Have insurers distorted the private credit market?
By some estimates, the amount of money insurers have pumped into private credit has more than doubled from $490bn in 2021 to $960bn in 2023. This, according to a recent paper, has had a “profound” impact on the asset class’s risk-return profile (Michael Nagle/Bloomberg)
Good morning. Ok, so I think I can assume by now that we all know there’s big demand for private credit and some people are predicting an apocalypse -- and some people aren’t.
This week we’re going to explore the question of whether a particular class of asset owners is distorting the private credit market: insurers.
That’s the charge levelled by a paper published by Sona Asset Management, a London-based institutional alternative asset management company.
The argument runs like so: a huge wall of capital has flooded into the private credit market in recent years and a significant chunk of this has come from insurers.
This stands up, as we can see from this chart from Oliver Wyman:
The proportion of money going into private credit from insurers has gone up, but since the total amount of money going in has gone up by nearly $1tn, that compounds the effect even more.
The actual amount of money insurers are investing in private credit has gone from nearly $490bn in Q4 2021 to $960bn in Q3 2024. It’s more than doubled in three years.
Of course part of this is the trend we have discussed before of insurers engaging in defined benefit pension buy-outs.
Sona, which estimates that the insurance sector has an average allocation to private credit of about 10 per cent, calls this “the most transformative structural development in private credit over the past five years” with a “profound” impact on the asset class’s risk-return profile.
Their white paper says: “The problem is not that insurers invest in private credit. Rather, it’s the capital dynamics they introduce. Insurance capital faces permanent deployment pressure -- a liability structure that must continuously generate matching assets.
“The result has been persistent spread compression precisely at a point in the cycle when spreads should be widening to reflect higher risk. Insurance capital has lowered the cost of private credit financing for borrowers at a time when credit quality, documentation standards, and macro uncertainty all point to the need for a greater risk premium.”
A common counterargument to its concerns is that insurers typically skew their private credit concentrations towards investment-grade assets.
But Sona warns the fact insurers increasingly access private credit through rated feeder funds means this isn’t necessarily the case.
They say: “[These funds] typically take a vertical slice of the capital structure and, in doing so, retain direct middle market loan exposure.
“In a stressed environment, especially one in which fundraising headwinds intensify, the ability to exit the least liquid positions will only become harder.”
Sona’s managing director of global credit strategy Craig Nicol, who wrote the paper, said: “We live in an environment where the world needs capital and private credit will play a role in that.
“But it needs to go through a period of reckoning to show the issues which have built up over time and get rid of the excesses.
“Credit cycles have been happening for decades, they are a very natural phenomenon. We haven’t had that in private credit because we have had so much capital thrown at it.”
Nicol said it was “difficult to say” whether the amount of money invested by the insurance sector alone had prolonged the current credit cycle, and added there was plenty of demand outside that sector.
But he added that by definition, a company ends up in the private credit market because it is riskier than one which isn’t.
“The increased amount of due diligence being carried out doesn’t mean the underlying assets are safe. They are still, in many cases, highly risky and that can’t be saved by the institutionalisation of private credit.”
