Why Asian insurers could drive new demand for high quality private credit

Max Davies

Director, Global Insurance team at Man Group

Throughout its history, the insurance industry has stood for stability and reliability. And with good reason: customers need to know that policies will pay out if the worst happens.

As a result, the sector has traditionally tried to match its long-term liabilities with long-dated assets that have reliable returns.

But insurers in Asia today are going through a period of profound change. The introduction across the region of risk-based capital (RBC) regimes – mirroring longstanding Solvency II regulations for insurers in Europe – alongside a shift in accounting frameworks towards IFRS 17, could spark an asset allocation shake-up.

This creates challenges, but also opportunities.

One of the biggest and most exciting opportunities is the strategic pivot towards private assets, namely private credit, given insurers’ fundamental need for fixed income-like investments. While private credit has gained a lot of media attention, insurers’ requirements are shaped by regulation and by their need for highly predictable cash flows. Most notably, the majority of their assets need to be investment grade (IG) to meet their liabilities in a capital-efficient format.

That means the real opportunity lies in the highest-rated corners of private credit. The result could be a new source of demand for IG private credit, through asset backed finance (ABF) and structured credit. We have seen this trend already in the US and Bermuda, and it is rising in relevance in Europe. But for insurers in Asia, it is still nascent.

According to the International Association of Insurance Supervisors (IAIS), as of the end of 2023 the global insurance industry held about USD $40 trillion of assets. About a quarter of that is in Asia, where the sector is dominated by life insurers, with very long duration liabilities.

To source the duration and high-quality cash flows that they need, life insurers invest predominantly in fixed income – government bonds and corporate credit. Risk-based capital regimes encourage this type of prudent risk-taking: the greater the perceived investment risk and the more volatile the asset, the greater the capital charge.

This has several impacts. One is that insurers may shift more risk onto policyholders, through unit-linked or investment-linked products, where returns are no longer guaranteed by the insurer but are instead dependent on market performance.

Another is to encourage insurers to improve the efficiency of their asset-liability management, the process by which they try to match the characteristics of their assets to their liabilities. And coupled with that is a push to rethink strategic asset allocations, with the objective of optimising returns amidst these new constraints.

While the exact numbers depend on the specific market and product set, Asian life insurers typically invest 60%-80% of assets into fixed income, with perhaps one quarter of that overseas, as Asian domestic credit markets are rarely big enough for their needs.

The remainder of their assets are often invested in equity and, to a lesser extent, alternatives. Equity markets have performed well for many years, and they have enabled insurers to offer attractive participating features to some of their life insurance products. However, equities are also the main driver of volatility in insurers’ portfolios, which is why they are now subject to the highest capital charges under the new RBC regimes.

Furthermore, under IFRS 9 and 17, the importance of mitigating income statement volatility has only risen. One way to do that could be to adopt more absolute return or hedge fund-type strategies, but those can also incur heavy capital charges.

For many, private credit offers an attractive alternative – which is why we see it as probably the fastest growing asset class from Asian insurers today.

One reason is its efficient capital treatment; another is its attractive return profile. Private credit offers an illiquidity premium over public credit at no additional capital charge, provided it has rating and duration equivalence. Furthermore, the spread premium for private credit has been remarkably stable over the years, even as the underlying risk-free rate has fluctuated.

Insurers have also been increasingly happy to accept the lower liquidity of private credit in return for a higher spread. With long-term investment requirements, life insurers don’t particularly need the daily liquidity offered by public securities. And the very fact that private credit is not regularly marked to market can reduce the volatility of an insurer’s asset base, offering a potentially more stable return profile.

This doesn’t mean that the whole universe of private credit is wide open to insurers. Historically, the biggest focus has been in core US middle market direct lending to sponsor-backed companies. This is a now mature asset class but one that has the potential to generate an attractive spread and provide access to a part of the economy not otherwise offered by traditional assets.

But this too can attract not insignificant capital charges. Many of these loans are unrated, as they involve lending to riskier borrowers, attracting a capital charge commensurate to just below IG. However, driven by capital requirements insurers are increasingly looking at IG-rated private credit – a segment that we think is ripe for development.

It can take several forms. Historically it was private placements, but increasingly it involves the fast-developing area of ABF, where investment grade opportunities emerge from the senior tranches of securitisations like private asset-backed securities – with a vast range of potential underlying cash flows.

For the moment, the focus of Asian insurers for these kinds of assets is likely to be on US and European markets, a function of their maturity and the lower availability of private credit in Asia. Building a local, regional ecosystem in private credit will take time – the fragmented nature of the Asian continent, its multiplicity of currencies and legal systems, all stand in stark contrast to the homogeneity of markets like the US or Europe.

The private credit asset class has grown a great deal in recent years and much ink has been spilt on the drivers of that growth. The rise of cumbersome bank regulation is often cited as the main catalyst.

But due to a new generation of insurance regulations, there is now a natural source of demand for these assets. When it comes to private credit, Asia’s insurers are just getting started.