Many of the most commonly used fixed-income investments, such as high-quality government bonds, now generate low to negative real returns. Consequently, insurers are looking beyond this, be that investing in illiquid forms of private credit, diversifying exposures globally or moving down the credit spectrum in order to find more attractive risk-adjusted opportunities.
In a new joint research paper produced by Invesco and Hymans Robertson, analysis of a selection of insurance companies fixed income portfolios, shows that average credit quality fell between 2010 and 2016. This observed reduction in quality will, in part, have occurred organically through downgrades. However some firms have been actively moving down the credit spectrum in order to boost risk-adjusted returns against today’s backdrop of low rates.
The paper reveals that there has been growing interest from insurers in Senior Secured Loans (SSLs), which are floating rate, sub-investment grade rated, USD/EUR-dominated loans to corporates. In comparison to high yield bonds, SSLs are secured on assets and sit higher in the capital structure. This combined with the higher spreads currently on offer results in higher risk-adjusted returns compared to high yield bonds.
While SSLs typically have a credit rating below investment grade, there are various credit risk mitigation mechanisms in place that rank SSLs at the top of a company’s capital structure, such as collateral packages, seniority in the capital structure and financial covenants. Additionally, there is the option for the borrower to redeem the loan early. These ensure that SSLs have historically shown significantly higher recovery rates than equivalently rated public credit.
Ed Collinge, Head of UK Insurance at Invesco states: “There is a diverse investor base in SSLs, ranging from insurers to institutional pension schemes and mutual funds. SSLs can be used for a range of purposes, including de-risking from equities, improving the risk-adjusted return potential of an insurer’s portfolio while also still providing access to liquidity.
“The research suggests that this asset class offers attractive risk-adjusted and capital-adjusted returns, alongside record low volatility and is a potential source of diversification within an insurer’s portfolio. With the continuing challenges posed by the low yield environment and restrictions from Solvency II, it is likely insurers will increase allocations to this asset class.”
Ross Evans, Head of Insurance Investment and ALM at Hymans Robertson added: “With the continuing challenges posed by the low yield environment and the new regulatory regime of Solvency II, Senior Secured Loans are worthy of further exploration by European insurers. The research highlights a number of features of the asset class which may appeal for investment portfolios backing participating business, surplus capital and property & casualty business.
We have seen some insurers actively moving down the credit spectrum in order to boost risk-adjusted return, and Senior Secured Loans offer the potential for a more capital efficient way of doing this than for some other comparable investments, such as high yield bonds.”
• Insurers are increasingly looking for ways to deliver attractive risk-adjusted returns following the introduction of Solvency II and historically low interest rates
• Between 2010 and 2016, some insurers have actively moved down the credit spectrum to boost risk-adjusted returns
• Senior Secured Loans provide higher risk-adjusted returns in comparison to high yield bonds and potentially a higher return on capital for insurers
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