Gerard T. (Jerry) Lynch, founder and CEO of General Re–New England Asset Management, Inc. (GR–NEAM), started New England Asset Management, Inc. (NEAM) in 1984. The firm was acquired by General Re Corp. in 1995 (hence the long name, and the adoption of GR-NEAM as its brand name). Three years later Berkshire Hathaway Inc. purchased the entire General Re group.

Jerry spent some time sharing his interpretation of the current state of the financial markets and the salient issues emerging that have challenged and will challenge insurance companies and insurance investment professionals. With 12 months gone by since the climactic moments of the financial crisis and 2010 approaching fast, IAM editor Alex McCallum asked the questions.

IAM: What do you believe were the key drivers of the recent financial crisis and do you believe the worst is behind us?

Lynch: I think you have to look at this crisis with a fairly long-term perspective. We had a multi-decade increase in credit, which was obviously a key driver. During this time, you had a secular decline in volatility with low inflation and low interest rates. People thought yield curves would remain inverted because of the huge influx of foreign capital coming into this country, and this was keeping rates -- at least at the ten-year part of the curve -- lower than most people might have expected. In any case, it certainly fueled the mortgage market.

Part of this thesis was also global economic growth and the global liquidity generated by the oil producers, the commodity producers, or just by reserves -- China being the chief example of that. As this thesis developed, it produced a high-degree of confidence. The combination of confidence and ample amounts of liquidity at a cheap price contributed to the extensive use of leverage and eventually led to the trigger event -- sub-prime. While the initial focus was sub-prime, leverage was pervasive and once that trigger event hit, things started to unwind very, very rapidly.

IAM: But now, after two years or more, and with 2010 approaching, do you think the crisis is behind us?

Lynch: At the moment, yes I do. The markets have come back very strongly from the bottom, and I think the Armageddon theory has been taken off the table. The conclusion that's been reached by authorities, I'd say, is that the risk of inflation is a small price to pay for political, social, and economic stability. The authorities will continue to do what is necessary to keep these markets calmed down and try to move forward.

IAM: That leads me ask, though, that if another shoe is going to drop, might it actually turn out to be inflation?

Lynch: The first shoe to drop that would really rattle this market would be if the government started to remove the stimulus before a pick up in final demand. A second concern that could unravel things would be a drop in China’s growth rate. Inflation is not such an immediate worry, I think, but we should still keep it on our front page.

Regarding China, it centers on whether their 9% real GDP growth is sustainable. Keeping at this rate would be enough to fuel world economic growth to allow countries like the United States and others to limp along at 1% or 2% real economic growth. Looked at the other way round, China needs 1% or 2% out of the United States to keep their export market on a stable footing.

Regarding inflation, take a look at capacity utilization and take a look at money. Right now, we have a high degree of capacity in the system, and I think it would require something like 4% real economic growth for the next five years to chew that up, 5% for the next three. We certainly have pumped enough money back into the system, but velocity remains low. I don’t think inflation is something we need to look at in the immediate future. I would add, though, that inflation is one of the key topics that our clients are asking about.

IAM: Thanks for putting China into the equation because I don't think, even today, that China’s growing impact is yet fully realized.

Lynch: You know, if you look at China right now and you look at the United States, 70% of our GDP is domestic consumption and in China it's 41%. They now have a program to get themselves to 50% to get a better balance between the demand for exports and domestic demand. It won't be a seamless process and could create some volatility, so we will need to keep our eyes on the situation going forward.

IAM: Can you give your brief assessment of how GR-NEAM has managed its business during the financial crisis, together with the primary lessons you have learned that will be useful for the next time round?

Lynch: We have been fortunate to have an amazingly stable, as well as experienced, staff of professionals here at GR-NEAM, and this has been an extremely important factor during the financial crisis. We know each other well, and we trust each other. You need that when the wheels are coming off in the wider world.

And there's no question, too, that the investment philosophy we pursue works very well in a crisis, as well as in more normal times. It’s based on the belief that insurance and investment risk are inextricably linked. Or in other words, the capacity to assume risk on one side of the balance sheet impacts risk capacity on the other.

To comment more directly on the crisis, we had been concerned for some time that adequate compensation for risk in most fixed income markets was lacking. This is GR-NEAM's relative value process, coupled with the experience of our team, helped us to effectively manage our clients’ portfolios through this volatile period.

IAM: Can you identify the top management team at GR-NEAM and explain the kind of culture that you have developed to become a leading player?

Lynch: GR-NEAM's investment professionals on average have 17 years of industry experience. This includes me and John Gilbert, our long-time CIO. As investment managers and advisors, we have considerable experience with most asset classes in the broad spectrum of fixed income and equity sectors, which we'd like to think has been very helpful.

"Team" is the right word because this is how we operate here at GR-NEAM. We have a very effective partnership-based model. One reason it works so well, I think, is because our teamwork approach applies both internally with our own colleagues and externally with our clients.

IAM: Do you think many investment managers at insurance companies themselves have learned from the crisis, and how might their conclusions affect their external manager relationships and outsourcing decision-making?

Lynch: Yes, I do. We have all learned from this experience – insurer investment managers and specialist external managers alike. And we are all still learning. If I had to pick one of the many vital lessons, I’d choose the importance of enterprise risk and capital management. It's a topic that has come right to the forefront. If the crisis has taught us anything, it's that you need to understand both sides of the balance sheet and the inter-relationships that occur. Sounds simple, but sometimes it takes a crisis to get greater clarity.

IAM: A number of crisis-affected large managers with insurer clients have folded their insurance investment groups into broader non-specific institutional groups. Has this created more immediate new business opportunities for GR-NEAM, and what does it mean for the competitive landscape going forward?

Lynch:Yes. You've got to be a specialist to succeed in the field of insurance asset management. Insurance companies are unique institutions with their own set of needs and operating objectives based on their liability streams. First and foremost, in my view, it is paramount for insurance companies to hire an asset manager that is absolutely focused on the unique business, financial, fiduciary and regulatory aspects of insurers. Nothing less than a full commitment is satisfactory, at least in my view.

To expand on this a bit, there's no doubt that insurance companies have become more interested in finding external asset managers that deliver the broadest range of services coherently and as seamlessly as possible. We have gone a long way to integrate our core competencies of capital management, investment management, risk management, investment accounting services and technology skills. Aimed directly at insurance companies. As I indicated, you can’t cut corners in this business.

IAM: Alternative investments and equities were topics of growing interest to insurers and their third-party managers before the financial crisis hit, as they sought to diversify their portfolios. Has enthusiasm for these asset classes started to return in 2009, or do you think insurers will now be more circumspect?

Lynch: Risk-taking behavior has run the full range of the spectrum from de-risking investment portfolios to increasing risk in portfolios. In my view, insurance companies will always seek to find ways to introduce equities or equity alternatives into their portfolios to the extent they perceive higher risk adjusted returns. However, after this crisis, they will no doubt be much more sensitive to the effects of volatility and its impact on enterprise risk adjusted returns on capital.

IAM: Where does GR-NEAM see the best prospects for growth in the next five years? Could these continue to be in sectors where you currently enjoy strong market share, such as US domestic P&C companies, or are there better opportunities for you, perhaps, in US Life & Health or in non-US markets?

Lynch: As a specialist in the insurance asset management field, we go where the growth prospects exist, and don't profess to have any sector favorites. I am confident that GR-NEAM will continue to build its presence in our traditional domestic property & casualty and life/health markets. We will continue to expand internationally, more aggressively through our Dublin, Ireland office. We see good prospects abroad as well as at home.

IAM: What do you consider to be special advantages that differentiate GR-NEAM from your competition when you are bidding for an insurer mandate? For example, is it better to be exclusively focused on the insurance industry? Do you specialize in certain asset classes? Are the support services you provide vital to success?

Lynch: We believe GR-NEAM has the best strategic vision when it comes to managing assets within the context of an insurance enterprise. At the same time, we are very aware that the business of managing outsourced insurer assets is highly competitive, and we have a high regard for our counterparts. We offer a great package, and the skills to go with it.

To answer your other questions: Yes, I think it is best to be focused exclusively on insurance. No, we don't specialize in particular asset classes. We have the entire range of asset classes available for our clients. And yes, support services are vital, and becoming increasingly so.

IAM: What adjustments has GR-NEAM made in 2009 for pitching for new business and managing insurance assets, and how is the second half shaping up compared with the first half?

Lynch: During the second half of 2009, we have been very encouraged by the amount of outsourcing activity and asset management searches taking place both inside and outside of the US. We are constantly looking at staffing levels and the logistics entailed in becoming a truly international firm. We will respond to the new business growth we anticipate both here in the US and abroad.

IAM: It's fascinating how the financial crisis has unearthed opportunities and has not only been confined to dealing with downside situations and being on the defensive.

Lynch: Oh, I agree. Right now there are 6.47 billion people in the world. 300 million of them live in the United States. When you think about that...

IAM: Six billion, yes.

Lynch:When you are looking around the world, there are many instances of emerging middle classes. For now, they may have a lower standard of living than exists in the United States, but their countries are committed..they have to grow.

Not to ignore factors like large youth populations, disillusionment, terrorism, etc., but what I see is the emergence of other centers of power and influence in the world, and America beginning to share leadership and not being the sole dominant power as we have been since the end of the Cold War.

Given this scenario, we have been talking to state regulators about their degree of flexibility with respect to international investments that reflect these global dynamics. Building a portfolio based narrowly on investments in the United States would fail to reflect on what is happening in the world. Generating attractive, risk-adjusted returns is what we're in business for, and we would be failing in our endeavor if we didn't reflect on what is happening in the wider world.

IAM: Thank you.

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