The share of life insurers’ general account assets invested in “risky” corporate debt has roughly doubled since the 2007-09 financial crisis, driven in recent years by partnerships between insurers and asset managers, according to the US Federal Reserve.
These partnerships have created complex and “arguably opaque” investment structures that shift allocations towards riskier corporate debt, like private credit, according to a March 21 note from the Federal Reserve Board of Governors, as part of its Finance and Economic Discussion Series (FEDS).
Life insurers invest directly in sub-investment-grade companies through high-yield bonds and leveraged loans, but they also gain indirect exposure to these borrowers through collateralized loan obligations, business development companies and joint-venture loan funds.
Furthermore, life insurers’ affiliated asset managers are now major corporate loan originators and managers of both CLOs and BDCs.
As an example “based on one of the largest and oldest life insurers in the US,” the note describes an affiliated asset manager with a BDC. While the BDC maintains a regulatory leverage ratio of 2x, its consolidated leverage ratio could reach up to 12x when taking into account affiliated joint venture loan funds and CLOs.
“Such complex arrangements thus obscure the true leverage of both the insurer and the insurer-affiliated [asset manager],” according to the FEDS note.
“Moreover, the insurer’s exposure to risky corporate debt is similarly opaque, as its equity positions in affiliated BDCs, JVLFs, and CLOs are not consolidated or reported and some are treated as investment-grade debt under statutory accounting,” the note states.
The industry’s exposure to sub-investment-grade debt now exceeds the life insurers’ exposure to subprime residential mortgage-backed securities in late 2007, according to the report.
The report highlights several life insurers that have partnerships with asset managers, such as Athene (affiliated with Apollo), Blackstone Insurance (which includes life insurance businesses formerly operating under AIG and Allstate brands), Global Atlantic (affiliated with KKR), Mass Mutual (affiliated with Barings and Jefferies), American National Financial (affiliated with Brookfield), Aspida (affiliated with Ares), Equitable Life (affiliated with AllianceBernstein) and Talcott (affiliated with Sixth Street).
These partnerships have led to intricate investment structures which the FEDS report says is enabled by loopholes in regulation, such as the ability of BDCs to increase leverage beyond limits set by the SEC by financing loans off of their balance sheet, and the ability of life insurers to dramatically reduce their risk-based capital charges by replacing direct loan holdings with investments in BDC vehicles that contain the same loans.
Read the full report, titled “Life Insurers’ Role in the Intermediation Chain of Public and Private Credit to Risky Firms,” here.
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