Disclaimer: Views in this blog do not promote, and are not directly connected to any L&G product or service. Views are from a range of L&G investment professionals, may be specific to an author’s particular investment region or desk, and do not necessarily reflect the views of L&G. For investment professionals only.
Sub-investment grade private debt investment opportunities for life insurers under Solvency UK reform
Solvency UK reforms are allowing life insurers to assess investments in additional asset classes. One area that may be of particular interest is sub-investment grade private debt.
The recent Solvency UK reforms have removed barriers on the ability of UK life insurers to benefit from investing in sub-investment grade (SIG) assets. In particular, the Prudential Regulation Authority (PRA) policy statement PS10/24, published on 6 June 2024, sets out changes to the Matching Adjustment (MA) framework. This included the removal of the cap on the MA that may be claimed from individual SIG assets, allowing firms to benefit from any additional risk-adjusted spread available on SIG assets.
L&G’s asset management division recently partnered with Hymans Robertson, co-authoring a whitepaper primarily focussed on private debt with a credit rating of BB, i.e., those at the highest credit-quality end of SIG (BB, B, CCC etc.) assets. These opportunities are already utilised by those insurers who do not have to be concerned with the UK’s MA regulations, albeit they also face many of the other challenges covered in this whitepaper. Until now, MA insurers’ holdings of BB-rated private debt tend to be ‘fallen angels’ – investments bought as investment grade that subsequently downgrade to sub-investment grade.
The so-called ‘BBB cliff-edge’ was a feature of the MA framework that disincentivised investment by annuity providers in SIG assets. The cliff-edge ensured that the MA benefit from SIG assets didn’t exceed the MA benefit that would arise on a BBB-rated asset with the same characteristics. This, and the fact that SIG assets will incur a higher capital charge than investment-grade (IG) equivalents, has contributed to MA firms largely avoiding SIG assets since the introduction of Solvency II in 2016.
With the removal of the cap, MA firms should now be considering the opportunities that this brings, in our view. In particular, how an allocation to lower rated assets can be complementary to their wider asset strategy, subject to compliance with the Prudent Person Principle and regulatory guidance[1]. This could include both SIG assets and increasing allocations to BBB/BBB- assets where the impact (related to the cliff-edge effect) of a future downgrade may have previously made investment unattractive.
You can read the full whitepaper from L&G and Hymans Robertson here.
[1] Paragraph 7.13A of SS7/18 sets out PRA expectations for firms investing in SIG assets
Recommended content for you
Learn more about our business
We are one of the world's largest asset managers, with capabilities across asset classes to meet our clients' objectives and a longstanding commitment to responsible investing.
