Underpinning life insurers' changing fixed income allocations are growing concerns about persistently low interest rates.

Hemmed in by competing investment priorities, portfolio managers at life insurance companies are treading a delicate balance. They’re endeavoring to increase credit risk and yields while not invoking excessive and regulatory-mandated capital charges that could prompt credit ratings agencies to downgrade them.

Cerulli Associates discloses this finding in a new report, “Insurance Asset Pools 2015: Emerging Addressable Opportunities for Asset Management.” The study examines the management of insurance investment portfolios in the U.S., as well as insurance companies’ increasing interest in outsourcing investment functions supporting their general accounts.

“[W]ithin the context of heavily high-quality fixed-income portfolios, insurers will generally try to add credit risk on the margin, taking advantage of an individual credit falling a notch or two either within the investment-grade universe, or into the upper reaches of high-yield/non-investment-grade spectrum,” the report states.

With the latter in mind, nearly 7 in 10 (69 percent of) asset managers and consultants surveyed by Cerulli say they intend to boost private income and private debt as a percentage of the fixed income allocations for their insurance general accounts. Solid majorities (56 percent) also plan to boost allocations of floating-rate debt and emerging market debt.

The heightened focus on private fixed income and private debt reported by Cerulli dovetails with the conclusions of a recent Fitch Ratings white paper. In tandem with shifts in corporate bond credit quality, Fitch noted, U.S. life insurers modestly increased their holdings of private placement securities relative to publicly traded bonds (rising to 34 percent in 2014 from 33 percent in 2007); and increased their exposure to statutory capital (to 147 percent from 135 percent over the seven-year period.)

Significant percentages of those polled by Cerulli Associates also say they intend to boost allocations of:

  • High-yield securities (38 percent)

  • Tax-exempt municipal debt (31 percent); and

  • Investment-grade fixed income (25 percent)

Underpinning the changing fixed income allocations, the report adds, are growing concerns among asset managers about how best to counteract persistently low interest rates since the 2007-2009 recession. Alexi Maravel, an associate director at Cerulli, describes the low interest rate environment as damaging to life insurers’ balance sheets over the long-term.

“While falling interest rates benefit fixed-income investments from a total return standpoint, as bonds mature or are called by the issuer, insurers have to reinvest in even lower-yielding securities,” Maravel says. “Depending on the type and duration of the insurer’s liabilities, this reinvestment risk can be detrimental to the financial performance of the company.”