Private credit continues to offer attractive risk-adjusted returns, but manager selection and underwriting discipline will become increasingly important.
Private credit remains compelling for insurers despite growing concerns around underwriting standards, valuations and market concentration, according to panellists at Longview Networks’ Insurance Investment Forum.
Speaking during a private credit panel moderated by Bob Tyley, head of insurance investment and ALM at Howden, speakers argued that insurers remain well positioned to benefit from the illiquidity premium available in private markets, particularly as banks continue to retreat from parts of the lending market.
Moritz Zander, head of investments at NewRe, said the reinsurer’s allocation to private credit and infrastructure debt had been driven by “diversification and yield enhancement”.
“Private credit allows us to access a class of borrowers that is not available in the public markets,” he said, pointing to the attraction of “an illiquidity and complexity premium at an accounting volatility lower than on the public market side”.
[L-R Gianpaolo Pellegrini, Moritz Zander, Malek Ghali and Bob Tyley]
Zander added that insurers also compare private credit strategies against regulatory capital requirements, making the excess return generated per unit of capital increasingly important.
Gianpaolo Pellegrini, managing director of private markets and co-head of parallel lending at Muzinich, said many insurers had been drawn to private credit because of the attractive risk-adjusted returns available compared with liquid markets.
He argued that tighter banking regulation continued to create opportunities for private lenders, particularly in parallel lending, by restricting banks’ appetite for lower-rated borrowers.
Hear how institutional investors are allocating at PMP’s Private Credit Forum in June.
“The pool of liquidity is not expanding,” he said. “Banks are not growing, are not expanding balance sheets. On the contrary, regulation is pushing banks to reduce exposure to even double-B quality names.”
That dynamic, he argued, was helping private lenders maintain stronger spreads and covenant protections than those available in liquid credit markets.
While private credit has historically been viewed cautiously by some insurers because of sub-investment grade exposure, speakers suggested attitudes are evolving. Pellegrini said insurers were increasingly looking at portfolio-level diversification rather than the ratings of individual assets.
“With a portfolio of 100 assets, 1% each, the strategy is providing a very strong embedded protection to the capital of the investor,” he said, noting that senior secured loans had historically generated recovery rates of around 70%.
Malek Ghali, managing director for private credit at Clearlake, said insurers were becoming more sophisticated in how they approached the market and increasingly selective about strategies and managers.
“Just like any credit, there is always risk of default,” he said. “You have to be selective with the managers, you have to be selective within each asset class.”
However, he argued that private credit continued to offer insurers attractive risk-adjusted returns relative to the capital they are required to hold against those assets.
The panel also highlighted growing insurer interest in more tailored structures, including separately managed accounts and evergreen-style vehicles with runoff features.
However, Zander remained cautious around liquidity risk. “We really mark these assets with 100% illiquidity charge,” he said, adding that the firm would “be very careful not to have liquidity options in those vehicles”.
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The discussion comes amid growing regulatory scrutiny of private credit markets internationally, particularly around valuations and underwriting standards.
Ghali said some of the concerns had been driven by developments in US evergreen vehicles, where rapid capital deployment may have encouraged weaker underwriting standards.
“I think we are going to see a bit of an increase in defaults,” he said. “Some managers have maybe taken excess risk, that have been more deployment managers rather than credit-focused managers.”
He added that managers with stronger underwriting discipline and deeper sector expertise were likely to outperform as market conditions become more challenging.
Pellegrini similarly pointed to growing dispersion across the market, particularly as large pools of capital have intensified competition in some sectors, including software. “We like pretty boring stuff,” he said. “We look for sectors which are resilient. We don’t chase 10% CAGR on the top line, we chase stability of the cash flows.”
He suggested Europe could prove more resilient than the US, because lenders have generally maintained a stronger focus on stable cashflow businesses.
Valuation practices also emerged as a key theme. Ghali said investors were demanding greater reassurance around valuation methodologies and expected to see increased use of third-party validation processes.
“Part of the attractiveness of that asset class is the lack of volatility,” he said, although he acknowledged that managers would need to narrow the gap between stability and transparency as scrutiny intensifies.
Zander said the true test for managers may only emerge once a more difficult credit cycle fully reaches private markets. “The default rates that we see in the portfolio are really, really low,” he said. “But once distress activity hits the private market, we’ll see which of our managers can deliver the alpha that they promised.”
Despite those concerns, panellists remained broadly positive on the long-term outlook for insurer allocations to private credit.
Pellegrini added recent reforms could increase the attractiveness of the asset class in the UK market and create opportunities for managers to structure vehicles better suited to insurers’ regulatory requirements.