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The year has kicked off with all-time tight public market credit spreads amid a flat to slightly upward-sloped yield curve, making public fixed income and long-duration assets less compelling. Against this backdrop and the continued evolution of global regulations, where can insurers find attractive investment income and credit spreads in 2025?
As the search for income and spreads intensifies, we expect insurers with healthy liquidity to capture illiquidity premiums by investing in private credit, including direct lending, real estate, and infrastructure projects. While banks have pulled back from private credit due to regulatory constraints, insurers have stepped in as an alternative lender. Though we recognize that bank regulations will likely loosen under Trump 2.0, we expect banks’ leveraged lending to remain constrained in terms of both balance sheet and risk capacity. These constraints are also a key reason banks are increasingly forging partnerships with asset managers and insurers.
Public Credit Spreads Are Historically Tight
Source: JPM CLOIE Post-Crisis Discount Margin, Bloomberg US Corporate Spreads, February 2025.
We expect insurers to maintain a significant role in direct lending, given their strong liquidity profile, limited policyholder surrender risk, and expertise in asset-liability management. Unlike banks, insurance balance sheets generally offer a natural fit for less-liquid assets, since insurers often have long-dated and sticky liabilities. For example, the US life industry exhibits a healthy 2x liquid asset to current liability ratio.1 The NAIC has also previewed favorable outcomes from its liquidity stress testing on life insurers subject to Actuarial Guidance 53 (AG53).2 Given 2024 rate cuts, US life insurers are seeing declining surrender rates, which further reduces their liquidity needs. In addition, to further enhance their liquidity and investment returns, sophisticated insurers continue to utilize tools such as funding agreement-backed notes (FABNs) and FHLB lending.
We expect leveraged finance to retain its appeal in 2025 across both public and private markets, with some insurers seeking income by locking in a higher fixed-rate yield in the current higher-for-longer interest rate environment. Our base case is that we are in a rare non-recessionary rate-cutting cycle that should support credit performance, particularly for leveraged finance. While the fundamental strength in credit metrics may have peaked, it started from a high base and should remain robust. We expect leveraged loan defaults, including liability management exercises (LMEs), to stay near historical averages.3 That said, more recently, market expectations on rate cuts have been moderating because of inflationary concerns arising from ongoing tariff wars.
CLOs continue to offer relative value, largely due to their complexity and perceived illiquidity premium versus single-name corporates. Pooled investment products such as CLOs also offer diversification benefits versus single-name corporates. In addition, 144A CLOs offer better liquidity relative to private credit. We believe senior CLO tranches are attractive despite pending NAIC model-based designations for CLOs and revised NAIC CLO risk-based capital (RBC) guidance to be finalized as early as year-end 2025. Separately, private asset-based financing may offer an additional spread advantage because it is relatively new and due to its illiquidity and complexity.4
We expect 2025 to be another year of evolving regulations. Several important NAIC adoptions became effective on 1 January this year, including implementation of the NAIC’s principles-based bond definition (PBBD), mandatory submission of rating rationale reports for private letter ratings, and NAIC discretion over filing exemption. In addition, the NAIC intends to better align the statutory treatment of funds under various legal forms, such as exchange-traded funds, mutual funds, and private funds.
With the implementation of the PBBD now in effect for 2024 annual statement filings, we expect more granular asset allocation data to become available by May 2025. Overall, private equity (PE)-owned insurers tend to hold more asset-backed securities (ABS) – as much as 50% of their investment portfolios, versus 25%-33% for US insurers overall.5 Annual filings for 2024 will shed significant light on insurance asset allocations to over two dozen different types of ABS and affiliated investments.
We expect the impact on statutory capital and surplus to vary by insurer. Under the PBBD, insurers must move assets not qualified for Schedule D-1 bond reporting to Schedule BA. This could result in a growing BA bucket for select insurers and have potential knock-on effects on reducing statutory capital and surplus. Separately, the NAIC is still working on risk-based capital revisions for CLOs and ABS broadly, and the new RBC factors, once adopted, may also affect insurers’ investment RBC. Overall, since PE-owned insurers tend to hold a greater share of structured assets, the effect may be more pronounced for these firms.
Regarding private securities, regulators globally have converged on greater disclosure requirements. In the US, the NAIC has requested that insurers upload rating rationale reports for private letter ratings for further review. The NAIC also gained the discretion to lower credit ratings for its designation purposes, although it may do so only sparingly. To gain more visibility around asset risks, the Bermuda Monetary Authority (BMA) proposed that insurers should submit security-level information in addition to portfolio-level data.
Offshore reinsurance has garnered growing attention from global regulators. US life insurers ceded $2.3 trillion of reserves from 2017-2023, and 40% – or approximately $1 trillion – were reinsured offshore (with 80% in Bermuda and 10% in the Cayman Islands).6 The NAIC, the BMA, and the UK Prudential Regulation Authority have all released additional guidance, including disclosure requirements and guidance for the use of collateralized/funded reinsurance.
Insurers and asset managers continue to form strategic partnerships to support insurers’ growing allocations to private assets, in forms ranging from traditional investment management agreements (IMAs), “sidecar” agreements, minority stakes, and outright acquisitions.
Successful partnerships should allow insurers to gain increasing access to attractive alternative asset markets in 2025. Rather than establishing their in-house private asset investment capabilities, which can be costly, these partnerships allow insurers to leverage managers’ established asset origination platforms, sponsor relationships, structuring capabilities, and reporting systems. We see a clear case for such synergies, although thoughtful governance to ensure proper alignment of interests is critical. To this end, regulators globally have rolled out guidance related to affiliated investments. Effective the first day of this year, US insurers must identify and report affiliated investments in stand-alone and granular investment categories in connection with the PBBD guidance.
We believe thoughtful investment vehicle formation and structuring can enable small to midsized insurers to access these spread opportunities along with proper regulatory and rating agency treatment, thereby leveling the playing field for those with limited asset scale or leaner operations. Depending on an insurer’s investment objectives and preferences, it may allocate to private assets using a variety of structures, such as separately managed accounts, rated feeder funds, securitizations, evergreen vehicles, or private business development companies. Thoughtfully structured investment vehicles can allow insurers to strike a healthy balance between achieving attractive yields and operational efficiency.
As the menu of privates continues to expand beyond the core group of private placements, direct lending, commercial mortgage loans, and infrastructure debt, we expect more nuanced structuring and reporting considerations for complex asset-based lending, residential whole loans, agricultural finance, and so on. But overall, assets that offer not only a spread advantage, but also strong credit lender protections and limited mark-to-market volatility, will continue to attract insurance interest – and properly structured investment vehicles can help insurers execute these strategies effectively.