Macroeconomic conditions and a shift in market outlooks have created considerable opportunity at the mid-year point for insurers to increase income generation. Such opportunities might encompass both the public and private markets—with the latter including investment grade private credit, direct lending, and real estate debt.
Strong growth, persistent inflation, and a cautious U.S. Federal Reserve have all contributed to the market walking back its expectation for aggressive rate cuts in 2024. This has resulted in a higher-for-longer interest rate environment and prolonged the opportunity for insurers to add attractive yields to their portfolios in both public and private markets across the curve.
Despite the inverted yield curve, given the high absolute level of rates we’ve increasingly seen clients thinking about extending duration on the margin within their public fixed income portfolio, enabling them to lock in higher yields for longer. While there is much uncertainty surrounding the future path of interest rates, what is certain is that any such move to extend duration should include careful consideration of the amount of liquidity needed to be held in adverse scenarios—be it a natural catastrophe for property and casualty insurers or a mass lapse event for life insurers—along with the available sources of liquidity including operating cash, investment income and lines of credit.
While rates have increased, spreads have continued to tighten on strong corporate fundamentals and technical tailwinds as the demand for income remains high from all types of investors in this space. The opposing moves of rates and spreads have created a dynamic where spreads as a percentage of all-in yields are at historical lows, even with record investment grade corporate bond issuance in Q1 2024. As a result, we generally remain cautious on credit exposure as spreads do not appear to be pricing in potential risks and headwinds of a slowing consumer in the coming year, as evidenced by the diminishing ratio of option-adjusted spreads to yield-to-worst.
Current opportunities to increase investment income
We see areas of opportunity for insurers across the spectrum to maintain quality positioning while providing attractive levels of investment income not seen in many years:
- Within public fixed income, securitized assets (mortgage-backed securities, asset-backed securities, collateralized loan obligations) offer potential relative value opportunities in the investment grade part of the market. Meanwhile, narrowly syndicated credit continues to offer a significant yield advantage above high yield bonds and broadly syndicated loans in the non-investment grade space.
- We continue to see strong relative value in investment grade private credit, particularly in the intermediate part of the curve, due to the inverted yield curve and lower competition for intermediate duration bonds. As these bonds primarily come with fixed rates, the opportunity to “lock in” these yields is compelling for all types of insurers. Within the investment grade private space, we note specific interest in private structured credit, specifically asset-backed finance and fund finance/net asset value lending.
- Also on the private credit side, we are seeing increasing levels of interest and allocation to direct lending as a result of double-digit yields and the potential for downside protection in this space, given strong levels of collateralization and direct lending’s senior position within capital structures.
- Finally, while real estate headwinds in certain sectors have kept some investors at bay, we’re observing more activity with insurers on the real estate debt side as a result of the yield profile of the asset class and capital efficiency in many regulatory regimes.
The remainder of 2024 is likely to bring surprises stemming from any number areas, including the degree of success of central banks to curb inflation while increasing growth, the upcoming U.S. elections, and, perhaps, even from updates on the insurance regulatory front. These surprises have the potential to negatively impact insurer investment portfolios. Fortunately, notable opportunities exist for insurers to meet their income and total return objectives while minimizing the negative impact of adverse market events.