Why Asian Insurers Are Exploring Private Credit and CLOs

• The recent rollout of new risk-based capital (RBC) regimes across Asia calls for a closer alignment between insurers’ assets and liabilities. For many life insurers, this often necessitates a greater allocation to long-dated government debt.

• A complementary allocation to alternative credit, such as private credit and collateralized loan obligations (CLOs), could make up for the relatively low yield on government bonds and enable insurers to maintain a healthy investment yield and robust returns on regulatory capital.

• Global insurers are increasingly turning to private credit for its stable value, predictable income, and diversification benefits, as well as to floating-rate CLO tranches for enhanced yield, liquidity, and shorter rate duration in a volatile market. However, APAC insurers have often lagged behind, deterred by the perceived complexity of these asset classes.

• By combining in-house asset allocation and balance sheet management expertise with the investment structuring and active portfolio management skills of specialist external managers, insurers can navigate the regulatory complexity and fully capitalize on the benefits of alternative credit.

Asia’s insurers are facing an unprecedented shift in the regulatory landscape. Emerging risk-based capital (RBC) frameworks and updated financial reporting standards are reshaping their investment, underwriting, and capital management strategies. Hong Kong’s new RBC regime went live in July. In South Korea, the dual rollout of the Korean Insurance Capital Standard (K-ICS) and new IFRS standards sent shockwaves through the industry. Meanwhile, insurers in Japan and Taiwan are preparing for new frameworks on the horizon, balancing the requirements of in-force regulations with forthcoming changes.

For life insurers, the new regimes intensify the challenge of asset-liability management, with duration and currency mismatches between assets and liabilities driving up risk-based capital requirements. Asian insurers, unlike their US and European peers, often face a scarcity of high-quality, long-dated local-currency bonds, limiting their options for building capital-efficient liability-backing portfolios.

To diversify their exposures and meet their investment income targets, insurers may need to explore less-familiar assets, such as private credit and collateralized loan obligation (CLO) tranches. In a shifting macroeconomic and regulatory landscape, these asset classes offer potential for generating capital-efficient returns and boosting portfolio resilience.

New approaches for a new regulatory regime

The latest regulatory changes across Asia are reshaping insurers’ balance sheets, hitting life insurers particularly hard with steep capital charges for duration mismatches between assets and liabilities. This pressure is pushing life insurers to either lock in lower yields with long-dated domestic government debt or turn to reinsurance to reduce the duration and volume of their capital-intensive liabilities.

We expect reinsurance activity to persist in developed Asia as life insurers seek to alleviate the capital strain of their liabilities, potentially benefiting Bermuda reinsurers, which are facing increasing regulatory hurdles in Europe and other regions.

On the asset side, the new capital regimes present challenges in many Asian markets, where local corporate debt markets often lack the depth and duration to meet life insurers’ appetite for long-dated income. To overcome this challenge while maintaining portfolio diversification and meeting yield targets, insurers can use a barbell strategy combining short-dated, higher-spread assets on one end with lower-yield, ultra-long-dated government bonds at the other.

Regulatory Convergence in Europe and Asia: New and Emerging Risk-Based Capital Regimes

*National risk-based capital regimes developed based on the International Association of Insurance Supervisors (IAIS) Insurance Capital Standard (ICS). Source: PineBridge interpretation of draft and in-force national insurance regulations.

Expanding the asset universe: private credit and CLOs

To implement a capital-efficient barbell strategy, insurers may need to venture beyond the comfort zone of domestic fixed income. Traditional life insurers, which benefit from more predictable long-dated liability profiles, are well positioned to harvest the illiquidity premium in private credit, which historically shows low correlation with traditional fixed income. For those prioritizing liquidity, CLO tranches offer attractive spreads over similarly rated corporates without the rates-driven volatility associated with long-dated bonds.

While the many flavors of illiquid and alternative credit have gained some traction across the region in recent years, APAC life insurers are still well behind their global peers. According to a recent Moody’s estimate, APAC insurers’ average allocation to illiquid credit (including real estate debt private placements of corporate debt) stands at 6.4% – a stark contrast with the 35.7% average for life insurers in the US and Canada, 23.6% for the UK, and 13.1% for Europe ex UK.1 And averages never tell the full story: For private equity-influenced US life insurers, allocation to private credit and other illiquid assets stands close to 50%.2

Similarly, CLO tranches remain an exotic foreign specialty for many APAC insurers. This is not the case in the US, where CLOs comprise 3.4% of insurers’ cash and invested assets in aggregate3 (5.5% for private equity owned insurers).4

The appeal of private credit for insurers is clear: illiquidity risk does not carry a regulatory capital charge under an RBC regime; at the same time, it is typically compensated with a spread premium. Unlike banks dependent on demand deposits and short-term funding, many insurers – especially life insurers – can leverage their stable, predictable liabilities to invest more in illiquid credit. When reporting their investments on a fair value basis, insurers also stand to benefit from stable spreads on private-market debt investments translating into lower profit-and-loss volatility.

Today’s volatile rates environment also strengthens the case for floating-rate CLOs. Compared with corporate bonds, investment grade CLO tranches offer higher spreads, historically negligible credit loss rates, and shorter interest rate duration, along with diversification benefits, while maintaining a similar level of secondary market liquidity. This makes CLO tranches particularly appealing for non-life insurers, which generally have a lower appetite for illiquidity than their life insurance counterparts.

Regulatory Capital Efficiency of US CLO Tranches and Private Credit by Risk-Based Capital Regime

Source: PineBridge Investments analysis based on ICE Data Platform (bond indices), JPMorgan (CLO indices), and Cliffwater (senior direct lending index) as of 30 June 2024 and PineBridge interepration of local risk-based capital requirements by country. Risk-Based Capital Efficiency is determined as the ratio of FX- and credit-adjusted index spread to required capital for spread risk and – where applicable – credit risk of fixed income investments under the relevant jurisdiction’s risk-based capital regime.

*In Japan and Taiwan, implementation of new national risk-based capital regimes based on the International Association of Insurance Supervisors (IAIS) Insurance Capital Standard (ICS) is currently underway and is due to be completed in fiscal 2025 (Japan) and fiscal 2026 (Taiwan). For these jurisdictions, we estimated risk-based capital requirements based on the latest available technical specification of the IAIS April 2024 ICS Data Collection Exercise of the Monitoring Period Project.

**As an element of prudence, CLO tranche investments are assumed to carry a 50% fixed risk charge under Singapore RBC as structured products. Alternatively, an insurer may apply a look-through aproach with a 50% premium on the derived market risk requirement.

Taking an active approach

Allocating across a broader asset universe requires a proactive approach to portfolio construction. Amid heightened political risks and geopolitical tensions, elevated rates, stubborn inflation, and persistent market volatility, insurers must closely monitor and actively manage their investments. For alternative assets, this means engaging closely with asset managers who can collaborate with insurers to enhance their in-house scenario analysis and stress testing.

In the illiquid credit space, investors tend to put their money on experience: established managers account for over 80% of recently raised private debt fund capital.5 We believe insurers seeking stable investment income should partner with prudent managers whose focus on capital preservation and risk management is evidenced by a solid track record.