A $700 Billion Insurance Product Is Powering the US Credit Market Rally

(Bloomberg) — An insurance product that consumers use to fund their retirement is selling at record levels, fueling demand for corporate debt and commercial mortgage bonds.

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Last year, sales of annuities, which allow consumers to buy income for the rest of their lives, reached a record $385 billion, according to life insurance trade group Limra. This represents an increase of 23% compared to the previous year. The products have become more attractive as rising interest rates translate into higher potential annual payments from the products.

Behind the scenes, life insurers that typically sell annuities buy bonds to generate income for the products, and particularly corporate debt and asset-backed securities, including mortgage bonds. Their demand may decline a bit this year after bond yields fell, but Limra says annuity sales should remain strong by historical standards.

Insurers' bond purchases underscore the extent to which demand for many debt securities is now driven by demographics and illustrate why corporate bond valuations can remain elevated even as the Federal Reserve maintains relatively tight monetary policy.

“The main drivers of credit demand at present are individuals and retirees seeking higher overall returns, as well as annuity sales driven by the increasing number of baby boomers retiring and by a higher level of interest rates that gives policyholders higher monthly payments,” said Torsten Slok, chief economist. at Apollo Global Management.

Money raised from annuities often goes to investment-grade debt securities, typically fixed-rate and ranging from three to 10 years — which is broadly the length of annuities, said Deutsche Bank strategist Ed Reardon AG.

For investment-grade corporate bonds, demand from annuities and other investors targeting retirees helps keep valuations high. The average risk premium, or spread, on a company security rated BBB- or higher is 0.95 percentage points, near the tightest level in the past two years.

Over the past two decades, spreads have moved closer by an average of 1.49 percentage points, according to Bloomberg Index data.

Record inflows into fixed-rate annuities are also a significant driver of insurance demand for commercial mortgage-backed securities, Reardon wrote in a Feb. 6 note. The excess returns of AAA CMBS in 2024 are higher than those of investment-grade and high-yield corporate debt, according to Reardon.

The average spread of AAA CMBS over Treasuries stood at 0.88 percentage points on Friday, after falling about 30 basis points from its October high, according to data compiled by Bloomberg.

Over the next two years, annuity sales could reach $693 billion, according to Limra estimates. The group expects revenue of up to $331 billion this year, a drop from 2023, but a level that would still have been a record in 2022.

“The last two years have been great and we expect this year to be the same,” said Dec Mullarkey, managing director overseeing investment strategy and asset allocation at SLC Management, which manages 264 billions of dollars. Lower rates “will have some impact on demand,” he warned, “but they will remain at reasonable levels, and the overall yield will remain attractive relative to history.”

Fixed rate deferred annuities

Fixed-rate deferred annuities are a type of annuity that sells particularly well. Policyholders make an initial investment, which accrues interest at a fixed rate over a specified period of time. After the so-called annuity point, they can start receiving income.

The product line recently posted its best quarterly sales, with $58.5 billion sold in the fourth quarter, up 52% ​​from the same period last year, according to Limra. Volume totaled $164.9 billion in 2023, up 46% from the annual high of $113 billion reached in 2022.

Annuities tend to be more popular with people nearing retirement or who have already left the workforce. The average age of buyers of these products is around 62, according to Bryan Hodgens, head of Limra research.

About 17% of the U.S. population was over 65 in 2022, up from about 12% in 2000, according to data from the Federal Reserve Bank of St. Louis.

Any rate cuts by the Fed this year would also support corporate debt as prices rise when yields fall.

“Credit has consistently outperformed other fixed income sectors since mid-2020, and increased annuity sales are almost certainly one reason,” wrote Steven Abrahams, head of strategy for investment at Santander US Capital Markets, in a note. “This is a positive for credit performance going forward.”

(Updates elsewhere in credit box. A previous version of the story corrected the Y axis label in the second chart.)

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