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US Insurance Investors: Key Storylines for 2024’s Second Half

24 June 2024

8 min read

Geoff Cornell, CFA| Chief Investment Officer—Insurance

Gary Zhu, CFA| Deputy Chief Investment Officer—Insurance

Deanna Leighton, CFA| Lead Portfolio Manager—Insurance Portfolio Management

We assess the investment landscape for insurers with half of 2024 in the books.

Midway through 2024, US insurers face higher-for-longer rates, slowing economic growth and gradually cooling inflation. It’s an opportune time to take stock of the investment landscape and assess positioning in areas such as duration and private assets, as well as evaluate an evolving opportunity set.

Duration Exposure: Not the Time for Taking Bets

With central banks indicating that they are near or at the end of policy-tightening cycles, we expect interest rate cuts to start at some point toward the end of this year. Inflation is decelerating but is still short of targets, and recent economic data has been stronger than expected, suggesting that rates will stay higher for longer. We don’t think this is the time for insurers to make duration bets that mismatch assets and liabilities.

This echoes our view entering 2024: insurers should stay closer to home in overall duration positioning. In our view, it’s better to lock in higher yields by swapping out longer-term floating-rate positions and to minimize duration mismatches with liabilities where possible. Reinvestment risk is also an important consideration, and investors should be thoughtful about which sectors provide enough compensation—an answer that may differ depending on whether investors are focused more on yield or spread.

Will the higher yield/spread of asset-backed securities (ABS) make sense over credit, given the reinvestment risk of lower yields or tighter spreads in the two years after the ABS mature? How much yield or spread on an ABS would be needed over those two years to at least equal that of the investment-grade credit?

An example can help illustrate this point (Display). From a relative value perspective, we see ABS as a way to diversify away from US investment-grade credit. But say an investor is looking at a five-year time horizon and choosing between a three-year ABS with a 5.71% yield and a spread of 104 basis points (bps) and a five-year corporate at 5.13% and 63 bps.

For Spread-Focused Investors, Short-Term ABS Offer Relative Value

Analysis of breakeven yields and spreads of ABS vs. investment-grade credit

Historical analysis and current estimates do not guarantee future results.
Metrics are calculated using median. EBITDA: earnings before interest, taxes, depreciation and amortization
Through December 31, 2023
Source: J.P. Morgan, Morgan Stanley and AB

It would take a yield of 4.27% and a spread of just 2 bps. In other words, there’s a spread cushion of 61 bps for the relationship between the two securities to narrow in years four and five while still breaking even. We don’t think spreads will fall that low, so a spread-focused investor might find this attractive. Yield-driven investors, on the other hand, would receive only a 0.86% yield cushion. That may be too lean for insurers, especially with central banks likely to start cutting rates in the short to medium term, affecting shorter-term assets.

Sound Corporate Fundamentals Now, but Caution Warranted

Markets aren’t expecting a global economic downturn or recession, and credit fundamentals have been generally resilient up to this point. However, higher interest rates typically erode underlying fundamental strength, a risk that bears watching.

Investment-grade fundamentals were mixed to flat in the fourth quarter of 2023. Margins on earnings before interest, taxes, depreciation and amortization (EBITDA), which have been declining, ranged from flat to down. Rising debt and interest expenses have generally pushed leverage up and interest coverage down (Display). Given a surge in first-quarter issuance, fundamental metrics may have worsened, yet rating agencies remain broadly positive on credit risk in investment grades, and upgrades exceeded downgrades for the ninth straight quarter.

Margins Weaker, Leverage Still Elevated and Interest Coverage Down

Trends in profit margins, leverage and interest coverage since 2008

The high-yield market enjoyed a solid end to 2023 on the back of earnings growth. Leverage fell and is now below historical averages. Interest coverage ratios eroded but are still above average. Interestingly, BB-rated issuers saw fundamental metrics worsen while B and CCC issues improved. Overall, we expect defaults to tick up in 2024 after rising to 2.59%, on a trailing 12-month par-weighted basis.

Heading into the year, the assumption for emerging markets (EM) was for steady growth outside of China and Russia, which has played out so far. Corporate high-yield defaults remain low at 0.7% year to date, with some investors lowering 2024 forecasts from 4% to 3%. China’s fundamental headwinds remain despite a growth surprise, and more policy support could be needed. Panama lost its Fitch investment-grade rating in late March (with a stable outlook). We expect low corporate defaults, but expected rating actions on sovereign bonds would affect corporates too, especially as agencies monitor major elections.

While the current fundamental picture is encouraging, our forward view is less certain, and we think caution is warranted. Rating agencies could take precautions at the first sign of higher default risk, leading to more downgrades that could pinch regulatory capital budgets. For insurers, we think it’s critical to design allocations with diversification and quality in mind.

This means diversifying across asset classes as well as underlying risk exposures and collateral, bolstering portfolios against possible headwinds. New flows should be invested selectively. Fundamental research is key to understanding the multiyear outlook for specific credits, and watch lists offer a guide to active portfolio decisions and could help avoid downgrades. Despite historically high overall yields in high yield, we’re very cautious when it comes to insurance portfolios. We prefer higher quality and lower spread volatility, though relative valuations in BB and BBB issuers should be monitored for select opportunities.

Relative Value Guides Marginal Allocations

Insurers benefit from two processes that provide opportunities to tactically rebalance portfolios and diversify away from traditional core bonds. The first is regular cash inflows; the second is the need to raise liquidity. With the help of a strong relative value process, it’s possible to direct these incremental cash flows to pockets of value—with securitized assets as a notable example for 2024 (Display).

Securitized Assets Offering More Value than Credit

Cross-Sector Spread Relationship of Securitized Assets vs. US Investment-Grade Corporates

Past performance and current analysis do not guarantee future results.
Cross-sector relationship percentile measures an asset’s current spread advantage over US investment-grade corporates relative to its historical advantage. A cross-sector relationship percentile of 90 indicates the 90th percentile versus the five-year historical range, so a higher percentile indicates stronger relative value. Blue circles indicate credit asset classes; yellow circles indicate securitized asset classes. CRT: Credit Risk Transfer Security; CMBS: Commercial Mortgage-Backed Security; CMBS AS: Commercial Mortgage-Backed Security Adjustable Rate Senior; LCF: Last Cash Flow; SASB: Single-Asset Single-Borrower; NA RMBS: non-agency residential mortgage-backed security; MBS: Mortgage-Backed Security; CLO: Collateralized Loan Obligation; BM: Benchmark; ABS: Asset-Backed Security; EM: Emerging Market; HY: High Yield. Investment-grade and HY data points reflect the US IG and US HY corporate bond markets, respectively.
As of May 31, 2024
Source: Bloomberg, J.P. Morgan, Wells Fargo and AB

ABS is one area where we’ve seen attractive relative value versus short US investment-grade corporates, though that advantage has moderated in the first part of this year. We expect stable to moderately weaker ABS fundamentals as higher-for-longer interest rates and inflation push household debt up and weaken credit strength. Still, the resilient consumer has been a source of support: a stronger economy, a robust jobs market and wage growth are keeping balance sheets healthy despite stubborn inflation pressure.

Strong ABS structure and consistent underwriting standards should support fundamentals in the sector. Auto ABS drove strong first-quarter issuance of $90 billion, the heaviest since 2016 and up 45% year over year. We expect as much as $275 billion for all of 2024. In prime consumer credits, delinquencies have risen but remain in line with pre-pandemic levels, while subprime auto loan delinquencies are elevated, particularly in the lowest FICO score cohort, but improving slowly. While the spread advantage of higher-quality ABS tranches versus US investment-grade corporates has declined, we still see attractive relative-value opportunities in single A and BBB benchmark ABS.

We see three options for insurers to deploy ABS:

Short AAA-rated issues can enhance cash yields over the fed funds rate.
On-the-run issues with long histories seem to offer relative value versus A and BBB corporates.
Investment-grade non-benchmark issues, including privates, offer an attractive spread advantage versus high-yield credit, along with a more favorable US risk-based capital treatment.

With agency mortgage-backed securities (MBS), we find risk-adjusted carry attractive, even though spreads aren’t as high as they were in 2023, when interest-rate volatility and a lack of natural buyers pushed spreads up to their widest since the 2000s. Despite a rally at the end of 2023, MBS still offer value versus US investment-grade credit. In our view, they offer attractive risk-adjusted returns in times of market stress and may also outperform corporates if spreads widen.

Given current expectations for slow growth and subsiding volatility as inflation decelerates, our outlook for agency MBS is positive. However, investors should be selective with various cash-flow profiles. We recommend positioning in MBS that are near par to avoid volatility in book yield, with an understanding that the cash-flow window could shift based on rate movement. We would caution that portfolio fit is important. An eventual decline in interest rates could trigger prepayments and reinvestment risk in current coupon mortgages, so concentration risk bears monitoring.

Striking the Right Balance: Private Allocations vs. Liquidity Considerations

Despite higher yields in public fixed income over the past two years, private markets’ presence in insurance allocations hasn’t fallen—it has stayed the same or climbed (Display). One catalyst has been the emergence of segments that are broadening the range of high-quality solutions.

Private Bond Allocations Continue to Grow in US Insurance Portfolios

Public and private allocations by life and P&C insurers since 2005

Past performance does not guarantee future results.
Left and middle charts as of December 31, 2022; right chart as of June 30, 2023
Source: Preqin, S&P Capital IQ Pro and AB

Residential whole loans are an area where we continue to see opportunity, though typically at a smaller allocation for insurers than more established segments such as commercial real estate. These loans offer an efficient way to deploy regulatory capital budgets into prime-quality performing assets yielding 6.5% to 8.0%. They’re also eligible collateral for Federal Home Loan Bank (FHLB) programs—for investors who have the necessary operational infrastructure and ability.

Net asset value lending, specifically loans to private equity funds, offers another investment-grade private-credit avenue for insurers. Loans are secured against diversified and divisible portfolios of private equity company holdings and offer a meaningful illiquidity premium at the Secured Overnight Financing Rate + 400 to 650 bps and modest loan to value ratios in the 5% to 25% range.

There’s also an intriguing opportunity as small and medium-sized banks continue to cut back on lending, leaving a capital void. Private credit investors can partner with banks, providing fresh capital to originate new loans or buying existing pools of commercial and consumer loans at a discount—whether the collateral is homes, credit cards, autos or other asset types. Insurers can access a diverse market that we think is underrepresented in allocations, with yields in the 7% to 8% range for investment-grade credit risk.

Liquidity is a big consideration in private allocations. Insurers should review private allocations regularly to ensure that they’re getting the most from them: assessing illiquidity premiums in light of higher public yields and the importance of liquidity in a volatile environment where fundamentals could soften.

Insurers may seek to partner with lending institutions to maximize their sources of liquidity or increase income earning power. For example, pledging residential whole loans to FHLB, exploring opportunities with the Federal Agricultural Mortgage Corporation and tapping capital markets with funding-agreement-backed notes can be creative solutions to unlock liquidity using private assets.

Efficiently analyzing portfolio holdings to identify sale candidates to fund liquidity needs is key, particularly for insurance portfolios with private allocations. This includes considerations such as tradability and, where possible, reducing overall risk and/or bolstering diversification. Portfolios with large allocations to investment-grade credit and high-quality securitized assets are better positioned, given that these are often highly sellable without too much disruption to gain/loss constraints, though every insurer has distinctive investment programs backing different product lines.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Geoff Cornell, CFA

Geoff Cornell is a Senior Vice President, Chief Investment Officer (CIO) of Insurance and a member of AB’s Operating Committee. He oversees AB’s Insurance Investment Management team, as well as insurance sales, solutions, relationship management and client-service efforts, and shares accountability for insurance marketing, accounting and operations with our centralized Marketing and Operations teams. Cornell partners with broader investment teams and the firm’s Business Development and Product Strategy & Development teams to deliver new insurance solutions and pursue inorganic opportunities. He provides investment oversight for the general account portfolio of AB's biggest insurance client, Equitable. Cornell joined AB in 2024 as the firm’s first CIO of Insurance. Prior to joining AB, he spent 30 years at AIG, where he held roles focused across asset classes and insurance portfolio management, most recently as the CIO of AIG’s life and retirement business (now known as Corebridge Financial) and the deputy CIO of AIG. Cornell holds a BS in business administration from Bryant University and an MBA from Fordham University. He is a CFA charterholder. Location: New York

Gary Zhu, CFA

Gary Zhu is a Senior Vice President and Deputy Chief Investment Officer of Insurance, where he is responsible for portfolio performance, strategic positioning and customized investment solutions for AB’s Insurance platform. Zhu joined AB in 2020 as the global head of Multi-Sector Insurance on the Fixed Income team, primarily focusing on developing and implementing multi-sector income portfolio strategies. In 2021, he was named director of Insurance Portfolio Management, where he led AB Fixed Income’s insurance business. Under Zhu’s leadership, the Multi-Sector Insurance team was named Investment Team of the Year in 2022 and 2023 by Insurance Asset Risk. He is also a portfolio manager in the US Investment Grade Credit and Sustainable Thematic Credit teams. Prior to AB, Zhu was a senior publishing research analyst and the head of cross-sector research at Wells Fargo Securities. He ranked first for cross-asset strategy in the 2019 Institutional Investor survey and earned the title of Best Cross-Asset Analyst in Global Fixed Income Strategy. Before joining Wells Fargo, Zhu was a senior securitized assets trader and portfolio manager at Genworth, where he managed ~$10 billion of fixed-income investments. Prior to his portfolio-management role, Zhu helped manage Genworth’s $70 billion general account, with a focus on US and European banking exposures during the 2008 financial crisis, and held various roles across the company. He holds a BS (summa cum laude) in finance and economics from Virginia Commonwealth University and an executive MBA (with Dean’s Honors) from Columbia Business School. Zhu is a CFA charterholder and holds the Fellow, Life Management Institute designation. Location: New York

Deanna Leighton, CFA

Deanna Leighton is a Vice President and Lead Portfolio Manager on the Multi-Sector Insurance Portfolio Management team, where she is responsible for formulating insurance portfolio allocation strategies, overseeing daily portfolio-management activities and leading insurance-specific cross-sector, relative-value discussions. Leighton leads the Macro Allocation and Strategy team that interfaces with AB Insurance’s strategic clients in building tailored liability-driven and asset-focused solutions. She uses her deep understanding of both cross-asset investments and insurance company needs to construct tactical and dynamic investment portfolios and co-leads AB’s biggest insurance client’s spread-lending strategies. Leighton is a frequent speaker at industry conferences, and she moderated the inaugural Private Credit panel at ABS East in 2023. Prior to joining AB in 2022, Leighton was a fixed-income portfolio manager at AIG Asset Management, where she oversaw around US$5 billion of high-yield bond investments and helped build AIG’s third-party asset-management business, contributing to its strong commercial success. Before this role, she was an associate portfolio manager for AIG Asset Management’s high-yield bond portfolio. Leighton holds a BA with a concentration in economics from the University of Michigan and is a CFA charterholder. Location: New York

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