Solvency UK reforms present sub-IG private debt opportunities for insurers
Recent Solvency UK reforms have paved the way for UK life insurers to invest in sub-investment grade (SIG) private debt assets, a new report has suggested.
The UK’s Prudential Regulation Authority last year made changes to the matching adjustment (MA) framework.
The MA is an upward adjustment to the risk-free rate where insurers hold certain long-term assets with cashflows that match the liabilities. The regulator removed the cap on the MA that may be claimed from individual SIG assets, allowing firms to benefit from any additional risk-adjusted spread from those assets.
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A white paper launched today by Legal & General in partnership with Hymans Robertson says that private debt at the highest credit-quality end of SIG, those assets with a BB rating, presents new opportunities for UK life insurers.
“The recent Solvency UK reforms represent a significant opportunity for life insurers to enhance capital efficiency by incorporating BB-rated private credit into their MA portfolios,” said Alex Wharton, managing director, partnerships and insurance, asset management at Legal & General.
“Insurers can strategically access these assets to improve risk-adjusted returns, diversification, and strengthen long-term liability management.
Read more: Regulators increase scrutiny of insurers’ private credit investments
“Beyond the potential financial benefits, these changes align with a broader push toward sustainable investment. BB-rated assets offer insurers a pathway to support impact led initiatives, such as renewable energy and social infrastructure, driving long-term economic growth. With greater flexibility under the new framework, insurers are well-positioned to explore new investment frontiers.”
Anecdotal evidence from the asset management division of L&G suggests that there is little difference in the probability of default between BBB- and BB-rated private debt assets.
Investment into BB-rated private debt produces higher returns than IG private debt, but does not generate the double-digit returns seen from lower rated SIG direct lending, the white paper said.
BB financings are likely to generate returns of 300-350bps above risk-free rates, equating to around 50-150bps above public BB spreads.
However, the white paper noted that SIG assets pose additional risks for an insurer compared to IG assets, around areas including liquidity, cashflow uncertainty, concentration risk and rebalancing constraints.
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