Insurance companies have been increasing their purchases of speculative-grade bonds this year, which has helped drive yields to record lows. They may just be getting started, according to Bank of America.
Life and property insurers now have an estimated $ 240 billion in US junk bonds, an all-time high and 23% more than at the beginning of last year, according to a Bank of America report. And that number could rise by another $ 120 billion over the next five years, strategists Oleg Melentyev and Eric Yu wrote.
This is a large amount of dollars in a high-yield market that, according to the Bloomberg Barclays indexes, is worth about $ 1.66 trillion. High-yield bonds now account for about 4.1% of insurers’ fixed-income portfolios, up from 3.8% in early 2020.
Allocations to speculative-grade bonds could continue to rise as persistently low yields put pressure on the earnings of life insurance companies, giving them more reason to increase their risk, Bank of America strategists said. New capital rules for life insurers may also give companies an incentive to buy more lower-rated notes, Barclays strategists wrote last week.
Although junk bond funds last week saw their largest capital outflows since March, investors are still clamoring for new, high-yield issues in an environment of rock-bottom yields and expectations of rising interest rates. Last week $ 9.85 billion in new high-yield instruments were sold and, so far this year, the supply of speculative-grade debt has reached records for several months.
In recent years, life insurance companies have reduced their allocations to speculative-grade debt because shareholders have pushed them to reduce their risk, while property and casualty insurers had increased those percentages to try to earn more, according to Bank of America.
“The persistent low interest rate environment is likely to continue to put pressure on life insurers to improve the return and risk-return profiles of their portfolios,” the strategists wrote.
In Europe, insurers have also been transferring money from safer investment-grade corporate and government bonds to high-yield notes, Bloomberg reported in March.
If insurers continue to increase their reserves in the United States and their allocations to high-yield debt approach the 5.5% estimate that pension funds have, $ 120 billion of additional money could flow into junk bonds, estimates Bank of America.
