Welcome to Know More, Risk Better, a Credit Sites podcast. Across the global strategy team, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets. As the macro makes headlines, we leverage our network of experts across fixed solutions to better understand economic trends, rates, gyrations, geopolitical events, and how these factors impact corporates. At Credit Sites, we understand that credit investing comes down to picking winners to generate alpha and avoiding losers.
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I'm your host, Zach Griffiths, head of U.S. Investment Grade and Macro Strategy at Credit Sites, and I'm excited to have back on one of the fan favorite guests that we have recurring. I think this is his fourth time on the podcast. Josh Esarov, our head of insurance, is coming back on to discuss his recent review of life and property and casualty insurance investment portfolios.
Josh, thanks so much for coming back on the show. Thank you very much. I'm shocked you didn't invite me back, but I'm happy to be here. Well, I think that we have a great base of work to build off of, and I was going back and listening at our prior versions of this podcast.
I know that this has been one of our most popular so far, so looking forward to building on that popularity today. Going through that last podcast, Josh, you had highlighted last year that life insurers' private credit exposure through the investment portfolio continued to rise and actually had surpassed public credit for the first time. So have life insurer investment portfolios continued to grow their exposure at the rapid pace we've kind of seen over the past couple of years? Has it really kept pace with the growth of the overall private credit market as a whole?
I mean, yeah, you're right. When we look exclusively at what's called industrial bonds for regulatory purposes, which is largely corporates and ABS type of securities, yeah, for the first time, private credit allocation exceeded public credit allocation. That was as of year in 23. And then in 24, what we saw was actually 5% growth in the private credit portfolio and 3% growth in the public credit portfolio.
So that very much remains the case that private credit has exceeded public credit. But that's industrial bonds. But in total, when we look at the entirety of the life insurer aggregate investment portfolio, private credit is up to nearly $1.8 trillion. And that's about 31% of this $5.6 trillion aggregate industry investment portfolio.
And it's basically growing at about a percentage point clip per year. So it was like 22% a decade ago. And the thing is, I don't really have a good sense for where the stopping point is for the life insurance industry. I don't see any evidence that life insurers are slowing down.
And in fact, I see a lot of evidence that contrary. It's a little bit different for the PNC insurers. They're definitely not absent from the private credit transit story that's emerging, but they do need liquidity a little bit more. Think of like freak weather events or severe hurricanes and the like.
But private credit is up to 12.5% of their aggregate investment portfolio. And that translates to another about $313 billion. And that's almost actually tripled in the last 10 years. It did slow down in 2023 for the first time, but then picked right back up again in 2024.
So actually, I think 2023 was an aberration rather than evidence that PNC insurers were hitting the brakes. Wow. So to say the least, private credit has continued to grow within these investment portfolios, reaching pretty staggering levels. And when you think about what's in private credit in terms of how the life insurers disclose or identify it, is there more than this?
I tend to think of private credit as just direct lending. But I imagine within that $1.8 trillion, there's a broader swath of assets. Do you have a sense of that that you could share? Yeah, sure.
I mean, historically, this kind of private lending is not new, especially the life insurance industry. It used to just be called private placements, and that was just a known quantity in the life insurance sector. But it's really exploded in terms of the breadth and depth of issuers that they are willing to lend to directly. But then there's also other private label asset classes, whether that's CLOs, MBS, commercial MBS, residential MBS.
You've got bank loans in there, other types. I mean, private credit is this enormously broad label. But I think what you'll find is that life insurers are active across this broad label to the extent that it matches both their yield, their liquidity, their duration, and regulatory capital charge targets. Okay, great.
I think that's helpful just to frame up. It's funny. I feel like you don't hear the term private placement as much anymore, and I guess it makes sense because everyone just says private credit. But can you remind us what some of the factors behind the explosive growth in private credit and the insurance industry specifically is about sort of the key drivers and how you're thinking about perhaps the durability of those key drivers?
Yeah, sure. So, I mean, at the very highest level and from the perspective of a life insurer, it does make sense to trade away liquidity for incremental yield. I mean, ultimately, insurers are trying to match the duration of assets with the duration of liabilities. And since the liabilities themselves are typically illiquid, given that most policyholders aren't going to exercise their options to pass away, insurers basically see value in incremental yield and trading away liquidity.
And, you know, one major factor actually in driving this trend is just this enormous influx of interest from PE players, private equity players in the life insurance sector. At least some, but a significant portion of the strategic motivation from the private equity players to be involved in the life insurance sector. And this actually creates this kind of ripple effect across the industry because now if you're a life insurer, even if you don't have any private equity relationship, you're forced to start playing catch up in private credit because if you can't compete on investment portfolio returns, eventually what you're going to be forced to do is reduce your product's benefit richness or raise your product price. And obviously neither of those are favorable from a product competitiveness perspective.
So what we're seeing across the industry is that insurers are either building out capabilities in-house to invest or originate private credit or exceedingly common now is to partner with a private equity player and allocate a portion of your investment portfolio to them. And, you know, just by way of example, just less than a month ago, Bain acquired a 9.9% stake in Lincoln National. Up until then, that insurer had no explicit PE relationship. And as part of that deal, Lincoln National and Bain agreed to enter into this 10-year investment management relationship.
And Bain is set to become basically Lincoln National's primary avenue for accessing private credit and also things like structured assets, mortgage loans, private equity investments. And really there's no shortage of examples that could give you a PE shop's outright-only insurers too, like Carlisle 423, KKR with Global Atlantic, Apollo with Athene. I mean, really the list goes on. But then in addition to that, you also have these asset management arrangements between companies like, let's say, Blackstone and AIG.
There's also insurers like Credential and MetLife, really notable names, are setting up sidecars with players like Warburg and Nomura and so on. So, you know, it's a private credit race. And I don't know if that's a race to the bottom or a race to the top, but it's some kind of race nonetheless. Yeah, it sounds like there are plenty of participants in this race.
And so I feel like, just to flush this out a little bit more clearly, obviously for these private equity players and asset managers, having a large dedicated base of long investment horizon, long duration liabilities that these insurers have, having that capital base to invest is very attractive for a private equity investor and allows them to take a long view and perhaps really allows them to take advantage of dislocations in the market should they arise. And what's the benefit to these insurers? Are they just kind of along for the ride in terms of, I mean, generating these partnerships? Obviously, private credit has produced superior returns.
And so is that really it? Is it kind of a, does it make perfect sense for these two to pair up? Or are there any sort of existential risks that you see to this growing trend of linking between private equity firms and insurance companies? Yeah, I mean, I think to your point, when you're thinking about risk factors here of some of this interconnectedness, you know, the private credit strategy, it's performed extremely well to date.
But for the long time, even in this kind of benign portion of the credit cycle, I think what's a little bit less clear is what happens during periods of elevated default activity. But what makes it a tough question is there's no, like, industry aggregate answer I can give you because different insurers are expressing their capacity to take risks in different ways. So, you know, by way of example, I can point to one of the strongest insurers in the life insurance space, and that's AA rated mass mutual. And they actually have the single largest private credit allocation, and that's a whopping, you know, $148 billion.
But supposedly it's overwhelmingly high quality stuff even within that private credit portfolio. But that in and of itself just kind of leads to the next obvious question, which is, you know, just because these private credit exposures are theoretically highly rated, are they really high quality, especially if it's, like, a single private letter rating from a loan agency? You know, or to take another example, like Corbett has $11 billion in CLOs, but 85% of those are A-rated or better. And, you know, they're not necessarily taking a ton of risk elsewhere in their investment portfolio.
So, like, quantifying the risk factor on an industry or interconnectedness basis, it's an answer I don't necessarily have at the ready, but I think what really needs to be done, especially, like, for potential investors looking at the intern spaces, is you need to do a holistic examination of both of the insurer's asset side of the balance sheet and its asset quality, but you also need to look at the liability side of the balance sheet, the capital intensity of the products, the sensitivity to interest rates and equity markets and so on. And, you know, luckily we do that, at least with the names we cover, so a resource here if you need it. No, that's a great point, and I think the reports that you put out has to be the most comprehensive out there. And so going back to this discussion that we had around this time last year, one of the points you made is you weren't necessarily totally concerned about insurance investment portfolios, exposure to private credit, and from a strategy perspective at the time, we had a pretty optimistic forecast for 2024.
This year we are expecting a little bit of spread widening, even from current levels, and it's fair to say that the macro picture has been very volatile in terms of what's coming out of Washington during the Trump administration's first 100 days. So does this change your perspective in terms of the risks to private credit and sort of how that would transmit to life insurers? And have you seen in any earnings that you've gotten so far, I think you've got a bunch still to come, any alluding to the risks from private credit? And just so our listeners know, we're not calling for a recession in the U.S.
this year, but definitely looking for a downshift in growth to something below potential after two very robust years in 2023 and 2024. Sure. I mean, so one of the elements is the fact that, you know, we've gotten first quarter earnings so far, and the bulk of first quarter earnings didn't really reflect most of the macro volatility that we've seen since Liberation Day, quote-unquote. And so really it's kind of about forward-looking commentary, but really from the insurers' perspective what they like is this rising rate environment, upwardly sloping yield curve.
That's kind of their ideal scenario. So even if we are calling for spread widening, that's not necessarily the worst-case scenario for insurers to the extent that we don't have a corresponding significant increase in default and impairment activity. You know, when you look at their gap balance sheets, one of the issues is that fixed income investments are typically marked to market with a change in valuation flowing through to AOCI. So from an optics perspective, it can look like during periods of rising rates or rising credits spreads that the insurers are doing worse, but that's not necessarily the economic outcome for them because rising investment-slash-reinvestment yields is both positive, obviously from a revenue perspective, but also from a reserve stability perspective as well.
So it can actually reduce the risk of the liabilities. And then for regulatory capital purposes, which determines their ability to upstream capital from the op code to the hold code, most securities are valued on an amortized cost basis. So changes in the interest rate environment won't necessarily impact their ability to distribute cash. And so from both an economic perspective and a free cash flow perspective, wider spreads can actually be positive in the medium to long term as it pertains to investment-slash-reinvestment income.
Wow, that's interesting. So I guess it's wider spreads absent a recession that pushes spreads much wider and deteriorates the overall underlying U.S. economy, right, Josh? Yeah, the ideal scenario for the insurers is that AAA bonds yield 10% and there's not a single default.
Man, that would be pretty nice. Hopefully we're not heading there because I'd imagine to get there we need treasuries yielding something like 7% or 8%, and I feel like that's something that's getting thrown out there again, and I don't know that that would be a net benefit to the global financial system, but that's a whole separate podcast. No, I do enjoy being employed. Yes, yes, as do I.
All right, so I think that's very helpful thinking about some of the moving pieces in terms of how wider spreads and higher yields, which really is our base case for this year, affects the investment portfolios and insurers' performance in ways perhaps different than you might immediately think. And so I want to shift to another point that you were making last year that I think is becoming more pervasive throughout the market, and that's about the risk transfer market. And I think there's more focus at least in the financial press narrative around synthetic risk transfers that banks do, but insurance companies do risk transfers where they can move whole books of business, and I think that was robust last year. Can you kind of provide us an update on it if that trend has continued and if there are any concerns you have about the robustness of that market?
Yeah, absolutely. And kind of to start, whether I'm concerned or not, private equity in the insurance sector is now this permanent factor, and that's not going to change, and that's really facilitated this robust risk transfer market, which I would absolutely still categorize as robust. I mean, what we saw in prior years was this absolute wave of deal-making activity, but a lot of the low-hanging fruit has improved, so to speak, so we're seeing a slowdown in that activity, but still, in a historical context, very high levels of risk transfer activity. And so, you know, with that having been said, I think we talked a lot already kind of about the risk factors associated with, like, private equity and private credit, but I think that this risk transfer market you're talking about is actually one of the major positives to come out of all this private equity involvement in the insurance sector, and, yeah, so it does certainly increase the interconnectedness between insurance and private equity, but I think more important is that, you know, life insurers finally have something to do with a lot of this legacy business and legacy stuff that they no longer consider core.
So historically, what would happen is insurers would basically say, I don't really want to sell this product anymore, I'm going to put it in runoff, but I've still got 20 years of history that have written all these policies, and I'm still on the hook for managing them, servicing them, and on the hook for all the liabilities associated with them. But now, there are these willing counterparties, and very often PE-backed insurers slash reinsurers, and they're going to take on the risk of these liabilities, and they're willing to do that. And this enables the traditional insurers to tailor their own insurance portfolios to better reflect how they want to be positioned, basically gives them an exit opportunity for products X, Y, or Z that they may no longer want. And so, you know, a non-exhausted list of some of these risk transfers in recent years that may not have been possible before private equity interest in the space.
I mean, for example, a $28 billion reinsurance deal between Carlisle-backed Fortitude Re and Lincoln National, a $26 billion risk transfer deal between Principal Financial Group and Sixth Street-backed Talcott. There was another $26 billion deal between Allianz and Blackstone-backed Resolution Life, and the list goes on. And I'd say that even some products that previously were considered functionally like persona non grata in the insurance industry, like long-term care insurance, even these policies are transacting in partnership with PE players now. So, you know, we have to take the good with the bad, and I think the risk transfer opportunities are actually a major positive for the sector.
Yeah, it's interesting, Josh. To me, that just strikes me as having more liquidity for what certainly would be considered a very illiquid market, very chunky transactions. And so it suggests there's plenty of cash to be put to work when you have these sort of, not one-off markets, but very specific books of business that can move. It could be concerning is a concentration of risk in one house, let's say, in one PE firm or anything, or, you know, one asset manager or something like that.
Are you seeing anyone gobbling up too much risk where maybe the liquidity aspect is good, but the concentration risk factor is becoming more of a concern? Well, what I would say is there's kind of two types of PE-backed insurers. They're the ones that are what I call the consolidators, which aren't really writing any business of their own and taking on liabilities from other insurers that no longer want this particular product. And then there are those that are still writing new business.
So an example of a company that is writing new business would be like Global Atlantic by KKR. I would say I have less concern about them because they're still very rating sensitive, given that they still need to be selling insurance products through brokers, which are highly rating sensitive. But some of the consolidators, they may be less rating sensitive because if they're not writing new business, they don't really care about the ratings profile. You know, they're going to be extremely focused on profitability metrics as opposed to any kind of rating agency assessment.
And so maybe there's a little bit more risk there. I wouldn't categorize any particular PE-backed entity as, at this point, having an over-concentration in, like, a particular product line area because actually with all the influence of private equity interest, there's a fairly competitive marketplace for insurers looking to offload their products. It's functionally kind of narrowed this bid-ass spread. So it prevents, you know, so it's a very competitive market there.
So I do keep a closer eye on what I call the consolidators that are less rating sensitive. And so perhaps that's a concern that could build over time as we see more of these restraints for arrangements. I think for now we're okay. So it's not a red flag situation.
Maybe a yellow flag worth monitoring. All right. So I'll earmark this one for our discussion this time next year and see where things stand. So I think one very clear theme throughout this discussion so far is interconnectedness.
And I'm going to try and trace this as well as I can. So if the PE firms own a lot of the companies that borrow in the private credit market and private equity and life insurers are investing more directly in private credit funds, many of which have links back to large private equity firms like Blackstone or Apollo, et cetera, does this issue become circular at some point? Maybe it's already circular. Perhaps it's fine as long as there's cash to be invested, the economy is growing and there's relatively liquid markets.
I suppose this is almost a question of if things get a lot worse, does this end up looking like a house of cards that kind of comes down if the economy slows down and cash gets locked up? Yeah. I mean, I... As much as it pains me to say, I think your head is actually in the right place to be thinking about this kind of risk.
You know, we've talked to clients in the recent past, and we've kind of described it as this self-fulfilling cycle, right? So you have, like, you have a PE entity. Maybe it does or it doesn't own somebody that needs to borrow in the private credit market. But in any event, the PE entity is originating some kind of private credit investment.
Theoretically, it's forming off the higher-quality tranches to its insurance counterparty, and maybe theoretically, it's forming off the lower-quality tranches to its other clients. The PE entity is probably collecting a fee throughout the process, and it's probably taking an asset management fee from the insurer as well. So we haven't really seen it yet, but the question is, at what point do the, you know, perhaps the PE shop's run out of takers for some of these lower-quality tranches? And, you know, we instead see that start showing up on insurer balance sheets.
I don't know that we've really seen that yet because insurers are still subject to regulatory capital charges for lower-quality investments. So I haven't quite seen evidence of it yet, but I'm not saying it's not a possibility. It's definitely something we're kind of ongoing watching for to see if and when that starts emerging. You know, whether it's a house of cards, I can't really speak to, but I can see, like, the incentive for the PE entity to just nonstop continue to originate these assets and service the assets and collect income streams from that all along the process.
Yeah, that's a great point, and perhaps describing it as a house of cards is a little hyperbolic, but when you think about what could cause that to be revealed, it sort of comes down to a shock to the system, and to say the global economy is going through a bit of a shock right now feels fair. And so I feel like that's something that we're definitely trying to monitor or keep in the back of our heads from a strategy perspective as we think about the risks and how policy out of Washington may cause some unexpected outcomes, especially if you just think about the size of tariffs being considered. Obviously, we're in a 90-day pause now and how the uncertainty alone set aside the actual implementation of those tariffs has caused a lot of global trade to seize up. If you're a borrower that is employing a lot of leverage like many borrowers in the private credit market are and you're highly sensitive to tariffs, this could become an issue fairly quickly.
And so, you know, we're not really seeing any signs of it yet, but we don't really have hard data yet past the Liberation Day. So it's something that we'll certainly be keeping an eye on. And in terms of these risks, I'd say last year we spent a lot of time focusing on the commercial real estate market and how exposed insurers are to that asset class as a whole, but also focused on office, which has really been widely viewed as the most at-risk or performed the worst for obvious reasons. Is CRE or office a big concern of yours still, Josh, or has that abated to a certain extent?
Yeah, I mean, I think overall the concern is definitely abated, but I think the clear and obvious exception is definitely still the office properties. But generally speaking, we're done hearing every single or every other question on earnings call being about the CRE portfolio. I think insurers have actually done pretty good with their office exposures so far, you know, a combination of like extending maturity dates and some other strategies. And actually life insurers have this interesting option where they could perhaps really take control of the office property and hope valuations recover over time.
I don't know how much an appetite they have for leading property managers into the foreseeable futures, but I think overall at this point I really can't point to a leading insurer where the commercial CRE portfolio or the office CRE portfolio is going to vary them. I mean, there are some notable names among the list of like leading life insurers that have significant exposures to office properties like MetLife or Principal Financial Group, and these kinds of insurers have long considered investing in office properties as core competency of theirs. You know, that worked really well for like 30 years, but, you know, all good things must come to an end at some point. And so like we're watching them, but their capital metrics are strong, even in a fairly severe scenario that it should be a manageable situation if indeed the pressure limits office properties.
And so are the life insurers still adding CRE exposure or are they avoiding it altogether? Are they just avoiding office? How have their portfolios evolved? I guess how has the flow evolved, not necessarily the stock of their portfolio, but kind of what they're doing over the past year, kind of in your view of 2024 investment portfolio behavior?
Sure. I mean, I definitely say that they're avoiding office properties in terms of new investments. We're on a second consecutive year now where the overall allocation office properties as a percentage of the overall mortgage lending portfolio is coming down, but they're definitely not necessarily avoiding mortgage lending altogether. You know, what I did notice is this interesting thing is that insurance are starting to explore residential mortgage lending in a big way now, and historically that was an asset class, so to speak, that they kind of generally avoided.
And just to set the table real quick, so as of year 2024, the reported book value in mortgage loans for the life insurance sector, that totaled $787 billion, and that was up another about 7% year on year, and it reflects about 14% of the aggregate life insurance investment portfolio. But hidden inside those numbers, growth in commercial mortgage lending was only about 3%. Instead, it's been growth in residential mortgage lending that's actually fueled overall industry mortgage lending growth. So residential mortgage allocation, that actually rose 40%, a little bit more, to $117 billion.
And I almost hate to say it, but guess who's driving this trend, too? And I'll pause just for one second. Okay, I think that was enough time for everyone to get who is. Yes, you got it on the first try.
It's the private equity-backed insurers. And let me just give you a couple examples here. A theme, so backed by Apollo, their residential mortgage lending grew by $13 billion by itself in full-year 2024, and that was about 37% of some of the industry's residential mortgage lending growth and global land at KKR. Their residential mortgage lending grew by $7 billion.
So what I'm actually expecting going forward is now we're going to see copycats. You know, we're already seeing some traditional insurers like Corbridge or Lincoln National. They're getting way more active in residential mortgage loans, and I suspect what we'll probably see when I get the year in 25 regular financials is we're going to see a little bit of a mini boom in residential mortgage lending from the life insurance. All right, so residential mortgages are in.
Private credit is in. Commercial real estate is out. Yeah, a little bit on the outs. A little bit on the outs.
Josh, this has been a great discussion. Again, I appreciate you coming back on No More Risk Better. Learned a ton. I'm looking forward to continuing the discussion this time next year, and we've got plenty of topics that we're going to be focused on.
So again, that was Josh Estorov, our head of insurance. Josh, thanks so much for coming on the show. Zach, thank you very much. And thank you all for tuning in.
We will catch you next time on No More Risk Better. We'll see you next time.