The Long and Short
Assessing private credit risk at life insurers
This material is a Marketing Communication and does not constitute Independent Investment Research.
Life insurance credit spreads widened and equity prices dropped in the last week as concerns about private credit exposure hit the sector. Several articles circulated highlighting the growing portion of total invested assets allocated to middle-market lending and private corporate issuance. A review of holdings at the 10 largest life insurers shows an average of 15% of portfolios in private placements with most insurers showing less than 10% of those placements rated below NAIC 2.
Year-to-date, investors have been rapidly repricing risk in several subgroups within the financial services industry over the threat of technological obsolescence from AI and potential deterioration in credit among software companies. Those industries have included business development companies (BDCs), private equity, traditional broker-dealers, and insurance brokers. Meanwhile, the fast-growing lending by the US money center and large regional banks to non-bank financial institutions was a hot button issue toward the end of last year and remains an overhang for the industry as well.
Stock prices of public life insurers dropped anywhere from 5% to 10% earlier in the week as concerns accelerated. In debt markets, the bigger investment grade issuers generically widened by about 20 bp and are off roughly 30 bp from the January tights (Exhibit 1). Individual issuers perceived to have the most exposure to private credit, such as Lincoln Financial (LNC: Baa2/BBB+/BBB+), widened by approximately 30 bp in the past week alone and have gapped out by as much as 40 bp to 50 bp since last month. This is a significant injection of credit risk in a sector of the investment grade index where performance has been highly consistent over recent quarters. Fluctuations in pricing have been a bigger function of duration positioning, given the concentration in the long-dated bonds within the sector, than actual credit concerns among the constituents.
Exhibit 1: Credit spread pressure for investment grade life insurers
Source: Santander US Capital Markets LLC, Bloomberg/TRACE YAS price indications only, contains only selected issuers from the private credit study below
It helps to look at the private credit exposure of ten of the largest issuers of investment grade corporate bonds (Exhibit 2). In each instance, their primary operating subsidiaries were used as a proxy for the overall operations of the parent company. This is because statutory financials that provide the most details on investment portfolio holdings are only reported at the operating subsidiary level. Therefore, the numbers below do not fully capture all investments across the organizations but give a good indication of how they are positioned for private credit risk. These figures are all generated from the issuers’ last annual statutory filings, which in most cases is for year-end 2024.
In each case, a percentage is generated for privately placed debt versus total invested assets at the opco. It is important to strip out bonds that were issued by public and private companies through 144a private placement, as they make up a growing portion of the investment grade and high yield corporate bond markets and do not represent middle-market lending exposure. The average percentage of privately placed debt to total assets invested for the peer group selected is roughly 15%. That compares with some reports pinning credit exposure across the entire life insurance industry closer to 20%. In this instance, only one issuer has total private exposure north of that threshold and that’s LNC at approximately 23.6%. MetLife (MET: A3/A-/A-) is close behind at just over 19%.
Exhibit 2: Private lending at public life insurance companies
Source: Santander US Capital Markets LLC, company filings, most recent statutory financials
The second layer of assessment is credit quality within the issuer’s privately placed bond holdings. This segment includes 144a bonds as the statutory financials do not separate private lending by category when presenting NAIC ratings. The aggregate amount of privately placed debt that falls below NAIC 2 rating is effectively a proxy for non-investment grade risk level. Generally, issuers appear to fall in the high single digit range. Prudential Financial (PRU: A3/A/A-) and Aflac (AFL: A3/A-) both come in well above at 12.3% and 13.3%, respectively – though it is worth noting that AFL’s US-based insurance opco represents a relatively small portion of the company’s overall risk profile. Also worth noting is the extraordinarily high-quality nature of LNC’s privately placed debt, which does appear an offset to an otherwise heavy exposure to the segment.
While exposure to private credit is highly material, it is important to recognize that the investment grade public life insurance operators are extraordinarily well capitalized, often at the ‘AA’ level. Furthermore, their investment holdings are diversified to mitigate major risk concentrations by comparison to smaller, private operators within the industry. However, the prospect for weaker performance across investment portfolios increasingly appears a legitimate potential overhang for near-to-intermediate term profitability, which over time can weigh on credit metrics. Therefore, there does not appear to be a very near-term catalyst for spreads to tighten back as these concerns are more likely to persist than unwind.
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