Insurance companies have, of late, jumped into the state development loan (SDL) forwards market, transforming it from nil activity just three months ago to now accounting for nearly 10–15% of the overall bond forwards market. The bond forward market began only seven months ago, on May 1, 2025, with Kotak Life Insurance executing the very first deal in government securities (G-Secs) on May 5, 2025, purchasing a 40‑year, 7.34% 2064 G-Sec worth Rs 20 crore from JP Morgan India. Building on that, insurers are now increasingly turning their attention to SDLs, particularly in the long-tenure bond forward market, as spreads over G-Sec widen and opportunities for higher yields emerge.
ICICI Prudential Life Insurance has taken the lead in this space, becoming the first insurer to execute SDL bond forwards in the 20–25 year segment, say market participants stating that the company, in August 2025, bought SDLs issued by Haryana and Bihar, locking in an IRR (internal rate of return) close to 8%.
Why is this significant?
This move is notable because SDLs, while carrying sovereign status, typically trade at a spread of 40–50 basis points above comparable G-Secs. For insurers managing guaranteed products and annuities, this incremental margin provides a meaningful boost to portfolio returns. Sources say Axis Max Life Insurance has also been tapping the bond forwards market, which has bought top states SDLs such as Gujarat.
“The introduction of bond forwards has made insurers agnostic between SDLs and G-Secs, since both are physically delivered instruments. With SDLs offering higher spreads, insurers now have a compelling reason to allocate part of their demand to these state-backed securities,” said a senior investment executive at a domestic insurance company, further adding that the growing traction in this segment has seen around 15% of the overall bond forwards today are SDLs.
Limited market
Meanwhile, the market remains limited, with only a handful of deals executed so far. The spread advantage in the 10–15 year segment has created opportunities for insurers to diversify. However, fund managers are cautious, stating that the SDL forward market is still evolving, with both buyers and sellers needing to strengthen systems and secure internal approvals before broader participation can occur.
The reasons behind insurers lining up for SDLs are multi-fold. First, the steepening of the yield curve has made long-tenure SDLs particularly attractive, especially for insurance companies that must match long-term liabilities in guaranteed products. Second, the regulatory environment has shifted flows away from pension funds, leaving insurers as one of the few natural buyers of long-dated bonds. Third, the seasonal borrowing patterns of state governments—where SDL issuance typically spikes in the fourth quarter—are expected to widen spreads further, creating additional opportunities for insurers to capture value.
“The SDL typically offers a 40-50 basis points (bps) additional over a G-Sec, providing a clear margin. Consequently, a portion of demand will shift towards SDL,” said a head of investment of a private insurer. “We will continue doing bond forwards in SDLs as long as these spreads persist. In the fourth quarter, SDL spreads are expected to widen further, providing an opportunity to capture the differential,” the insurer added.
“Though we have not done any bond forwards in SDLs yet, we are open to doing it in good state papers,” said a senior fund manager at the private life insurance company. “The outlook for SDLs in the bond forward market appears promising. As more insurers follow, the market could see incremental growth, particularly in the 20–30 year segment where spreads remain compelling,” he added.
In the coming months, as state governments ramp up borrowing and spreads widen, SDLs are likely to become a more prominent feature of insurers’ bond forward strategies. Says Gaura Sengupta, chief economist, IDFC First Bank, “The state government borrowing is expected to rise to Rs 4.7 lakh crore compared to Rs 4.3 lakh crore in Q4FY25. For the year, we expect gross issuances by states at Rs 12.3 lakh crore.” She added that the state fiscal deficit is expected to widen to 3.5% of GSDP (gross state domestic product) in FY26, up from 3.2% in the previous year. “The higher deficit is led by a sharp slowdown in tax revenue collection – both own tax and share in the centre’s tax collection. Grants from the centre continue to decline, reflecting just-in-time cash management for schemes.”