Insurers’ Demand for Private Credit Shows no Signs of Slowing Despite Spike in Yields
Many institutional investors are increasingly attracted to private credit, the insurance sector providing an example where demand has surged in recent years. The belief that demand was driven by very low yields in public markets has shown to be erroneous, with demand continuing to rise even as yields have spiked higher since 2022.
Growing Demand for Private Credit from Insurers to Continue
Insurance companies around the world have been increasing their exposure to private credit in recent years – and that trend will continue, according to Moody’s. In June, the ratings agency released the results of a survey which found that nearly 80% of insurance respondents planned to increase their holdings in at least one class of private credit.[i]
Insurers have already increased their private credit holdings in the US to 36% of their total investments in the region, according to Moody’s. Globally, the ratings agency says almost two-thirds of insurance companies invest in private credit from a variety of places in their portfolios.
Around 42% of private debt investments came from insurers’ traditional allocations to private equity, 20% came from multiple allocation buckets, and 16% was shifted into private credit from general alternatives allocations, said Moody’s. Private credit also had its own dedicated allocation in 13% of insurance company portfolios, according to a Preqin report that included data from 900 insurers across the globe with an estimated $37.9 trillion in total assets.[ii]
Private Credit’s Appeal to Insurers
Insurers first started to get interested in private credit after the global financial crisis and the plunge in interest rates that left yields from public credit at very low levels for many years. Sub-zero yields briefly disappeared at the start of the pandemic in 2020, only to reappear days later as central banks drove borrowing costs down again to support economies. By November 2020, for example, a record 26% of the world’s investment-grade debt was delivering negative yields.[iii]
However, despite interest rates rising sharply from 2022 onwards as inflation took off following Russia’s invasion of Ukraine, insurers have continued to increase their exposure to private credit.
There are various reasons why private credit has proven so attractive to insurers in the past and continues to do so despite rising yields in public markets. These include:
Private debt generally delivers regular contractual interest payments, providing insurers with a stable source of income that matches well with their own liability profiles. Insurers have long-term obligations to policyholders and need consistent cash flows to meet these commitments.
Private debt offers incremental returns over and above those provided by public fixed income, thanks to the illiquidity premium, and brings diversification benefits given low levels of correlation with public markets. Moreover, as interest rates rose, yields on most private credit assets, which tend to have floating rate structures, also moved higher, while the illiquidity premium further increased.
Public bond and equity markets fells sharply in tandem as interest rates took off in 2022: global equity markets fell by around 20% during the year,[iv] while global bonds lost 31% – the worst annual performance for fixed income in data stretching back to 1900.[v] Consequently, insurers with a duration gap between their long-term liabilities and short-term assets saw the present value of their liabilities fall by significantly more than the value of their assets. The resulting improvement in their overall solvency position lessened the need for exposure to higher-growth, yet riskier assets to meet long-dated liabilities. That, in turn, generated increased demand for longer-dated private credit.
Private credit assets offer insurers stronger covenant protection, lower observed volatility, and a favorable return-on-capital treatment under the Solvency 2 framework.
Higher Returns Offset Risks?
There are, of course, risks associated with private credit. As credit conditions tighten and economic conditions deteriorate, there is a danger that defaults will rise. However, experienced managers should be able to minimize this risk through underwriting, careful analysis of individual borrowers, and a reallocation to more defensive areas of the market. Many insurers have also diversified their portfolios toward less liquid assets of similar credit risk, thus obtaining additional compensation for this lower liquidity.
Moreover, the turning of the interest rate cycle - with the Federal Reserve cutting rates by an oversized 50 basis points in September amid signs that inflation was moderating, and the labor market was weakening - suggests that credit conditions may improve. Further monetary loosening is expected around the world over the coming year, easing pressure on the corporate sector.
Conclusion – The Only Way Is Up
Given that insurers’ desire to increase their allocations to private credit has continued to grow despite higher yields in public markets, we expect demand to rise further as interest rates around the world appear to have peaked and begun heading downwards. The intrinsic appeal of private credit to insurers – factors such as higher relative returns, low volatility, and liability-matching characteristics – are unconnected to the global interest-rate cycle.
Key Takeaways
Insurers’ exposure to private credit grew rapidly after the global financial crisis and the ensuing record low yields in public markets.
However, demand has continued to surge despite the spike in yields that has taken place since 2022.
This suggests that the intrinsic appeal of private credit for insurers is so strong that demand will continue to grow irrespective of the global interest-rate cycle.
Interested in learning more?
