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The opportunities and challenges of investing in private debt are viewed by insurance investment teams as the ultimate goal, says Rohit Vohra, Head of Global Wealth Alternatives, Principal Real Estate.
The insights appeared in Clear Path Analysis’ new "Global Insurance Asset Management report", produced in partnership with Principal Asset Management, which contains interviews with dozens of re/insurers from Europe, Australia, North America, and Latin America and charts the biggest challenges and opportunities that senior insurance investment and asset management professionals noted in 2022.
“Interest rate sensitivity is important for insurance companies because
it impacts the asset side in terms of generating returns."
According to S&P Global report, private debt surged during the pandemic years. “Assets under management of funds primarily involved in direct lending surged to $412 billion at end-2020—including nearly $150 billion in ’dry powder’ available to buy additional private debt assets,” it said.
“Interest rate sensitivity is important for insurance companies because it impacts the asset side in terms of generating returns as well as the liability side,” said Vohra, of where he sees the challenges and opportunities.
This is largely because interest rates have been at historic lows from 2008 to 2021, which has put a lot of strain on insurance companies in terms of their spread between assets and liabilities. “Now this year things have started to change when it comes to the interest rate environment,” he said. “As interest rates have gone up it is good news for the spread business, and the compression that we saw over the last 15 years is likely to start reversing.”
However, as interest rates have become more aligned with their historical averages over the course of 2022 - and a more normalised interest rate regime has resumed - the public fixed income allocation of insurance company portfolio should also be generating meaningful return going forward.
"Does the normalisation of interest rates to pre-GFC levels change
an insurance company’s interest away from private debt?”
“The short-term challenge is the negative impact on existing fixed income holdings as interest rates have moved up this year,” said Vohra. “Over the long term, we see spread compression reversing which is favourable to insurance companies.”
Vohra says that this situation leads to another question: “does the normalisation of interest rates to pre-Great Financial Crisis levels change an insurance company’s interest away from private debt in favour of traditional public fixed income?”
This situation had been one of private debt’s large positives over previous several years. A 2022 Mercer report specified that “Given the continued tailwinds for [private debt], the opportunity for attractive risk-adjusted returns is set to persist, in particular relative to low interest rates and public market credit spreads,” it said. “Private debt offers a number of diversification benefits by targeting different parts of the market and borrower profiles compared with liquid credit,” the report added. However, with interest rates back up, this could begin to change.
Still, Vohra thinks this won’t be the case. “In my opinion, the answer is no,” he said. “Because there are a lot of things that are still attractive from a private debt perspective.”
There are many predicting a difficult 2023 ahead with interest rates, and some recently told Insurance Investor that interest coverage has tightened for all leveraged loan issuers. “But experienced loan managers are attuned to the risk of higher rates,” said one.
The private debt premium over public counterparts remains, as both asset classes will partake in the rising rate environment due to loans often being structured as floating rate across both public and private, said Vohra. “The spread that is available to insurance companies above what public fixed income can offer is still there and certain areas have grown.”
