S&P Global Ratings banner, from a 2017 S&P conference in New York. (Photo: Allison Bell/TA) (Photo: Allison Bell/TA)

Years of bond yield famine have led U.S. life insurers to make major changes in their investment portfolios, according to analysts at S&P Global.

Life insurers have respected regulators’ and rating analysts investment-quality guidelines, but many have stretched the guidelines by investing in the lowest-rated, highest-paying assets that meet the guideline criteria, and by increasing their exposure to assets that might be hard to sell quickly in an emergency, the analysts report.

U.S. life insurers’ exposure to three major types of slow-to-sell assets — private bonds, mortgages and alternative investments — increased to 38% of the insurers’ assets in 2017, from only about 33% in 2011, according to an S&P compilation of data from insurers’ financial reports.

“For every dollar of investments made over the past five years, 63 cents went toward less-liquid assets,” the analysts write.

(Related: Thirsty Life Insurers See Bond Yields Rise to Highest Level in Five Years)

A team led by Deep Banerjee talk about the impact of life insurers’ hunt for yield in a new commentary posted behind a paywall on the S&P Global fixed-income research website.

Bond Market Basics

An “interest rate” is really the rent a borrower pays to rent money.

In the world of bonds, borrowers seen as risky, such as small, shaky companies, usually pay higher interest rates to rent money. Borrowers seen as safer, such as the governments of rich, stable countries, pay lower rates.

Central bankers in the United States and the rest of the world pushed the interest rates they control close to zero, and, in some cases, to less than zero, in the wake of the Great Recession that struck in 2008.

Low rates help homeowners with variable-rate mortgages, shaky companies that have issued variable-rate bonds, and the stock market.

Central bankers were hoping holding rates low would help nurse the economy through the widespread panic caused by the Great Recession.

Life insurers rely heavily on investments in bonds and other fixed-income obligations to support life insurance policies  and other products that might lead to long-lasting streams of benefits payments, or to claims that might arrive far in the future.

When possible, life insurers try to match the expected durations of the fixed-income assets they buy with the durations of their insurance and annuity obligations.

Falling interest rates increase the re-sale value of bonds held by speculators. But falling rates hurt the yields life insurers can get when they buy new bonds with the intent of holding the bonds until the bonds mature.

Years of near-zero interest rates in bonds have hurt life insurers’ ability to earn the yields they expect on newly invested money.

What Life Insurers Did

Investment managers told executives at U.S. life insurance companies to cope with the low rates by investing more of their assets in mortgages, private bonds and alternative investments, and less in high-rated, publicly traded corporate bonds.

For life insurers, “alternative investments” refers to investments in vehicles such as private equity funds, venture capital funds and hedge funds.

S&P analysts say life insurers did, in effect, expand use of mortgages, private bonds and alternative investments.

Life insurer exposure increases between 2011 and 2017 amounted to 28% for alternative investments, 40% for mortgages and 30% for private bonds, the analysts write.

Meanwhile, when life insurers have been managing their portfolios of “investment-grade” bonds, or bonds rated BBB or higher, they have emphasized

Results

In the real world, the number of bond issuers defaulting on their bonds has been very low in recent years, and, even during  the Great Recession, the number of BBB-rated issuers that defaulted was low, the S&P analysts write.

“Credit impairments may increase, but a strong capital buffer can take a few hits,” the analysts write.

The increase in exposure to less-liquid investments may be interesting, but “we don’t expect insurers to shy away from less-liquid assets in the near term,” the analysts write.

One reason that life insurers can handle more exposure to less-liquid asset is that the structure of most life and annuity products limits the customers’ ability to “run to the bank” and cash out early, according to the analysts.

“Even in a downturn, insurers don’t expect a ‘run-on-the-bank’ scenario, and therefore will likely hold on to their less-liquid assets that match their longer-dated liabilities,” the analysts conclude.

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