Best’s Special Report: U.S. Life/Annuity Insurers’ BBB Bond Exposures Continue to Grow

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

The Best’s Special Report, “U.S. Life/Annuity Insurers’ BBB Bond Exposures Continue to Grow,” notes the U.S. property/casualty and health segments also have increased the holdings to approximately 16% from the 8-9% 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% in 2018 from 51% in 2013. Allocations to the BBB+ and BBB- categories have increased by roughly similar percentages of the BBB drop, to 34.1% and 23.2%, 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. 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 U.S. investment-grade corporations will mature, accounting for roughly half the U.S. investment-grade corporate bond market. Of the $2.5 trillion of bonds maturing, 34% 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.

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. Liquidity risks also need to be considered, particularly as blocks of business age and policyholder behavior 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.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=292155.

AM Best is a global credit rating agency, news publisher and data provider specializing in the insurance industry. The company does business in more than 100 countries. Headquartered in Oldwick, NJ, AM Best has offices in cities around the world, including London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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