PineBridge Investments | Why Asian insurers are exploring private credit and CLOs

September 24 2024

Asia’s insurers are facing an unprecedented shift in the regulatory landscape. Emerging risk-based capital (RBC) frameworks and updated financial reporting standards are reshaping their investment, underwriting, and capital management strategies. Hong Kong’s new RBC regime went live in July. In South Korea, the dual rollout of the Korean Insurance Capital Standard (K-ICS) and new IFRS standards sent shockwaves through the industry. Meanwhile, insurers in Japan and Taiwan are preparing for new frameworks on the horizon, balancing the requirements of in-force regulations with forthcoming changes.

For life insurers, the new regimes intensify the challenge of asset-liability management, with duration and currency mismatches between assets and liabilities driving up risk-based capital requirements. Asian insurers, unlike their US and European peers, often face a scarcity of high-quality, long-dated local-currency bonds, limiting their options for building capital-efficient liability-backing portfolios.

To diversify their exposures and meet their investment income targets, insurers may need to explore less-familiar assets, such as private credit and collateralized loan obligation (CLO) tranches. In a shifting macroeconomic and regulatory landscape, these asset classes offer potential for generating capital-efficient returns and boosting portfolio resilience.

New approaches for a new regulatory regime
The latest regulatory changes across Asia are reshaping insurers’ balance sheets, hitting life insurers particularly hard with steep capital charges for duration mismatches between assets and liabilities. This pressure is pushing life insurers to either lock in lower yields with long-dated domestic government debt or turn to reinsurance to reduce the duration and volume of their capital-intensive liabilities.

We expect reinsurance activity to persist in developed Asia as life insurers seek to alleviate the capital strain of their liabilities, potentially benefiting Bermuda reinsurers, which are facing increasing regulatory hurdles in Europe and other regions.

On the asset side, the new capital regimes present challenges in many Asian markets, where local corporate debt markets often lack the depth and duration to meet life insurers’ appetite for long-dated income. To overcome this challenge while maintaining portfolio diversification and meeting yield targets, insurers can use a barbell strategy combining short-dated, higher-spread assets on one end with lower-yield, ultra-long-dated government bonds at the other.

Regulatory Convergence in Europe and Asia: New and Emerging Risk-Based Capital Regimes

*National risk-based capital regimes developed based on the International Association of Insurance Supervisors (IAIS) Insurance Capital Standard (ICS). Source: PineBridge interpretation of draft and in-force national insurance regulations.

Expanding the asset universe: private credit and CLOs
To implement a capital-efficient barbell strategy, insurers may need to venture beyond the comfort zone of domestic fixed income. Traditional life insurers, which benefit from more predictable long-dated liability profiles, are well positioned to harvest the illiquidity premium in private credit, which historically shows low correlation with traditional fixed income. For those prioritizing liquidity, CLO tranches offer attractive spreads over similarly rated corporates without the rates-driven volatility associated with long-dated bonds.

While the many flavors of illiquid and alternative credit have gained some traction across the region in recent years, APAC life insurers are still well behind their global peers. According to a recent Moody’s estimate, APAC insurers’ average allocation to illiquid credit (including real estate debt private placements of corporate debt) stands at 6.4% – a stark contrast with the 35.7% average for life insurers in the US and Canada, 23.6% for the UK, and 13.1% for Europe ex UK.1 And averages never tell the full story: For private equity-influenced US life insurers, allocation to private credit and other illiquid assets stands close to 50%.2

Similarly, CLO tranches remain an exotic foreign specialty for many APAC insurers. This is not the case in the US, where CLOs comprise 3.4% of insurers’ cash and invested assets in aggregate3 (5.5% for private equity owned insurers).4

The appeal of private credit for insurers is clear: illiquidity risk does not carry a regulatory capital charge under an RBC regime; at the same time, it is typically compensated with a spread premium. Unlike banks dependent on demand deposits and short-term funding, many insurers – especially life insurers – can leverage their stable, predictable liabilities to invest more in illiquid credit. When reporting their investments on a fair value basis, insurers also stand to benefit from stable spreads on private-market debt investments translating into lower profit-and-loss volatility.

Today’s volatile rates environment also strengthens the case for floating-rate CLOs. Compared with corporate bonds, investment grade CLO tranches offer higher spreads, historically negligible credit loss rates, and shorter interest rate duration, along with diversification benefits, while maintaining a similar level of secondary market liquidity. This makes CLO tranches particularly appealing for non-life insurers, which generally have a lower appetite for illiquidity than their life insurance counterparts.

Regulatory Capital Efficiency of US CLO Tranches and Private Credit by Risk-Based
Capital Regime

Source: PineBridge Investments analysis based on ICE Data Platform (bond indices), JPMorgan (CLO indices), and Cliffwater (senior direct lending index) as of 30 June 2024 and PineBridge interepration of local risk-based capital requirements by country. Risk-Based Capital Efficiency is determined as the ratio of FX- and credit-adjusted index spread to required capital for spread risk and – where applicable – credit risk of fixed income investments under the relevant jurisdiction’s risk-based capital regime.

*In Japan and Taiwan, implementation of new national risk-based capital regimes based on the International Association of Insurance Supervisors (IAIS) Insurance Capital Standard (ICS) is currently underway and is due to be completed in fiscal 2025 (Japan) and fiscal 2026 (Taiwan). For these jurisdictions, we estimated risk-based capital requirements based on the latest available technical specification of the IAIS April 2024 ICS Data Collection Exercise of the Monitoring Period Project.

**As an element of prudence, CLO tranche investments are assumed to carry a 50% fixed risk charge under Singapore RBC as structured products. Alternatively, an insurer may apply a look-through aproach with a 50% premium on the derived market risk requirement.

Taking an active approach
Allocating across a broader asset universe requires a proactive approach to portfolio construction. Amid heightened political risks and geopolitical tensions, elevated rates, stubborn inflation, and persistent market volatility, insurers must closely monitor and actively manage their investments. For alternative assets, this means engaging closely with asset managers who can collaborate with insurers to enhance their in-house scenario analysis and stress testing.

In the illiquid credit space, investors tend to put their money on experience: established managers account for over 80% of recently raised private debt fund capital.5 We believe insurers seeking stable investment income should partner with prudent managers whose focus on capital preservation and risk management is evidenced by a solid track record.

Alternative Credit: Dispelling Common Misconceptions
Misperceptions about private credit continue to weigh on some insurers. These may stem from media headlines proclaiming excessive risks in these assets given their rapid growth in recent years, leading to questions about origination and underwriting standards.

The reality is more nuanced. Within the broad private credit universe, traditional lower-middle-market direct lending (which we define as loans to companies with EBITDA of US$7.5 million to US$30 million) has so far demonstrated resilience, low default rates, and limited mark-to-market losses in periods of market stress. Attractive deals in this market segment would typically feature conservative structures, strong covenants, borrowers from traditional sectors, and experienced private equity sponsors. In PineBridge’s experience, lower-middle-market companies with long operating histories, leadership positions in their market segments, and seasoned management teams have demonstrated durability through both strong and weaker environments. Borrowers that benefit from real cash generation and a competitive “moat” – businesses that provide distinct relevance and value to their clients – are more favored. When paired with a conservative approach to portfolio construction and underwriting, investors who target these types of opportunities have historically stood to garner durable risk-adjusted return potential across macroeconomic environments.

Insurers should also look beyond the headlines when considering CLO tranche investments. While “structured credit” is often perceived as a high-risk asset class that left many investors reeling in the aftermath of the 2008 global financial crisis (GFC), the vast amount of data accumulated by rating agencies shows lower historical credit losses on CLO tranches than on same-rating corporates. On top of that, modern CLO structures introduced in the wake of the GFC have significantly boosted protections for investors in senior tranches. Finally, the introduction of risk retention requirements for securitization managers in the US and Europe means that the experience of the GFC is highly unlikely to be repeated in the future.6

For additional insights from PineBridge’s insurance investment specialists and other expert perspectives, please visit here.

 

About PineBridge Investments
PineBridge Investments is a private, global asset manager focused on active, high-conviction investing. We draw on the collective power of our experts in each discipline, market, and region of the world through an open culture of collaboration designed to identify the best ideas. Our mission is to exceed clients’ expectations on every level, every day. As of 30 June 2024, the firm managed US$169.7 billion* across global asset classes for sophisticated investors around the world.

*AUM as of 30 June 2024 includes US$69.5 billion (US$40.3 billion equities, US$22.3 billion fixed income, US$6.8 billion multi-asset and US$49.1 million alternatives) of assets managed by joint ventures or other entities not wholly owned by PineBridge Investments. Includes PineBridge Benson Elliot Real Estate AUM of US$4.0 billion.

To learn more about PineBridge Investments, please visit here.

 

1 See Exhibit 2 in Moody’s report, “Insurers’ private credit holdings will grow, with benefits outweighing risks” 4 June 2024.

2 See Figure 4 in International Monetary Fund’s “Global Financial Stability Note: Private Equity and Life Insurers”, 19 December 2023.

3 See Exhibit 2 in Moody’s report “Life Insurance – US: CLO holdings rise as regulators review capital charges”, 1 March 2024.

4 PineBridge estimate based on Moody’s data as of 1 March 2024.

5 Source: Preqin data as of 18 June 2024, PineBridge Investments interpretation and analysis.

6 For more on CLOs for insurers, see PineBridge Investments’ thought piece “The Case for Collateralized Loan Obligations for Global Insurers”, 22 May 2023.

Disclosure
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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