US insurance regulators on Monday will meet to consider boosting capital charges on complex corporate loan instruments that some in the industry warn are creating excessive risk.
The issue pits insurers backed by large private equity firms such as Blackstone, Apollo Global and KKR — who are increasingly investing in the loans — against traditional life insurers such as MetLife and Prudential Financial, who warn of growing risks. Monday’s gathering is hosted by the National Association of Insurance Commissioners, a trade group whose standards are relied upon by state insurance commissioners.
The private equity-backed insurers are resisting a proposed 50 per cent increase in the capital charges held against the riskiest slices of corporate loan packages that are purchased with annuity premiums. Those increases are supported by many of the largest life insurers in the US, who warn that their aggressive rivals are overloading customer portfolios with excessive risk. Higher capital requirements can help absorb potential investment losses but also depress investment returns.
“We are creating a potential bubble within US life insurance,” one insurance executive said. “It is a critical story for the US insurance industry to work out.”
The debate centres on the $3tn annuities market — financial products that life insurers sell to millions of US savers looking to build income streams for retirement.
Regulators have been increasing their scrutiny of new insurance players built out of private equity firms, whose credit investing units rely on insurance and annuity premiums to invest in fixed income securities, bolstering the firms’ overall assets under management.
The insurance businesses inside private equity firms tend to invest in more complex securities in order to earn greater “spread” profits between investment returns and obligations owed to policyholders. The private equity firms have insisted that their portfolio choices do not increase risk of losses but rather seek excess returns through buying illiquid or complex instruments.
The working group of the NAIC is set to discuss the capital charges associated with collateralised loan obligations, or CLOs, that bundle multiple corporate loans and sell in tranches that range in rating from AAA down to high yield and equity.
The current risk-based capital regime, the NAIC noted, allows for an “arbitrage” opportunity for the holder of a CLO loan. A B-rated corporate loan owned by an insurer has to set aside equity of 9.5 per cent. However, a CLO created from a package of B-rated loans with six tranches would have a blended capital charge of just 2.9 per cent.
Comment letters to the NAIC now publicly disclosed show disagreement on whether to synchronise the capital treatment between underlying loans and CLOs.
A letter signed by several large traditional insurers including Equitable, MetLife, New York Life and Prudential, said “structured securities are important financial products, but they also have unique ‘cliff risks’ not present in most financial assets”, referring to the possibility of a sudden catastrophic outcome.
The group supports a recommendation to raise the capital charge for the riskiest equity tranche from 30 per cent to 45 per cent.
In a letter signed by insurers backed by the likes of Apollo, billionaire Todd Boehly’s Eldridge Industries, KKR and Blackstone, this group said the current capital charges were appropriate.
“Based on a long track record of available data, it is clear that corporate bonds have higher default and loss experience than equivalently rated structured securities, making comparable structured securities’ risk-based capital factors overly conservative as they currently stand”, they wrote.
Two traditional insurers, MassMutual and Guardian Life, have aligned themselves with the private equity firms, according to letters that the pair submitted.
Data compiled by NAIC show CLO holdings of insurers have surged to more than $200bn, though that figure represents only about 3 per cent of the aggregate investment portfolio of the companies in the insurance universe.
One private equity backed insurer, Apollo’s Athene Holding, publicly disclosed that its CLO investment allocation comprises a tenth of its $200bn portfolio.
NAIC has noted the vast majority of insurance CLO holdings are in high grade tranches and are not likely to be affected by any upward revisions to capital charges for riskier tranches.
The NAIC published in 2022 a document listing 13 “regulatory considerations” for insurers affiliated with private equity firms, revealing its interest in better understanding the newer insurance players. The CLO debate is seen by some as a proxy for how the group will apply future scrutiny to private equity-backed insurers.
Some PE-backed insurers have also characterised the potential higher capital charges as a backdoor attempt to ward off competitive threats posed by newer entrants that are cannier investment managers.
But some in the legacy insurance industry say that private equity backed insurers are downplaying the underlying risks in their portfolios.
“[We] are not willing to play the arbitrage,” said one traditional life insurance executive. “It is dangerous for our industry.”
