Re-Mixing Asset Allocation: Insurers Decrease Bonds, Then Do a Partial Reversal

Art by Gizem Vural

Insurance asset allocation has long had a conservative orientation, with a heavy tilt toward bonds. After all, the industry’s business hinges on being able to provide long-term benefits and meet accident claims, and bonds have a history of furnishing steady returns. In recent times, though, bonds have had an interesting journey: ebbing in importance in recent years, only to rebound somewhat lately as rates have surged.

Asset allocations for insurers are changing. Not radically, mind you, but noticeably.

During the many years of Federal Reserve-induced low interest rates, the insurance business became even more cautious, and went deeper into fixed income. Yet those lower bond yields were not doing wonders for insurers’ returns, so in the 2010s, the allocation shifted slightly toward more stocks and alternative investments—such as mortgage-backed securities, which offer the prospect of higher yields than most long-term traditional bonds.

Now, however, yields have shot up, and that has prompted signs that the bond portion of insurer portfolios is expanding again, to a degree. The Fed’s tightening campaign has altered the game board. Now that bond yields have catapulted, with the benchmark 10-year Treasury currently paying 3.71%, up from 0.64% in mid-2020, bonds are a lot more attractive.

Bonds: Down, Then Up a Bit

To be sure, there’s a universal belief that bonds always will be the largest asset class for insurers; it’s just a question of how much. Even during the low-rate era, bonds continued to have by far the largest piece of the investment pie. The insurance industry’s 2012 asset mix was 68.3% bonds, 11% equities and 6.6% mortgages. The 2022 asset allocation was 62.3% bonds, 13.2% equities and 8.9% mortgages.

But a survey by Nuveen LLC, taken at year-end 2022 and released recently, found that 39% of insurers are thinking about increasing their credit exposure in 2023. With the Fed expected to end its rate escalation in the near future, the danger is receding that bond prices will fall (they go the opposite direction from rates, of course).

Hence, 50% of respondents anticipate increasing the duration of their bond holdings, says Joe Pursley, head of insurance, Americas, at Nuveen, the asset management subsidiary for insurer TIAA.

Allocations differ between life insurers and property-casualty carriers. Actuarial tables, forecasting how long customers are likely to live, make things easier for life companies, thus they traditionally have held more bonds: 68% of assets, versus 47% for P-C, which must deal with unknowns such as hurricane frequency and intensity, year in, year out, per the National Association of Insurance Commissioners.

“Life has more predictable cash flow needs over time,” says Pursley. In addition to holding more bonds, life insurers’ fixed-income holdings have longer durations, averaging around 10 years. P-C’s bonds have two- to four-year durations, he adds—and NAIC statistics show P-C holds more cash. “You never know when the next earthquake will come,” he notes.

Stocks and Alts Rise, Too

Other asset classes are on the move, as well. The increase in stocks made sense during the longest bull market in history, which began in early 2009 and ended in early 2022. “Low interest rates meant that [insurers] had to look someplace else,” other than bonds, says Olaf van den Heuvel, global head of multi-asset and solutions at Aegon Asset Management. Nonetheless, stocks severely disappointed investors last year, with the S&P 500 losing 19.5%.

While no survey data are in to support how insurers are actually investing this year, the current runup in stocks (the S&P 500 is up 14.4% in 2023) suggests that the insurers are not retreating from equities.

In addition, another plus for equities is that corporate profits should rise 5% this year, in the view of Cindy Beaulieu, chair of the investment and risk policy committees at asset manager Conning Holdings Ltd. If so, that would mark a vast improvement from forecasts: FactSet reported that analysts’ consensus was for S&P 500 companies to generate just 1.1% in earnings in 2023.

To be sure, stocks usually fare the worst in a recession, and economists have been predicting a downturn for some time. Strong consumer spending and high employment back up the argument that any slump would be mild and short-lived. The hope is that an accompanying stock decline would not be painful. Further, the end of a Fed tightening cycle has historically been followed by a 7.1% S&P 500 boost over the following 12 months.

Even with today’s bond yields and stock prices climbing, the industry also wants to boost its alt investments. These days, insurers wish to “look at offbeat areas, the less traveled,” says Beaulieu. Indeed, 76% of insurers intend to increase their presence in private markets this year, which means private equity, private credit, private placements and infrastructure, per the Nuveen survey.

At Prudential Financial Inc., one of the largest U.S. insurers, which focuses on life coverage, bonds made up 73% of its $373 billion investment portfolio as of 1Q 2023, down from 76% in 2012. Where did the difference go? Over the last decade, Pru expanded its mortgage holdings.

Private equity funds, for instance, most often outperform stocks, with the exception of the 2010s, when the bull market roared. For the three years ending in December 2022, buyout funds cumulatively gained 81.4%, compared with 25.6% for the S&P 500, PitchBook stats show. Similarly, private credit (also known as private debt or private lending) has done well, filling in the gap as banks have curtailed lending.

Asset-backed securities are ideal for insurance companies, since they pay 1.3 percentage points more than single A-rated investment-grade corporate bonds, as of May, investment manager Western Asset Management Co. calculated in a study. The ABS include securities backed by payments from aircraft leases, data centers and auto rentals. And ABS are not correlated with other types of credit, says the study’s author, Alba Abourjeili, a senior research analyst at Western Asset.

All in all, insurers are stepping into more adventurous territory. To Nuveen’s Pursely, “We’re not going back to sleepy insurance companies.”