With the introduction of Solvency II at the start of 2016, and with interest rates continuing to remain at historically low levels, insurers are increasingly looking for ways to deliver attractive risk-adjusted returns that are efficient from a capital perspective.
Many of the most commonly used fixed-income investments, such as high-quality government bonds, now generate low to negative real returns. Consequently, insurers are looking beyond traditional asset classes, be that investing in illiquid forms of private credit, diversifying exposures globally or moving down the credit spectrum in order to find more attractive risk-adjusted opportunities.
One asset class that has seen growing interest from insurers is Senior Secured Loans (SSLs). SSLs are floating rate, sub-investment grade rated, USD/EUR-denominated loans to corporates. They sit senior in the capital structure and are secured on assets, hence loss on default should be lower than on comparable, unsecured investments.
Combined with the higher spreads currently on offer, this results in potentially higher risk-adjusted returns compared with high yield bonds.
Given that there is no difference in the capital treatment under the Solvency II Standard Formula (for an equivalent rating and duration), it also means the potential for a higher return on capital for the insurer.
From a historic performance perspective, SSLs have recorded positive returns in the vast majority of years, and annual volatility has been relatively low. They have exhibited a moderate (post crisis) correlation to investment grade corporate bonds, and at the same time correlations to government bonds have been close to zero – this may provide insurers with potential diversification benefits.
This paper takes a closer look at SSLs and considers how the asset class may fit within an insurance company's investment strategy.