The flight down the credit spectrum by US life insurers is expected to slow, as firms grow uneasy about the share of low-rated bonds in their portfolios, CreditSights said in a report.
The research firm predicts that insurers chasing yield will look beyond fixed-income instruments and towards alternative assets such as hedge funds and private equity funds.
Insurers have increased credit risk in their fixed-income portfolios largely in response to protracted low interest rates in the aftermath of the financial crisis.
Reinvesting the proceeds of high-quality maturing securities in lower-rated bonds was a way to sustain average yields in fixed-income portfolios.
The average share of BBB-rated or sub-investment grade bonds increased to 37.4% in 2013, up from 30.9% in 2007, according to the report.
But this trend is expected to slow down or reverse, as insurers reach "the point of BBB and below investments they are comfortable with", Rob Haines, analyst at CreditSights wrote.
Haines points at the cases of MetLife and Lincoln National, which have both reduced their exposures in the first half of the year.
At the end of June 2014, MetLife held 30.4% of its bond portfolio in BBB or sub-investment grade assets, compared to 30.9% in December 2013. As for Lincoln National, BBB and below investment grade bonds accounted for 45.2% of the portfolio, down from 45.4%.
An alternative strategy to increase yield is to invest in longer-dated bonds.
However, there has been only a marginal uptick in the average duration of insurers' portfolios, which reflects widespread reluctance to locking-in low rates for long durations, especially as the Federal Reserve moves to tighten monetary policy.
Haines said that going forward insurers are expected to look beyond their fixed-income portfolios towards alternative assets to get yield.
He added that investments in hedge funds and private equity are expected play a key part in insurers' asset allocation strategies over 2015.
