Insurance Assets

Seeking Yield in All the Right Places

Seeking Yield in All the Right Places
clock
3 min 14 sec

The portfolios of insurance companies have been tested during this low-rate environment. They tend to be highly tilted toward fixed income due to regulatory and accounting considerations. Moreover, the high-quality nature of certain fixed income investments has generally served to produce reliable income and match liabilities. But now these companies are increasingly challenged to identify yield-enhancing strategies to produce incremental returns.

There is one potential solution to help insurance investors meet their return goals without disproportionately adding risk: investment-grade private placements. This strategy presents opportunities to increase portfolio yields with higher spreads compared to other types of fixed income for similar levels of required capital.

Private placements have been a part of insurance company fixed income portfolios for several decades. While predominantly used by life insurance companies due to their long investment horizons and ability to withstand more illiquidity, there has been an increase in interest from both health insurance providers and property and casualty insurers. There are many reasons for the growth in interest and use of private placements, and we highlight a few that may make private placements a suitable option for insurance company portfolios. When evaluating private placements, insurers must consider a number of dynamics that are unique to the regulatory environment in which they operate, including credit quality, time horizon, and loss experience.

Insurance investors must be mindful of maintaining a high-quality portfolio since non-investment-grade securities carry a higher capital charge for risk-based capital calculations. Importantly, public bonds and private placements face equal treatment, so there is no increase in risk capital when insurance investors shift from publics to privates. Private placements are available across the rating quality spectrum; however, approximately 75% of issuance is made on behalf of borrowers with credit quality between A- and BBB-.

These securities are often bilaterally negotiated between the borrower and lender or syndicate of lenders. As such, several of the deal points are customizable, among them being the duration or tenor of the lending arrangement. Given the different duration of liabilities for many insurance investors, the ability to customize transactions to meet liabilities of varying horizons is attractive. Typically investment-grade public credit bonds are issued with standard tenors of 3, 5, 10, and 30 years; investment-grade private placements can be issued with tenors anywhere from 2 to 30 years. In return for accommodating the customized needs of particular borrowers, lenders have been able to extract a yield premium of roughly 100 basis points relative to comparably rated bonds in the public credit market.

The private nature of negotiating the lending agreement has resulted in a favorable credit-loss experience compared to public bonds. Much of the increased protection comes in the form of covenants structured into the lending agreement, which serve to maintain the lender’s senior position in the capital structure and to protect against defaults due to any financial action detrimental to the business or its cash flows. Having conservatively structured covenants can provide an early indication of potential deterioration to the borrower’s health and lead to a more proactive approach to resolving those issues. Another factor in reducing losses is the ability to participate actively in credit recovery strategies. With fewer counterparties involved in each transaction, each lender/participant can play a more active role in influencing a better outcome. These may involve a restructuring, a recapitalization, or a bankruptcy. Each of these strategies can produce a higher recovery rate that is otherwise not as easily achievable in the public markets.

This is a challenging time for producing yield for insurance assets, and at Callan, the focus of our research has been on seeking out ideas such as private placements to help insurance investors navigate this low interest rate environment. We focus on asset managers that have proven track records in investment-grade private placements, and we emphasize thorough diligence on fees and appropriate strategies to better position investors to experience the right outcome.

Posted by

Share
Share on facebook
Share on twitter
Share on linkedin
Related Posts
Public Markets

Stellar Markets Across Asset Classes

Kyle Fekete
Callan expert assesses the global markets in 3Q24 and the outlook heading into the election.
Private Markets

Nonprofits: Same Mission, but New Approach to Allocations

Tony Lissuzzo
Callan expert discusses changes in nonprofit allocation trends over the last 20 years.
Private Markets

Gains Outpace Leveraged Loans Over Time; Spreads Contract

Constantine Braswell
Callan experts analyzes private credit activity in 2Q24.
Public Markets

Gains for Stocks Mask Wide Disparities; Little to No Change for Bonds

Kristin Bradbury
Callan expert analyzes the global stock and bond markets in 2Q24.
Private Markets

Private Credit Gained in 4Q23 but Lagged High Yield Benchmark

Constantine Braswell
Callan expert analyzes private credit activity in 1Q24.
Public Markets

Stocks Continue Rally; Bond Returns Fall Amid Rate Cut Uncertainty

Kristin Bradbury
Callan expert analyzes the performance of global markets in 1Q24 and the outlook for the year.
Private Markets

Private Credit Performance Tops Leveraged Loan Index Over Long Time Periods

Alternatives Consulting Group
An update on private credit performance in 4Q23
Public Markets

Stocks Near a Record High, and Bonds Reverse Course

Kristin Bradbury
Kristin Bradbury analyzes global stock and bond markets in 4Q23.
Private Markets

Private Credit Returns Exceed Those of Leveraged Loans

Roxanne Quinn
Our analysis of 3Q23 private credit activity.
Public Markets

Tough Quarter for Stocks, with Bonds Facing Third Straight Annual Fall

Kristin Bradbury
Kristin Bradbury assesses the global markets in 3Q23.

Callan Family Office

You are now leaving Callan LLC’s website and going to Callan Family Office’s website. Callan Family Office is not affiliated with Callan LLC.  Callan LLC has licensed the Callan® trademark to Callan Family Office for use in providing investment advisory services to ultra-high net worth clients, family foundations, and endowments. Callan Family Office and Callan LLC are independent, unaffiliated investment advisory firms separately registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940.

Callan LLC is not responsible for the services and content on Callan Family Office’s website. Inclusion of this link does not constitute or imply an endorsement, sponsorship, or recommendation by Callan LLC of their website, or its contents, and Callan LLC is not responsible or liable for your use of it. When visiting their website, you are subject to Callan Family Office’s terms of use and privacy policies.