Junk Seen Enticing Yield-Hungry Insurers as Capital Rules Shift

  • Regulators may ease some junk-bond rules, CreditSights says
  • Low Treasury yields also push buyers to add risk, Haines says

U.S. life insurers may boost bets on junk bonds as regulators consider easing capital charges on some of the assets, according to a CreditSights Inc. report.

“Yields are basically at record lows, and then you apply the change” in capital standards, Rob Haines, an analyst at CreditSights, said Wednesday in an interview. “That’s a lot of incentive for insurers to chase yield at the lower end of the rating spectrum.”

Insurers are struggling to generate satisfactory investment income as central banks suppress rates to stimulate economic growth, and events such as the U.K.’s Brexit vote send U.S. Treasury yields tumbling. That’s weighed on the industry’s stocks, sending the S&P 500 Life & Health Insurance Index slumping 11 percent since Dec. 31 while the S&P 500 Index gained 2.5 percent this year as of 12:57 p.m. in New York.

Insurers have scaled back from hedge funds after being burned by losses on the holdings, which are also subject to strict capital rules. That leaves assets such as private equity, real estate and junk debt as alternatives to counter the low yields available on the safest bonds.

Under proposals being considered by the National Association of Insurance Commissioners, capital charges could decrease for some junk securities, according to Haines. For instance, bonds rated B1 could face a charge of 5.99 percent before taxes, down from 10 percent, according to CreditSights.

‘Big Money’

That’s the result of a possible switch to more than a dozen classifications of credit risk from six. The idea is to prevent insurers from crowding into the worst-ranked bonds that qualify for a particular tier, including credits rated A3 and Baa3. For some grades of debt, the rules could become stricter. The NAIC didn’t immediately make anyone available to discuss the capital standards that are under discussion after input from the American Academy of Actuaries.

Life insurers’ holdings of below-investment-grade debt fell 7 percent to $44.6 billion at the end of 2015 from a year earlier, according to data compiled by Bloomberg Intelligence on 11 companies, including MetLife Inc. and Prudential Financial Inc., the largest U.S. companies in the business. A change in strategy could impact the broader credit markets, according to Haines, who said companies could accelerate portfolio shifts if the proposal gains traction next year.

“This is one of the major investors in corporate bonds and you’re changing the regulatory incentive for them to hold larger proportions of high-yield bonds,” Haines said. “Even a small change for life insurers is big money.”

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