The recent turmoil in the market for General Electric Co.’s bonds has started to remind investors that corporate borrowers sometimes fail to make their debt payments.
But, for now, life insurer stability trackers see tales of debt issuer problems as something interesting to think about, not as a symptom of a bad financial head cold, let alone anything more serious.
Analysts at S&P Global, Moody’s Investors Service, and the U.S. Treasury Department’s own Office for Financial Research have inspected life insurers’ tonsils in three new reports.
Deep Banerjee and other S&P analysts have made a data-driven case for something agents and brokers already know: publicly traded insurers and insurers controlled by private equity firms and other “alternative capital” providers tend to pursue strategies with more ups and downs than the policyholder-owned mutuals do.
The S&P analysts see the public companies offering more products with performance tied to shifts in stock prices and interest rates, and the alternative capital-provider-owned companies offering products backed pools of assets that expose the issuers to somewhat more investment risk than other issuers tend to take.
The S&P analysts see a tendency for life insurers to use what the insurers classify as “excess capital” to buy back stock or make acquisitions.
“We are starting to see early signs that capitalization will not get any stronger,” S&P says in a summary of the report.
But S&P expects to see most life insurers continue to have enough capital to support their ratings. “Capitalization will remain a key strength,” the company says.
The S&P report is behind a paywall.
Shachar Gonen and other analysts at Moody’s give a similar assessment in their 2019 life outlook report: the overall outlook for life insurers is still stable, rising interest rates are helping, capital remains strong, and portfolio asset quality is something interesting to think about.
U.S. life insurers had about 48% of their $4.4 trillion in general account assets invested in corporate debt securities in 2017, according to data from the American Council of Life Insurers’ ACLI 2018 Life Insurers Fact Book. In part because of the rules set by state insurance regulators, and the rating guidelines set by the rating agencies, life insurers tend to invest mainly in debt securities from companies with high credit ratings.
Life insurers’ continue to have high-quality, well-managed, diversified investment portfolios, but “we do see evidence of increasing risk,” the Moody’s analysts write in their report.
Corporate borrowers have been taking on more debt, and all types of lenders have eased their credit standards, the analysts write.
“Given that life insurers are major fixed-income investors, their recent purchases reflect these trends,” the Moody’s analysts write. “The record number of highly leveraged companies along with elevated geopolitical risk and uncertainty in economic policy has set the stage for a wave of defaults in the next downturn that is potentially larger than in the past. Life insurers have been increasing their allocations to higher-risk and/or less liquid assets at the margin. This includes greater investments in private bonds, lower-rated investment-grade fixed-income securities and commercial mortgage loans, giving up liquidity to gain additional yield at the margin. Life insurers have also modestly increased exposure to leveraged loans, [collateralized loan obligations (CLOs)], and companies in the middle market through direct lending.”
But “credit quality in the portfolios is steady, and the industry in aggregate should be in a solid position when the long credit cycle finally turns,” the analysts write.
The Moody’s report is behind a paywall.
Office for Financial Research
S&P and Moody’s try to help lenders decide whether borrowers will pay off their debts, and they try to help insurance customers decide whether insurers will make good on insurance and annuity obligations.
The Office for Financial Research (OFR) tries to help the U.S. Treasury Department decide whether companies will be coming to the federal government for big bailouts, or whether problems with companies could knock down the U.S. financial system.
OFR analysts have included their own version of a 2019 life insurance outlook commentary in their 2018 annual report to Congress.
The OFR analysts show, in one figure, that they believe U.S. life insurers create much less financial crisis “contagion risk” than banks or mutual fund companies.
But life insurers do have more exposure to stock market risk than they used to, through variable annuities, and they are using more annuities to hedge their variable annuity risk, the OFR analysts write.
An OFR figure shows that U.S. variable annuity issuers had derivatives with a notional value of more than $1.5 trillion in 2017. That’s up from less than $1 trillion in 2010, according to the figure.
“This hedging has its own risks,” the analysts write. ” As with banks, derivatives increase life insurers’ interconnectedness with other large financial institutions.”
The analysts also note, in a general overview of credit quality, that less creditworthy companies account for a bigger share of bond issues these days, and that borrowers are issuing more “ covenant lite” bonds, or bonds that with fewer built-in restrictions on what the borrowers can and can’t do.
The OFR report is available here.
— Read Life Insurers’ Investments Look Fine: Moody’s, on ThinkAdvisor.