Insurers scream for securitized debt amid surging annuity demand

Insurance companies are snapping up asset-backed bonds to fund future payouts on their annuity products which are seeing record demand — a trend that is expected to continue, according to Morgan Stanley.

Securitized products grew to 25% of insurers’ bond portfolios in 2023 compared to 22% in 2017, adding roughly $365 billion in exposure to the segment, the bank said in a January 31 research note. Insurers putting together annuity products are drawn to longer-dated asset-backeds as their duration is a good match for annuities, and also for their attractive yield profiles.

The higher-for-longer interest rate backdrop has led retirees to pour cash into annuity products, which effectively allow them to buy income for the rest of their lives. Sales of annuities soared to a record $432.4 billion in 2024, according to life insurance trade group Limra. That marks a 12% increase from 2023 and the third year of record sales. In turn, that’s fueled insurers’ demand for corporate debt and asset-backed securities to power annuity payouts.

“Despite the potential for interest rates to come down, we think life insurers’ meaningful demand for securitized products can be sustained,” the Morgan Stanley strategists wrote. “Interest rates coming down might dampen attractiveness for fixed rate annuities to some degree. At the same time, though, it could prompt a bump in sales, as potential annuities purchasers may look to lock in an attractive rate.”

The growth of securitized products is easiest to see in the ABS market, as well as the collateralized loan obligations market where leveraged loans are bundled into bonds. Insurance holdings of ABS and CLOs jumped to a combined $312 billion in 2023 from $78 billion in 2019, Morgan Stanley estimates.

Sales in both markets hit records last year, as ABS sales rose to their highest level since the financial crisis, while CLO sales set an annual issuance record for the third time since 2018. CLO risk premiums have also tightened, pushing spreads on AAA-rated broadly syndicated CLOs to around the lowest in more than a decade. An expected uptick in buyout activity this year could bolster CLO sales further.

Meanwhile in the ABS market, average spreads tightened in mid-January to their lowest level in nearly three years. Esoteric ABS make up a significant chunk of insurers’ holdings, with whole business securitizations growing by $15.2 billion from 2019 to 2023, according to Morgan Stanley, followed by a $13.8 billion increase in equipment ABS and an $11.3 billion increase in digital infrastructure ABS over the same period.

“Unlike the rest of the securitized products landscape, ABS holdings are actually more concentrated in the single-A and BBB buckets, a dynamic driven at least partially by the reality that the esoteric ABS capital structures that have the combination of yield and duration that insurance companies are looking for might not actually have AAA rated tranches,” the bank notes.

“We have seen an explosion of annuity product demand, particularly on the fixed side, from consumers interested in this product as a retirement solution,” said Mike Nowakowski, head of structured products at Conning. “With spreads on investment-grade corporates being as tight as they are, structured credit offers a very compelling case, particularly in the esoteric ABS market.”

Looking ahead, Morgan Stanley expects the ties between insurance and structured credit to strengthen as the retirement age population grows, projecting 6% annualized growth in securitized products from the end of 2023 to 2027.

“Boomers are getting older everyday regardless of Treasury Yields and that demographic tailwind will likely drive insurance demand as much as available annuity yields,” said Ben Hunsaker, head of structured credit at Beach Point Capital Management.