Should insurer shareholders worry about private credit?

Signs of stress are growing in the private credit market on concerns over lending to AI-exposed software companies, illiquidity and default risk. Insurers have increased their exposure in recent years, raising questions over how seriously investors should take the current market ructions.

Major US asset managers have limited redemptions as retail investors sought to withdraw more than $20bn (£15bn) from private credit funds in the first quarter, per FT analysis, with the shares of big players such as Apollo (US:APO) and Blackstone (US:BX) down by a fifth this year.

European insurers generally have a small amount of pure private credit in their investment portfolios, but investors are becoming wary of spillover risks. Berenberg says money is rotating into insurers that have “relatively small investment portfolios and negligible private credit exposure”.

Among London-listed insurance companies, shares in motor insurance specialist Admiral (ADM) are 5 per cent up this year, while Standard Life (SDLF) and Aviva (AV.) are in the red and Legal & General (LGEN) is flat.

Insurance and private credit

Private credit means different things to different people. For insurance companies, Moody’s Ratings defines it as non-bank lending to private middle-market companies, which are mostly owned by private equity, as well as asset-backed finance.

Notably, in the US market, life insurers have merged and partnered with private credit managers in search of better returns. American insurers with material private credit exposure include Athene (owned by Apollo and the leading US annuities player), F&G Annuities & Life (US:FG), MassMutual and KKR (US:KKR)-owned Global Atlantic.

The asset class offers insurers a way of matching long-term assets and liabilities, higher yields (because of the relatively illiquid and higher-risk nature of investments) and portfolio diversification from publicly traded instruments. Life insurers are more into private credit than property and casualty (P&C) insurers.

Private assets now take a significant share of insurers’ investment portfolios, but pure private credit is relatively small. Bank of America estimates that European insurers hold about 27 per cent in private assets, but just 7 per cent in private credit, excluding “typically high-quality mortgage portfolios” and “highly diversified” real estate.

In the UK market, Standard Life and Legal & General have between 10 and 15 per cent of their investment portfolios in private credit, while Aviva and M&G (MNG) are in the mid single digits, according to RBC Capital Markets.

Insurance analysts are currently sanguine about the risks to European insurers from private credit investments, however.

RBC analyst Mandeep Jagpal told Investors’ Chronicle that UK life insurers hold “very high quality” private credit assets. While private assets now make up 40-50 per cent of annuity portfolios, most is in real estate, with only a small share in private credit.

Berenberg analysts said that private credit exposures at large, diversified European insurers are “very manageable”, and “see no risk to the earnings outlook” for Allianz (DE:ALV), AXA (FR:CS), Zurich Insurance (CH:ZURN), Generali (IT:G) and Standard Life.

Bank of America analysts argued that insurers’ holdings are “far away from current market concerns”. “Software and the IT sectors represent a minority of holdings (across debt and equity) while infrastructure & energy make the bulk of it,” they said.

They estimate that potential losses on private assets, assuming default rates of 5 per cent for infrastructure debt and 10 per cent for other types of private credit and equity, would amount to around 4 per cent of the European insurer sector’s market capitalisation.

Resilience is helped by the path of capital positions under insurance regulations. Bank of America forecasts that European insurers’ average Solvency II capital ratio will keep increasing in the coming years, from a current position of around 225 per cent.

A wake-up call for regulators?

Yet in the context of outflows from private credit funds, the stage is set for valuation markdowns and defaults. The default rate for US private credit borrowers rose to 9.2 per cent last year, according to Fitch Ratings, up from 8.1 per cent in 2024.

Verdad Capital credit director Greg Obenshain said that, just like the junk bonds of the 1980s, “too much credit” has been extended to “too-risky borrowers as excessive optimism and a lending boom sow the seeds of a credit crisis”. He noted that private credit direct lending has grown more than the investment-grade bond market since 2010.

Regulators on both sides of the Atlantic are taking note amid growing anxiety around private credit investment ratings, illiquidity and the impact on the sector from higher interest rates.

The US Treasury announced earlier this month that it would bring together domestic and international insurance regulators to “survey recent market events, emerging risks, risk management practices, and outlooks for the [private credit] sector”.

The Bank of England plans to publish the results of a stress test on private credit next year. Its Financial Policy Committee recently noted that problems in the private credit market could damage “relatively more resilient borrowers reliant on private-market financing”, particularly UK corporates given their dependence on overseas investors.

Saying that, a move this week by the UK’s biggest workplace pension scheme suggests private credit’s appeal still outweighs the risks. Nest plans to invest £450mn in US private credit with alternative investment manager Crescent Capital as part of its plan to allocate 30 per cent of its assets under management to private markets by 2030.