Private credit and life insurers: Is there a problem?

The terms private credit and life insurance have appeared together in multiple negative headlines in recent weeks, and to casual observers the link between the two may not be immediately obvious.

Life insurance firms play a critical role in the financial landscape. They provide financial protection and savings products to households, while on the investment side they are a key source of funding for governments and the real economy. Life insurers globally have around $25-30tr of assets under management, which represents around 8% of the world’s financial assets. Clearly, a systemic issue in the sector could have broader ramifications for global financial stability.

Given their profile as financial institutions with long-term liabilities, private credit is a perfectly sensible allocation for insurance companies, whose long-term investment horizon enables them to benefit from the illiquidity premiums on offer in the asset class.

At present, however, there are three major concerns around these holdings. One, that private credit markets have seen rapid growth in recent years and this has been achieved at least partly thanks to weaker underwriting. Two, insurers’ allocations to private credit generally have been on the rise. Three, and perhaps most pertinently, some insurance companies are owned by private equity houses who originate private credit, adding potential risk to a system that could already be considered somewhat opaque if PE-owned insurers are investing in PE-originated private credit.

Are these concerns justified?

First, it is important to underline that private credit is a rather broad umbrella term for a range of activities that involve non-bank lenders creating debt that is not sold publicly to investors (as it is in the public bond markets). Globally, the asset class is thought to stand at around $3tr. About half of this comes from direct corporate lending, both to investment grade and sub-investment grade companies, which is the area of private credit that has experienced the most explosive growth in the last few years. This is the one that has garnered the most negative headlines, but it is only one type of private credit. For example, the asset class also includes infrastructure, commercial real estate, and asset-backed finance deals, which are essentially private securitisations where periodic cashflows are generated from a defined pool of assets. Of course, there are private credit investors and originators that are better than others, and varying levels of leverage and risk management. But it is extremely inaccurate to say that the whole of private credit is “good” or “bad”, just as it would be to say that the whole of public credit is “good” or “bad”.

Second, it is worth reiterating that life insurance balance sheets are a natural home for longer dated, illiquid assets. Unlike banks, which are another major source of funding to the economy, life insurers often hold long dated, sticky liabilities. One example is annuities, a product where the insurer collects an upfront payment (say upon a persons’ retirement) and in exchange commits to a payment of annual cashflows to the policyholder. The insurer needs to source assets that can provide sufficiently high return to service the payments on these products, some of which can last over 40 years. Banks by contrast fund themselves mostly with deposits, which makes their liabilities structure inherently more liquid and prone to outflows, making the illiquid nature of private credit arguably less suitable.

Third, though we acknowledge that at the global level the use of alternative assets (including private credit) has been on the rise among life insurers over the last 25 years due to a period of low interest rates, save for certain pockets of the market, we still consider the allocations to be rather conservative. In Japan, alternative assets represent less than 5% of insurers’ allocation. In Europe it is higher at about 15-20%, but focused on mortgage-related exposures (mostly equity release mortgages in the UK). In the US, the share is north of 30%, though it is skewed by the presence of PE-owned insurers (more on this below). Clearly, the pockets of higher concentration could lead to contagion if the risks are not managed appropriately. European life insurers in particular tend to have lower allocations to direct corporate lending, though they would likely not avoid some contagion if private credit losses at other players were to mount. As for the UK, where private credit exposures have also been growing, the recent Bank of England stress tests showed little sign of weakness.

Fourth, we share some of the concerns raised by regulators regarding PE-owned insurers. This model may create skewed incentives for the insurers in terms of the private credit assets they look to acquire. It is also a rather pro-cyclical business model; an economic downturn would impact the sale of insurance policies, the quality of the insurers’ assets and the profitability of the asset originators within the broader group all at once. We acknowledge the model has some notable benefits such as capital optimisation (e.g. offshore affiliated insurers or so-called asset intensive reinsurance), but these come with a cost in that it might exacerbate the already opaque nature of these large groups.

We do take comfort in the fact that the PE ownership of life insurance firms in Europe remains moderate, below 10% of equity capital according to the Bank of International Settlements. This compares to around 25% for US life insurers and around 5% for life insurers in Asia. Regulatory authorities in Europe may be particularly cautious on this form of ownership after 2023, when a PE owner (Cinven) walked away from a smaller Italian life insurer (Eurovita), putting policyholders at risk of losses. PE firms have generally found the European insurance market more challenging to push into than the US.

At present, we remain watchful of developments at the intersection between private credit and life insurers. We share some of the concerns of global regulators, but broadly we consider the share of private credit in life insurance portfolios to still be low, leaving more scope for growth. The PE ownership model carries its own risks, but until now at least PE ownership in European life insurance has been moderate, and regulators are vigilant to the risks out there – in our view, this should not be the key focus point for bond investors in European life insurance firms. Contagion for European insurers is the key risk we will be monitoring, should we see further pressure in the US space.