Making Sense of the NAIC Risk Oversight Landscape

What You Need to Know

The NAIC will do its own risk assessments of CLOs.
One concern is that private equity-backed insurers might have binged on the riskiest CLO slices.
Risk assessment affects how much of the value of an investment flows into risk-based capital ratios.

From private equity-backed insurers rolling out increasingly aggressive strategies, to historic market unpredictability, the insurance investing marketplace has been one of the most interesting sectors to watch over the last several years.

Recently, the National Association of Insurance Commissioners added to the excitement, by announcing that it would pursue landmark capital charge rules — by basing on collateralized loan obligation (CLO) capital charges on a process managed by the NAIC, rather than on ratings from rating agencies.

The concern about CLOs is just one of the worries surrounding insures’ exposure to investment risk.

This is set to be a year in which the NAIC and the RBC Working Group will roll out rule changes and oversight changes that will fundamentally reshape the insurance investing marketplace for years to come.

Life and annuity issuers have especially big investment portfolios,

With that in mind, here are a few priority areas that the advisor community should consider when trying to understand how the life insurers your clients work with are thinking about their own investments.

CLOs

A CLO is a structured finance security backed by what, in many cases, is a pool of syndicated, first lien bank loans, with smaller allocations of other types of loans and other investments thrown in.

Dealmakers carve a CLO deal into tranches, or CLO slices with different levels of risk. If the borrowers start to default, holders of CLOs in some tranches will get paid before the holders of the CLOs in the other tranches.

With strong historic performance, relatively wide spread yields and low default rates, CLOs have had strong appeal for insurance investors.

However, as demand for yield has continued to grow following three years of market upheaval, questions about risk exposure have begun to swirl. Some regulators fear that too much policyholder capital is being exposed to the investments.

This confluence of market factors has made tackling CLO risk a foremost priority for the NAIC and its Risk-Based Capital (RBC) Working Group.

The NAIC builds risk levels into insurers’ capital totals by having an insurer apply a “charge,” or reduction in the value of an asset, when the asset is included in the insurer’s capital calculations.

Regulators may soon take a tougher approach to charges when insurers are putting CLO assets in capital calculations.

Private-Equity-Backed Insurers and the CLO Market

The capital charge rule changes should be seen as a shot across the bow for private-equity-backed insurers.

While traditional life insurers typically operate with a long time horizon, and invest life insurance premiums and annuity considerations in longer-term assets, PE-owned life insurers tend to be far more aggressive in their investing strategies.

For example, traditional life insurers invest mainly in corporate bonds and mortgage loans, whereas PE-backed insurers routinely put a much higher percentage of their cash in complex and riskier assets — such as privately issued structured securities — in an effort to produce higher returns for shareholders.

PE-backed insurers have increasingly been gravitating towards the riskiest CLO tranches.