How the bond investment mix is changing for insurers

Canadian life insurers are increasing their junk bond holdings and some are raising premiums to make up for Covid-19 claims costs, according to A.M. Best Company Inc.

Lifecos are looking to corporate bonds for additional yield in their investment portfolios even though recent interest rate hikes are having a positive effect on investment yields, A.M. Best suggested in a report on the Canadian insurance industry released last week. This is because interest rates have long been at historic lows. The New Jersey-based rating agency expects the attraction to bonds will continue over the near term because corporate spreads have widened somewhat.

Nonetheless, the asset allocations of Canada’s life and annuity insurers have not changed much over the past several years, the report said.

From 2017 to 2021, bond allocations remained at about 65%, ranging from 64.7% in 2019 and 2021 to 65.2% in 2018.

However, junk bonds rose to their highest level in five years in 2021: 2.2% of the bond allocation, up from 1.5% in 2017. As a percentage of equity, the allocation rose to 9.7% in 2021 from 6.7% in 2017. The change occurred primarily because of credit downgrades, A.M. Best said, adding these allocations are “appropriate for a well-diversified portfolio.”

Life insurers “are well positioned to manage any credit impairments, which thus far have been minimal,” the report said.

As for life insurers’ asset management divisions, A.M. Best said that mutual fund deposits have “increased substantially” over past two years, rising to $19.0 billion in 2021 from $13.6 billion in 2018. Canada’s life insurers have “gravitated to these less capital-intensive and more fee-driven retirement products in recent years, partly because of the low interest rate environment,” the report said. 

Recent interest rate volatility, rising inflation and the slowing global economy all mean investors can expect volatility in life insurers’ earnings, the report said.

Moreover, life insurers continue to face “headwinds” arising from the pandemic — in particular, uncertainty over long Covid-19 and potential Covid-19 variants, A.M. Best warned.

Because of Covid-19, life insurers have experienced “some spikes” in mortality over the past year, as well as in disability claims arising from mental health, said Michael Adams, associate director with A.M. Best. As a result, some carriers are starting to raise life insurance premiums, he said, and clients applying for or renewing policies could be asked whether they have had Covid-19 and whether they are vaccinated.

The pandemic also encouraged lifecos to try to become “digital leaders,” A.M. Best said, adding that many lifecos that adopted mobile apps early generally outperformed their industry peers.