Who ultimately "pays the bill" for the AI frenzy? U.S. insurers
U.S. life insurance companies are becoming key financiers in the AI investment frenzy, as their massive pension investment needs align with the multi-trillion dollar funding gap for tech companies building data centers.
On November 14, it was reported that Morgan Stanley analysts estimate that global data center capital spending is expected to reach about $3 trillion by 2028, with about $1.5 trillion of that unable to be covered by expected cash flows and requiring external financing. Tech giants have recently issued a flurry of bonds; companies such as Oracle, Meta, and Alphabet have entered the high-grade bond market. JPMorgan estimates that this market could absorb $300 billion in AI data center-related issuance over the next year.
In the past two or three years, U.S. life insurance companies have become the largest marginal buyers in the credit market, driving investment-grade corporate bond spreads to their tightest levels since the 1990s. This trend coincides with a peak in U.S. population aging, and annuity sales in the first nine months of this year have reached a record $345 billion.
Analysts indicate that the demand of insurance companies for longer-duration, higher-yield assets provides an ideal investor base for AI-related bond issuance, and more such financing is expected in the future. This supply-demand match is changing the rules of the traditional corporate bond market, prompting the market to accept more complex financing instruments and longer bond terms, but also presenting new evaluation challenges for ordinary investors.
Tech Giants Face Trillion-Dollar Funding Gap
Tech companies’ investment needs in AI have exceeded their own financial reserves.
Morgan Stanley analysts estimated in July that global data center capital spending will reach about $3 trillion by 2028, of which only about half can be provided by expected cash flows, leaving a funding gap of roughly $1.5 trillion.
To meet such huge funding requirements, tech companies must turn to the largest financing markets. In terms of corporate borrowing, the investment-grade bond market is one of the main channels.
According to data compiled by Sifma, investment-grade corporate bond issuance accounts for about two-thirds of the more than $2 trillion total issuance in the U.S. corporate bond and asset-backed securities market through October this year.
Recently, there have been several large-scale bond issuances from AI competition participants, including Oracle, Meta, and Google’s parent company Alphabet. JPMorgan analysts expect that the high-grade bond market could absorb $300 billion in AI data center-related issuance over the next year.
Insurance Capital Becomes Largest Marginal Buyer in Credit Market
The biggest technical change in the credit market over the past two or three years is that U.S. life insurance companies have become the largest marginal buyers. Morgan Stanley Chief Fixed Income Strategist and Director of Quantitative Research Vishwanath Tirupattur said:
"The biggest technical change in the credit market over the past two or three years is that U.S. life insurers have become the largest marginal buyers, which has tightened overall credit spreads."
Insurance company demand has become a broad driving force in the credit market. This is one of the factors behind the narrowing of investment-grade corporate bond spreads—that is, their premium over benchmark Treasury yields—to the tightest levels since the 1990s.
This growth in demand is closely related to demographic changes in the United States. This year is a peak year for the number of people aged 65 and over, spurring another record for U.S. annuity sales.
According to industry group Limra, sales reached $345 billion in the first nine months of this year. Life insurance companies need to invest in the growing pension pool, helping people generate income when they are no longer working.
A recent report on life insurance companies by Swiss Re Institute economists stated:
In developed markets and rapidly aging emerging markets, the rising need for retirement income "may shift liabilities toward longer durations." Advances in bioscience and healthcare resulting in greater longevity risk mean that insurers also need to seek longer-term asset allocations.
Market Rules Are Being Rewritten
The mainstream corporate bond market is one of the largest and typically lowest-cost ways for companies to borrow.
Historically, however, this market had certain conventions: it targeted companies with the highest credit ratings, focused on bonds with public reporting and fairly straightforward structures, and many bonds matured in under 10 years.
However, when a company’s borrowing exceeds what its cash flows can support, its credit rating may be affected. There are still many unknowns about AI: How much end-user demand will there ultimately be? How long will the chips needed to power AI last? Will there be enough cheap electricity?
Nevertheless, insurance companies have become more willing in recent years to invest using less traditional tools. Research analysis from the Chicago Federal Reserve found that life insurers have been increasing investment in "privately placed securities offering higher yields but more complex structures."
JPMorgan analysts wrote in October that the publicly-traded high-grade bond market "has become increasingly adept at absorbing unconventional financing instruments related to data center growth."
Ben Hunsaker, head of structured credit at Beach Point Capital Management, said:
"You’ll see more of these moves from hyperscale cloud providers. The expectation is, if they win at AI today, they’ll earn trillions in the future. So what’s a little extra interest?"
As insurers become more accepting of higher-yielding, larger, and more complex products, even in the investment-grade market, more issuances to fund AI construction seem inevitable.
For regular investors, it may become necessary to spend more time evaluating what they previously saw as a highly straightforward market. Those who chose corporate bonds mainly to minimize risk may need to be more cautious about which part of the market they buy from.
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