Private equity insurance investors facing higher capital charges for CLOs

State insurance regulators held a robust discussion Thursday on an interim proposal to increase capital charges for private equity backed insurers who invest in riskier collateralized loan obligations (CLOs).

They found no agreement and ended the spring meeting session seemingly no closer to a decision.

The Risk-Based Capital Investment Risk and Evaluation Working Group devoted most of their hour-long session to the proposal to increase capital charges for the riskiest elements of CLOs by 50% in the interim.

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 good return.

The issue is splitting insurers backed by large private equity firms such as Blackstone, Apollo Global and KKR against traditional life insurers such as New York Life and Prudential Financial, which warn of growing risks.

'Very limited'

Francisco Paez, head of structured products research at MetLife Investment Management, spoke for a group of traditional insurers. Taking note of the irony, Paez nonetheless reiterated the strong support for raising the capital charge for the riskiest equity components of CLOs from 30% to 45%.

Insurers are nearly always opposed to stronger regulation. Not in this case, Paez said.

"We feel that following a modeling approach is a much better way to get to the real risk associated with CLO tranches than using the historical performance data," he explained. "Historical performance data for CLOs is very limited and therefore, inadequate."

Many regulators questioned the need for an interim approach. Kevin Clark is chief accounting specialist for the Iowa Insurance Division. He questioned whether regulators have the analytical analysis to support the 50% increase and whether the group is moving too fast.

"We have some pretty good idea that it should be higher, at least in the examples that we've looked at," Clark said. "But we don't know what that should be. To me, a key point on taking such an interim step would be what is the magnitude of the population that we're looking at? And is it a pressing enough issue that an interim step is needed?"

The working group closed a 45-day comment period Jan. 27 on its interim proposal. It would have to adopt a change by the end of April and then agree to the details by the end of June, regulators said.

Pump the brakes

Jeff Johnson is vice president of product development for Global Atlantic Financial Group. He spoke briefly on his company's opposition to the interim proposal, calling it a rush job.

"There's time to do this and do it in a way that gets the right capital for the right risk, which we all support," Johnson said. "We're not in the camp of not doing anything, but we are in the camp of doing something that is thought out in line with the way capitol changes have been approached in the past."

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 of traditional insurers 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.

Doug Stolte is deputy commissioner at the Virginia Bureau of Insurance. There is some "concentration risks for certain insurers," he said, adding that he doesn't know what the right charge should be for the riskier elements of CLOs.

"It's very binary," he said of the riskier investments. "You either hit a home run or you're out. So that's a concern I have. There's a lot of attention being paid to these complex investments."

InsuranceNewsNet Senior Editor John Hilton 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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