Introduction
Historically, insurers have relied on stable returns, often achieved through traditional bond portfolios. However, with yields dwindling in recent years, they are turning to private credit (see graph 1). In particular, Asset Based Finance aligns neatly with insurers’s needs, catering to their long-duration liabilities and predictable cashflow requirements, while also offering diversification and reduced volatility compared to public markers.
Image 1: US High Yield and Corporate OAS
Insurers are increasingly joining forces with private credit managers to unlock the potential of private asset-based finance (ABF). As they shift away from traditional public markets, these collaborations offer the opportunity for higher risk-adjusted returns. By partnering with experienced asset managers who optimize costs and tailor investments to specific needs, insurers can better navigate this landscape and maximize their impact.
US vs Europe: A historical perspective on private credit
Private credit plays a significantly larger role in US insurance compared to Europe. In the US, insurers have already increased their private credit holdings to 36% of their total investments in the region according to Moody’s Ratings. While European insurers are also adjusting their strategic allocations to the changing market conditions, the industry remains comparatively under-allocated.
This disparity reflects key differences between the regions: private markets are far more developed in the US, where insurers often have strong relationships with alternative asset managers, providing better access to private credit opportunities. European insurers, on the other hand, have traditionally favored highly liquid, investment-grade fixed-income assets, such as government and corporate bonds, due to their more risk-averse investment approach.
Strategic collaborations: real-world examples
In an era of environmental and climatic unpredictability, investors in asset-backed securities often face significant challenges:
- Uncertainty about asset exposure: Without precise data on asset Global insurers are increasingly partnering with asset managers to access private credit opportunities. Most recent examples are Northwestern Mutual partnering with Sixth Street, and Generali teaming up with Natixis. Guardian Life and HPS have also deepened their strategic ties. These collaborations extend beyond traditional partnerships, with capital infusions and acquisitions highlighting the growing alignment between insurers and asset managers. MetLife Investment Management is set to acquire PineBridge Investments, Manulife Investment Management has completed the acquisition of CQS and Blue Owl Capital is acquiring Kuvare Asset Management for $750 million. This trend reflects a broader industry move towards private credit, with insurers planning to significantly increase their allocations in the coming years.
Why Private Credit? Enhanced returns and diversification
Unlike public market instruments, private credit investments provide access to niche opportunities that often offer higher yields due to their limited liquidity, allowing investors to achieve higher returns while maintaining stability in their portfolios (as illustrated in graph 2). This is especially beneficial for insurers, who can partner with experienced private credit managers to gain direct access to asset originators and eliminate intermediaries. This direct approach not only drives cost efficiencies but also enhances control over asset selection and structuring, enabling investments to be tailored to specific risk and return objectives.
Moreover, private credit offers unique diversification benefits by exposing investors to non-traditional asset classes such as real estate debt, infrastructure finance, and asset-backed lending, which tend to have low correlations with public markets and help mitigate broader market volatility. The strong covenant protections often associated with private credit further reduce credit risk, while the predictability and flexibility of cash flows make it an ideal solution for meeting long-term liabilities such as pension risk transfers and structured settlements.
Even the perfect synergy requires navigating risk
Despite its benefits, private credit comes with inherent risks that require careful management:
- Illiquidity: Limited liquidity can create challenges during unexpected cash needs.
- Complexity: The opacity of private credit instruments demands robust due diligence and specialized expertise.
- Concentration risk: Overexposure to specific asset classes or industries can undermine diversification.
- Regulatory scrutiny: As private credit grows in popularity, insurers must adapt to increasing regulatory scrutiny and evolving compliance requirements.
Regulatory changes: implications for insurers
The regulatory landscape is evolving, with the National Association of Insurance Commissioners (NAIC) in the United States, introducing measures to ensure insurers effectively manage risks in private credit. The regulator is focusing on two major risks:
- Tail risk in subordinated tranches
The goal is to tackle regulatory rating arbitrage, where owning equally weighted tranches in CLOs or Asset-Backed Securities (ABS) often results in a lower risk-based capital (RBC) charge than holding the underlying assets, even when the default risks are comparable. Currently, in some CLOs and ABS structures, this lower “Blended RBC Charge” suggests that the security carries less default risk than the underlying assets. While subordination typically provides adequate protection for investment-grade tranches, it may not offer the same level of security for speculative-grade tranches. - Concentration risk
Asset-backed structures are typically treated as uncorrelated individual securities with systematic risk. However, cumulative risks can emerge if the underlying assets across issuers are highly correlated, such as belonging to the same asset class, industry, or geography. These risks are similar to those seen in the 2008 Financial Crisis, where price changes across correlated assets amplified systemic vulnerabilities. The NAIC is particularly concerned about this type of concentration risk, which can occur at various levels, including single borrowers (e.g., Company XYZ), asset classes (e.g., data centers, offices, autos), industries, or regions. This misjudgment of correlation could lead to significant idiosyncratic risk in insurers’ portfolios.
The NAIC aims to finalize an updated RBC framework for CLOs and ABS by 2025. Beyond the insurance sector, regulatory bodies like the Federal Reserve and SEC are also increasing oversight, with initiatives such as expanded FR Y-14 reporting for non-bank lending and broader access to private markets through updated accredited investor definitions. These developments are set to reshape insurers’ strategies, balancing risk management with capital formation goals.
Bridging the gap: the need for technological innovation
Insurance companies have the opportunity to ride the coming wave of private credit, capturing the lion’s share of the $40tn opportunity market. However, this potential is threatened by a complex and evolving regulatory landscape, which imposes significant constraints on the capital that can be deployed. Effectively managing risk in this environment requires not only a level of transparency that private markets have historically lagged to provide but also robust tools capable of handling vast amounts of data efficiently.
Due diligence processes can often be inefficient, lacking the technological sophistication to provide a comprehensive view of underlying assets. Furthermore, reporting often falls short of insurer expectations, with limited customization and infrequent updates hindering effective monitoring and decision-making. For asset managers, this presents a crucial moment to adopt more innovative, technology-driven solutions that align with the specific requirements of insurance investors. By leveraging automation and advanced analytics, they can bridge the gap between private credit and insurers’ needs.
How Cardo AI helps
Portfolio Look-through and scenario analysis are crucial in assisting insurers navigate complex risk decisions in private credit investments. They also act as essential tools for monitoring multidimensional – idiosyncratic risks while supporting broader goals of maintaining financial stability by managing systemic risks.
Scenario analysis:
Scenario analysis can provide insurers with a valuable tool to manage tail risks effectively by identifying vulnerabilities, aligning capital charges, and mitigating regulatory arbitrate.
- Addressing rating arbitrage: Scenario analysis allows insurers to conduct a transparent comparison of risk between the underlying collateral (securities) and liabilities. By testing the resilience of both under identical adverse scenarios, insurers can demonstrate whether the tranches justify reduced capital charges. Hence the insurer’s portfolio can be better aligned with regulatory requirements and enables better-informed capital allocation decisions.
- Mitigating tail risk in speculative-grade tranches: Speculative-grade tranches, such as BB-rated, are particularly vulnerable in adverse conditions, with equity-like loss potential. Scenario analysis quantifies the exposure of these tranches to extreme market events, such as widespread defaults or sector-specific shocks. This analysis highlights their disproportionate risk and allows insurers to adjust portfolios by reducing exposure to high-risk tranches or reallocating capital to more senior tranches.
Example: Correcting discrepancies in RBC charges
Structured tranches can face discrepancies in RBC charges compared to the underlying collateral, which can distort risk assessments. Scenario analysis identifies mismatches by simulating how collateral risks flow through the structure (waterfall) and negatively affects individual tranches (especially subordinated). Hence, scenario analysis, can assess that RBC charges accurately reflect the true risk, enabling insurers to optimise their portfolios by favouring securities where the risk-adjusted capital charge is justified.
Concentration risk:
As highlighted by the NAIC’s focus on correlated exposures across issuers, sectors and geographies, look-through technology helps manage concentration risk through:
- Consolidated exposure analysis across multiple issuers to reveal hidden correlations
- Dynamic visualization of risk concentrations at borrower, industry and geographic level
- Automated monitoring of concentration limits with customizable alertsExample: Utilising an interactive dashboard, an insurer managing a diversified portfolio of CLO’s can aggregate issuer (borrower) exposure by seniority, to identify hidden correlations (potential default risk) across different transactions.
Monitoring collateral evolution:
Look-through capabilities enable insurers to track underlying portfolio and collateral performance over time:
- Analysis of historical trends in collateral quality metrics like delinquency rates
- Early identification of deteriorating credit quality in underlying pools
- Enhanced regulatory reporting demonstrating a thorough understanding of asset performance
By incorporating look-through technology with powerful scenario analysis, it allows insurers to dynamically assess their underlying risk exposure to take proactive actions for risk mitigation and optimizing capital efficiency.
Example: An insurance firm can track historical performance for delinquency rates by geography and simultaneously assess trends in credit quality of the underlying portfolio to proactively adjust the portfolio’s strategic asset allocation.
Advanced AI analysis for insurers:
CARDO AI is pioneering next-generation scenario analysis with generative AI. Our platform rapidly simulates complex economic downturns, predicts asset performance across diverse portfolios, and identifies vulnerabilities in high-risk tranches, delivering predictive insights and tailored capital reallocation recommendations.
See how Cardo AI gives insurers the transparency and tools to confidently scale into private credit.
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