An insurance product aimed at funding retirements is experiencing unprecedented demand, fueling a surge in corporate debt and commercial mortgage bonds within the US credit market. Annuities, which offer consumers the ability to secure income for life, achieved record sales of $385 billion last year, marking a 23% increase from the previous year, according to the life insurance trade group Limra. This surge in sales is attributed to the attractiveness of annuities amid rising interest rates, which translate into higher potential annual payouts.
Behind the scenes, life insurers selling annuities are investing in bonds, particularly corporate debt and asset-backed securities like mortgage bonds, to generate income for these products. While demand may slightly decrease this year due to falling bond yields, annuity sales are still anticipated to remain robust by historical standards, according to Limra.
The bond purchases by insurers underscore how demographic shifts are driving demand for debt securities, highlighting why valuations for corporate bonds can remain elevated despite the Federal Reserve maintaining relatively tight monetary policy.
“Credit demand is currently being propelled by retail and pension funds seeking higher yields, along with annuity sales driven by a growing number of retiring baby boomers and higher interest rates resulting in increased monthly payments to policyholders,” noted Torsten Slok, chief economist at Apollo Global Management.
Sales proceeds from annuities are typically allocated to investment-grade debt, predominantly fixed-rate and spanning three to ten years, aligning with annuity durations, as stated by Deutsche Bank AG strategist Ed Reardon. This demand from annuities and other retiree-focused investors helps uphold high valuations for investment-grade corporate bonds, with spreads remaining close to their lowest levels in two years.
Record inflows into fixed-rate annuities also bolster insurance demand for commercial mortgage-backed securities (CMBS), with AAA CMBS excess returns surpassing those of both investment-grade and high-yield corporate debt, according to Reardon. Despite a decline in the average AAA CMBS spread versus Treasuries, annuity sales are projected to reach up to $693 billion over the next two years, with Limra estimating sales of up to $331 billion in 2024, marking a potential decline from 2023’s record levels but still historically high.
The popularity of fixed-rate deferred annuities, in particular, has surged, with sales reaching their highest quarterly level of $58.5 billion in the fourth quarter of 2023, up 52% from the previous year. This product appeals to individuals nearing retirement or already retired, with the average age of buyers around 62, according to Limra.
The aging population trend in the US further bolsters the demand for annuities, with approximately 17% of the population being over 65 years old in 2022 compared to about 12% in 2000, according to data from the Federal Reserve Bank of St. Louis.
Any potential rate cuts by the Fed this year are expected to further support corporate debt as bond prices rise inversely to yields, contributing to continued robust performance in the credit market.
