Research summary

Insurers play key role in European credit markets

November 07, 2022

European insurers’ investment preferences changed when bond yields were at all-time lows, and are expected to change again as yields and spreads reach decade highs. We spoke with Vanguard experts to understand what drives the investment decisions of insurance companies and their impact on credit markets. We also asked how understanding the investment behavior of insurance companies informs fixed income investing at Vanguard.

How important are insurance companies in European corporate bond markets and how is their role changing with central banks stepping away as buyers?

European insurers currently hold about €1.9 trillion in corporate bonds. After adjusting for non-investment-grade, unrated, and some private credit, and assuming a small share of investments would be in bond markets outside Europe, we calculate that insurers own more than 50% of the European investment-grade credit bond universe.

Insurers are key players in credit across regions, but especially in Europe and the U.K.
Three pie charts show the percentages of indexes held by insurers and by other investors. In the Bloomberg Euro Aggregate Corporate Bond Index, insurers own 52% and other investors own 48%. In the Bloomberg Sterling Corporate Bond Index, insurers own 56% and other investors own 44%. In the Bloomberg U.S. Corporate Bond Index, insurers own 23% and other investors own 77%.

Note: The total investment-grade corporate bond universe for each pie chart is based on the following indexes as of September 23, 2022: Bloomberg Euro Aggregate Corporate Bond Index, Bloomberg Sterling Corporate Bond Index, and Bloomberg U.S. Corporate Bond Index.

Sources: Vanguard estimates based on Bloomberg data, National Association of Insurance Commissioners, UK Association of British Insurers, European Insurance and Occupational Pensions Authority, S&P Global Market Intelligence, and Barclays Research.

The recent pivot to quantitative tightening by the European Central Bank (ECB) has created an annual supply-demand gap of €65 billion to €70 billion in the corporate bond market.

Getting back to equilibrium will require some supply adjustments, such as lower issuance volumes, but it will also require other market participants to step up to help fill the ECB’s shoes. Insurers have the scale to do this, and therefore their investment preferences are likely to drive performance with regard to individual bonds and issuer sectors, as well as currency and tenor. 

With insurers having a continuing inflow of fresh cash to invest from premiums earned, a small change in their allocation strategies can have a large impact on the market.

All in all, we believe insurers will continue to be constrained by the need to match liabilities, and in a rising yield environment, we expect corporate bonds to remain a sweet spot.

How will high inflation, rising rates, and slowing economic growth affect insurers’ investment decisions and the credit markets?

The current macroeconomic backdrop argues for insurers holding higher-quality corporate bonds and more liquid securities.

In recent months, record-high inflation levels have forced central banks across the globe to start hiking rates, which in turn has led to yields on government and corporate bonds surging to their highest levels in years. The charts below illustrate how yields have moved to the highest they have been in over a decade (chart on the top) and that the share of bonds with negative yields has fallen to zero from recent highs of almost 50% (chart on the bottom).

Yields in European investment-grade credit have moved significantly higher
A line chart shows the yield to worst for the Bloomberg Sterling Corporate Bond Index, Bloomberg Euro Aggregate Corporate Bond Index, and Bloomberg U.S. Corporate Bond Index. All three lines show a gradual and uneven decline in yield to worst from January 31, 2012, through August 31, 2021, and then a sharp, uneven upturn to end at highs for all three indexes on June 30, 2022. A mountain chart shows negative yields for corporate bonds appearing at the beginning of 2016. From that point, the percentage of negative yields varied greatly from zero to almost 50%, but it returned to zero at the end of April 2022 and has remained there since then.

Note: “Yield to worst” is the lowest potential yield that a bondholder could receive except in the case of default.

Sources: Vanguard and Bloomberg.

With the escalation of the energy crisis in Europe, a recessionary scenario in the region is looking highly likely, which will bring with it an increased level of corporate defaults and a migration of more bonds to non-investment-grade status.

In this context of economic deterioration, we expect insurers to tilt their investment portfolios even more toward higher-quality bonds, supporting the demand for and consequently the performance of these assets.

All in all, we believe insurers will continue to be constrained by the need to match liabilities, and in a rising yield environment, we expect corporate bonds to remain a sweet spot.

Why insurers’ investment behavior is important to bond investors

We expect changes in the economy, markets, regulatory environment, and future priorities (like ESG considerations) to affect the way insurers invest. 

Insurers tend to be sticky, long-term owners that are likely to remain invested even as central banks raise rates and unwind their holdings. They’re likely to keep cash flowing into the market given that they will need to continue investing insurance premiums regardless of the market environment.  These dynamics should help dampen volatility and pave the way to a new equilibrium in the credit market as central banks back down. That said, given the size of insurers’ portfolios, a small change in their allocations can have a large impact on the markets.

Because insurers provide significant liquidity to the market, it’s important to understand their investment philosophies, constraints, and objectives. While we do not try to time the market and are laser-focused on generating alpha through consistent selection regardless of the market environment, we see the supply-demand dynamic in credit as a key input alongside fundamental and relative-value analysis.

Read more insights on this topic from these experts in Vanguard Fixed Income Group.

Active Fixed Income at Vanguard
The graphic shows that Vanguard’s active Fixed Income Group managed $227 billion in taxable bonds and $199 billion in municipal bonds as of September 30, 2022. The active management team includes more than 25 portfolio managers, more than 35 traders, more than 60 research analysts, and more than 130 dedicated team members.

* Includes funds advised by Wellington Management Company LLP

Note: Data are as of September 30, 2022.

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