New Regulations Impacting Life Insurance Debt Structures
Over the past four years, U.S. insurance regulators have concentrated on enhancing regulations concerning risky debt in life insurance portfolios. This effort has culminated with the introduction of new regulations this month. The focus has been on collateralized loan obligations (CLOs), securities comprising corporate loans to entities often holding subpar credit ratings. Developed by the National Association of Insurance Commissioners (NAIC), revised capital rules for these securities now make holding large amounts of CLOs more capital-intensive, covering approximately $314 billion in structured debt held by insurers.
Despite the regulatory changes, the insurance industry has proactively diversified into other structured debt forms not covered by new regulations. This reflects a broader trend where insurers, driven by long-term liabilities, are exploring complex debt structures to optimize yields. Between 2018 and 2022, insurer holdings of CLOs doubled, though this growth slowed in response to regulatory signals and changing interest rates. The expansion in total structured securities, including those backed by student loans, auto payments, and music royalties, has sustained a steady annual increase of 10%, indicating insurers' persistent interest in structured debt.
Aaron Sarfatti, former Chief Risk Officer at Equitable and current Federal Reserve Insurance Policy Advisory Committee member, noted insurers have reallocated investments into alternative structured securities. This strategic shift follows an internal NAIC analysis, showing insurers purchasing entire CLO tranches could meet capital requirements with less capital than holding the loans directly. Pratik Gupta, Bank of America’s head of CLO research, validated that regulatory adjustments would increase capital requirements for single-A CLO tranches.
The American Council of Life Insurers (ACLI) advocated for an alternative approach, endorsed by the American Academy of Actuaries, easing capital requirements for these holdings. Athene, an Apollo unit, exemplifies this trend; it reduced CLO holdings due to diminishing yields while investing in other structured credits. Although regulation has influenced asset allocation strategies minimally, reallocations are supportive of long-term liability management practices, aligning structured credits with corresponding asset demands.
Structured credit accounts for nearly 13% of overall insurer holdings, with significant variation among different carriers. This landscape underscores the differential impacts a repricing of structured credit could have on insurers, particularly those heavily invested in these securities. Across the Atlantic, UK insurers active in pension risk transfer markets, such as Legal & General and Standard Life, are following similar trends. S&P Global Ratings indicates that over 10% of these firms' portfolios comprise opaque private assets, though the true figure might be underreported due to limited disclosure requirements.
Despite the complexity, insurers argue that private credit offers a viable solution for managing long-duration liabilities. Roman Hederer of Legal & General and Nuwan Goonetilleke of Standard Life note that private credit portfolios could withstand substantial financial shocks if investment-grade ratings hold. Although trends do not indicate an immediate crisis, the shift towards less transparent asset classes and the latency of regulatory frameworks remain focal points for professionals involved in underwriting and risk management. The ongoing challenge lies in accurately assessing and managing the gap between disclosed and actual risk within investment portfolios.