Insurers staring at higher capital charges for investments in risky CLOs

State insurance regulators are taking aim at the capital charges for insurers who invest in riskier collateralized loan obligations (CLOs), concerned that too much policyholder capital is being exposed to risky investments.

New proposed rules highlight the divide between private-equity backed insurers, who are much more likely to invest in CLOs, and traditional insurers.

"The main goal is to protect the policyholders but also they want to make sure the financials are stable," said Sabrina Wilson, global regulatory policy expert for Clearwater Analytics, a software fintech company.

“The main goal is to protect the policyholders but also they want to make sure the financials are stable.” Sabrina Wilson, global regulatory policy expert, Clearwater Analytics

The National Association of Insurance Commissioners is moving ahead with a rule change that will tie CLO capital charges to the NAIC's own modelling rather than CLO ratings. Regulators want to remove an inconsistency in the rules that results in insurers holding less capital against CLOs than they do against the underlying loans that CLOs hold.

A CLO is a single security backed by a pool of debt. They are often backed by corporate loans with low credit ratings or loans taken out by private equity firms to conduct leveraged buyouts. Given the low-interest-rate environment of the past 20 years, insurers sought out riskier investments in order to make a solid return, Wilson explained.

Upping the capital charges for the riskiest tranches of CLOs could have a big impact on insurers and their choice of investments, she added.

"They had to do it," Wilson said of the riskier investments, "because they have the commitments with the annuities or the life insurance policies, they have the minimum guarantees and so they had to do it. But now in this rising interest rate environment, I think they have other choices now."

PE vs. traditional insurers

A separate effort in under way to increase capital charges in the interim, and an NAIC group met Monday to discuss their plans.

The Risk-Based Capital Investment Risk and Evaluation Working Group effort to increase the capital charges for the riskiest elements of CLOs by 50% in the interim is opposed by newer private-equity backed insurers.

It shared comment letter from a group of PE-backed insurers, including Athene and Global Atlantic Financial Group, who claimed the interim effort "is not supported by the thoughtful analysis and field testing that the NAIC has implemented in the past."

Those opposed to increasing the capital charges on CLOs claim that the recent market of CLOs are not nearly as risky as in decades past and should be judged differently.

"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," the PE-backed insurers wrote.

In support

On the other side, a group of traditional insurers propose raising the capital charge for the riskiest equity components of CLOs from 30% to 45%.

"Structured securities, including CLOs, are material to insurer solvency. Structured credit has become a core asset strategy in U.S. Life General Accounts, similar in size to commercial mortgages," wrote a group of insurers including New York Life, Prudential and Northwestern Mutual.

"CLOs in particular are a fast-growing asset class that are highly correlated to other credit exposures within insurers’ asset management portfolios and have indirect implications for other insurer capital holdings under stress."

Over the past decade, U.S. Life Insurer CLO investments have grown at about 20% per year while General Accounts have grown at less than 5% per year, the group pointed out in another comment letter.

NAIC officials have noted that most of CLO holdings are in higher-grade investments unlikely to be affected by their proposal for increase capital charges.

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.

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InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.