US life/annuity insurers’ BBB bond exposures continue to grow

The US life/annuity industry has increased its bond allocations to NAIC Class 2 Securities markedly over the last decade, to more than 34 percent of overall holdings from 27 percent in 2009, as current market trends remain attractive for BBB debt issuance, according to a new report from AM Best.

The Best’s Special Report, US Life/Annuity Insurers’ BBB Bond Exposures Continue to Grow, notes the US property/casualty and health segments also have increased the holdings to approximately 16 percent from the 8-9 percent range during the same 2009-2018 timeframe.

However, life/annuity writers consistently have held the highest percentage of these Class 2 bonds, or bonds rated the equivalent of BBB+ to BBB-. The allocation of Class 2 bonds for life/annuity insurers remains weighted toward the BBB category, although these holdings have declined in more-recent years to 43 percent in 2018 from 51 percent in 2013. Allocations to the BBB+ and BBB- categories have increased by roughly similar percentages of the BBB drop, to 34.1 percent and 23.2 percent, respectively, in 2018.

The prolonged low interest rate environment remains conducive for debt issuance. AM Best believes that the next downturn will be characterized more by ratings transitions than large-scale impairments.

“The growing issuance of corporate debt by noncyclical consumer-focused industries (e.g. pharmaceuticals, telecommunications, cable, utilities, technology, food and beverage and health care) could mitigate any concern about BBB bonds’ greater sensitivity to credit deterioration,” said AM Best.

“These industries often remain resilient during economic downturns owing to stable cash flows. However, an issue for the BBB bond market is that by year-end 2022, $2.5 trillion of the debt of US investment-grade corporations will mature, accounting for roughly half the US investment-grade corporate bond market. Of the $2.5 trillion of bonds maturing, 34 percent is rated BBB. Given that these bonds must be refinanced or repaid by then, close attention should be paid in the next few years to the interest rate environment, credit spreads and ratings issued to bonds.”

AM Best added that life/annuity insurers with higher BBB bond exposures are writing in very competitive lines of business, for which yield enhancement is important.

“AM Best considers Class 2 bond exposures in the balance-sheet strength and operating performance assessments of its rating process,” it said. “Liquidity risks also need to be considered, particularly as blocks of business age and policyholder behaviour trends emerge from what was expected. As the products being sold become less interest-rate-sensitive, AM Best anticipates that the level of BBB holdings will drop off.”