Three often-overlooked investments insurers are using to add duration

Increasing duration was the most popular course of action in Nuveen's 2024 EQuilibrium survey of institutional investors. Half of the 800 respondents said they would be doing this, in contrast to the 19% who planned to decrease it. And insurers were even more likely to extend: 61% of North American insurers, 58% in Asia Pacific and 53% in Europe.

It's not surprising insurance companies are looking to capitalize on ways to lock-in higher rates and match long-term liabilities.

The surprise is the investment choices used to express this view: two lesser-known but innovative debt instruments - Commercial Property Assessed Clean Energy (C-PACE) and credit tenant loans; and U.S. municipal bonds, which are often overlooked to extend duration.

C-PACE

C-PACE is a U.S. state policy-enabled financing mechanism. It secures repayment through a senior, special assessment on the underlying property, allowing commercial property owners to obtain low-cost, long-term and fixed-rate financing for commercial real estate projects related to energy efficiency, water conservation, renewable energy and resiliency. These projects could include LED lighting installation, improved insulation, solar panel installation and much more, which also have the potential to reduce a building's running costs.

Along with duration, insurance companies are attracted to C-PACE's credit quality (typically investment grade) and low risk (given its seniority). It also gives exposure to sustainability-themed investments and impact opportunities, and is a way to add diversification to portfolios.

Over the coming years, we anticipate the C-PACE market will continue to grow, with new C-PACE policy and program launches expanding the addressable market of eligible buildings. In 2015, only a handful of U.S. states had C-PACE programs. Today, over 30 states have active programs with completed projects. At the same time, real estate investors and tenants are demanding more sustainable buildings, which are not only better for the environment, but can also reduce operating expenses and benefit real estate values.

Credit tenant loans

Credit tenant loans (CTLs) are the monetization of a tenant's lease payments. They typically deliver long-term income streams (in the region of 30 years), with the leased property as collateral - providing indirect exposure to real estate without having it on the balance sheet.

Tenants are usually high quality, investment grade organizations, such as the U.S. government, municipalities and well-established public and private companies.

The appeal of CTLs to insurers, particularly life insurers, lies in the ability to diversify sources of long-dated duration and investment grade income, and match long-term liabilities.

CTLs have been available for decades (Nuveen set up its platform in 1996), but it's a relatively small and niche market, which may partly explain why they are often overlooked or not considered at all as a duration extension tool.

Consistent origination of CTLs at scale requires strong relationships across market participants - asset owners, brokers and other intermediaries - to ensure access to deal flow; legal and financing expertise to structure the loans; and experienced credit research teams to assess the tenant's ability to repay. As a result, investors can expect to see a spread premium for this type of complexity when considering CTLs.

Like other private placements, we anticipate CTLs will continue to benefit from the growing demand for alternative financing.

Municipal bonds

Municipal bonds are issued by U.S. state and local governments, with the proceeds supporting and financing public projects and infrastructure, like roads, bridges, schools and hospitals. These are essential services and long-term in nature, which lends the asset class long average duration and stable credit ratings. These features provide a level of predictability and consistency that insurance companies desire in their asset portfolios.

Municipal bonds can be taxable or tax-exempt. This status relates to their tax treatment for U.S.-based taxpayers. While the tax-exempt market is dominated by U.S. retail investors, the taxable market, which has grown substantially over the last decade, sees significant demand from life insurance companies and other institutional investors across the entire globe.

Issued by highly rated government or quasi-government institutions and with significantly lower default rates than comparable corporate bonds, municipal bonds add diversification to a portfolio. And with maturities up to 30 years, long-dated munis can be used to tailor a portfolio's duration profile.

Specific to insurance companies, the high-quality nature of the municipal market can provide additional value. Favorable capital charges and compelling valuations relative to corporate bonds have garnered increasing demand from insurers as the diversification benefits and more favorable capital treatment have offered an efficient way of extending duration.

Adding to the attraction for insurers globally is the ability to align these bonds with environmental, social and governance (ESG) objectives. The infrastructure and other services funded by municipal bonds can have positive environmental and social outcomes for communities. Provision of mass transportation or health care facilities, recycling and waste disposal or water management are a few examples. Financing these types of projects - with the ability to track and measure progress - can help insurers achieve specific sustainability goals.

What next?

Insurance investors never cease to amaze me. Learning how they think about duration and how to extend it in the current rate environment is fascinating. And the use of new and emerging asset classes, along with time-tested traditional fixed income, to express their views underscores their sophistication. I can't wait to see how insurer's strategic and tactical asset allocations continue to evolve.

For further insights into the investment behaviors of insurance companies, download Nuveen's EQuilibrium survey.

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