Forecasters Wonder About Scratchy Credit Market Throat

S&P Global

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.

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.

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