last year. As the world becomes more and more interconnected, cyber risk becomes an even larger problem. Cyber (re)insurers will have to serve a huge role in being able to measure the impact and frequency of these events, despite the lack of historical loss data. For 2023, there were four 144A Cyber bonds issued and will secure about $415 million in protection for those sponsors, showcasing the start of what can be an important tool for firms to minimize cyber risk. As Richard Gray of Breazley stated at the conference, there will be a need for capacity, but it is extremely important that investors are educated and confident in the cyber modeling. Because this is such a new area of expertise, despite the similarities to CAT bonds in terms of structure, indemnity traits, and catastrophic tail risk, cyber modeling companies like CyberCube must be transparent in how they think about trends. This is definitely an area worth reading about and I am starting to do more research on this instrument for perhaps future articles.
Thank you for reading and hope you enjoyed learning a bit more about the developments happening in the insurance industry.
Sources
Evans, Steve. “Around $20bn of Catastrophe Bond Issuance Possible, Market Growth Could Soar.” Artemis.Bm - The Catastrophe Bond, Insurance Linked Securities & Investment, Reinsurance Capital, Alternative Risk Transfer and Weather Risk Management Site, 20 Feb. 2024, www.artemis.bm/news/around-20bn-catastrophe-bond-issuance-possible-market-growth-could-soar/.
Evans, Steve. “Family Offices Leaning into Insurance for Diversification. so Is KKR: Mcvey.” Artemis.Bm - The Catastrophe Bond, Insurance Linked Securities & Investment, Reinsurance Capital, Alternative Risk Transfer and Weather Risk Management Site, 13 Feb. 2024, www.artemis.bm/news/family-offices-leaning-into-insurance-for-diversification-so-is-kkr-mcvey/.
Evans, Steve. “First Cyber Cat Bonds a Watershed Moment: Moody’s RMS Video Interview.” Artemis.Bm, 30 Jan. 2024, www.artemis.bm/news/first-cyber-cat-bonds-a-watershed-moment-moodys-rms-video-interview/.
Lee, Sheryl Tian Tong, et al. “The World Being on Fire Is Swelling ‘catastrophe Bonds’ to a Record $45 Billion-and It’s a Key Hedge Fund Strategy.” Fortune, Fortune, 22 Jan. 2024, fortune.com/2024/01/21/hedge-funds-climate-change-catastrophe-bonds-disaster-insurance-record-high/.
“Property Catastrophe Reinsurance Market Dynamics to Slow in 2024.” Fitch Ratings: Credit Ratings & Analysis for Financial Markets, 23 Nov. 2023, www.fitchratings.com/research/insurance/property-catastrophe-reinsurance-market-dynamics-to-slow-in-2024-23-11-2023.
“Reinsurers Defend against Rising Tide of Natural Catastrophe Losses, for Now.” Moody’s | Better Decisions, www.moodys.com/web/en/us/about/insights/data-stories/reinsurers-mitigate-lower-profits.html. Accessed 23 Feb. 2024.
