Let's say you have billions of dollars you need to invest to make a reliable income. What do you do?
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Buy relatively safe bonds, even though such debt is paying almost nothing;
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Expect to earn less on your investments;
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Buy riskier debt that pays a higher rate but has a greater chance of getting wiped out.
Many investors have been doing some combination of all of the above. Insurance companies, however, are more limited than others because regulators interfere with their ability to profit from riskier debt. This is a headache for life insurers in particular, which rely heavily on their fixed-income investments to fuel their earnings. Not surprisingly, their profits have dropped.
The solution, apparently, is for regulators to simply loosen up and make it easier for insurers to plow their money into more highly leveraged companies. The National Association of Insurance Commissioners is considering a proposal that would effectively reduce the risk-based capital charges for the lowest-rated corporate notes while increasing charges on some higher-rated debt, according to a CreditSights analysis.
Amount of corporate debt held by life insurers: $1.6 trillion
The likely result is that life insurers — and perhaps other types of insurers down the line — will direct a greater proportion of their money to high-yield bonds than they have in the past. At the end of last year, life, property and casualty insurers had almost $2 trillion allocated to corporate debt, with about 8.8 percent of that in high-yield corporate bonds, CreditSights analysts Rob Haines and Josh Esterov wrote in a report this month. Life insurers accounted for more than $1.6 trillion of the corporate-debt allocation, more of which could soon be headed to high-yield territory.
The NAIC's proposal will likely go into effect for life insurers at the end of 2017, and CreditSights analysts see a good chance that the measure would be expanded to other types of insurers soon afterward.
A cynic would say the insurance lobby just scored a big win. It's been rare for regulators to ease up on any requirements since the 2008 financial crisis, so this is a notable departure from the trend. It also paves the way for life insurers to take bigger risks when the credit quality of many borrowers is starting to deteriorate.
An optimist would say this measure will prevent insurers from crowding into the same bonds to take advantage of the highest possible yields with the lowest possible regulatory charge.
