Insurance debt opportunity emerges, as yields & credit quality rise: Plenum

The market for subordinated insurance debt bonds is expected to bottom out soon, as more clarity is gained on the future direction of interest rates. But while this can slow issuance of insurance bonds and debt, specialist investment manager Plenum Investments believes an opportunity is emerging for investors to capitalise on market forces.

In a recent paper, Rötger Franz, Partner, Plenum Investments Ltd., explains how the subordinated insurance bonds landscape is playing out, with particular focus on European issues.

Interest rate nerves have been a consideration in the market for insurance debt investments and as a result insurance bonds underperformed this month, while issuance is expected to be down this year.

But this helps to create a scarcity factor that can drive higher yields for investors that are attracted to the private debt issuances of insurance and reinsurance companies, Franz explains.

While, at the same time, interest rate trajectory may add to the positivity in this investment sector, making for a growing opportunity.

“Potential buyers are currently adopting a wait-and-see atti- tude until there is more clarity on interest rates, in the US and especially in Europe. In the next two weeks, we expect clearer signals from the Fed on the timing of the next rate hikes and also indications from the ECB, which should support the markets,” Franz said.

The fact the private and indeed public insurance debt segment tends to be less liquid is a factor in its recent underperformance. Investor sensitivity to interest rate decisions is another factor.

But sensitivity to interest rates is also apparent in the insurance and reinsurance sector, with interest rate increases tending to support the credit quality of subordinated insurance debt issuers, Franz believes.

“Based on published sensitivities, we expect the positive effects of the interest rate increases on the Solvency II ratios to be in the low single-digit percentage range, which will lead to a slight strengthening of credit quality. We expect this strengthening to be more pronounced for life insurers than for non-life insurers, with continental European insurers benefiting more than UK insurers,” Franz continued.

Because of this, buyers of subordinated insurance bonds can expect to benefit from a more attractive risk-return profile, once the market settles down over the coming weeks, Franz expects.

On the technical support side for this niche of the insurance and reinsurance investing spectrum, lower supply of new insurance debt paper can also serve to boost demand, while interest rates could also be a factor in issuance activity, Franz notes.

Issuance in 2022 could be as around one-fifth lower, perhaps more, than the recent historical averages, coming in at €15-20bn in 2022, compared to the more typical €24-26bn.

As a result of dynamics affecting this market, Franz sees an investment opportunity in subordinated insurance bonds at this time, because of rising yields alongside rising credit quality of issuers.

“Subordinated insurance bonds have historically generated significantly higher yields than bonds issued by banks or non-financial companies,” Franz said. “At the same time, default rates have been lower than in any other sector. The high yields are flanked by high ESG ratings. In addition, the asset swap spreads of the different maturity bands have consistently increased by about 18 basis points.”

Looking ahead, Franz said that at Plenum Investments, “We expect the market for insurance subordinated debt to bottom out soon, once there is more clarity on the interest rate side.

“Bond prices have fallen while the credit quality of issuers has improved. I.e. investors will be able to benefit from higher quality at lower prices in a sector that consistently offers higher yields than others.”