Private equity-backed insurers under US scrutiny over risky loans
US insurance regulators on Monday will meet to consider boosting capital charges on complex corporate loan instruments that some in the industry warn are creating excessive risk.
The issue pits insurers backed by large private equity firms such as Blackstone, Apollo Global and KKR — who are increasingly investing in the loans — against traditional life insurers such as MetLife and Prudential Financial, who warn of growing risks. Monday’s gathering is hosted by the National Association of Insurance Commissioners, a trade group whose standards are relied upon by state insurance commissioners.
The private equity-backed insurers are resisting a proposed 50 per cent increase in the capital charges held against the riskiest slices of corporate loan packages that are purchased with annuity premiums. Those increases are supported by many of the largest life insurers in the US, who warn that their aggressive rivals are overloading customer portfolios with excessive risk. Higher capital requirements can help absorb potential investment losses but also depress investment returns.
Regulators have been increasing their scrutiny of new insurance players built out of private equity firms, whose credit investing units rely on insurance and annuity premiums to invest in fixed income securities, bolstering the firms’ overall assets under management.
The insurance businesses inside private equity firms tend to invest in more complex securities in order to earn greater “spread” profits between investment returns and obligations owed to policyholders. The private equity firms have insisted that their portfolio choices do not increase risk of losses but rather seek excess returns through buying illiquid or complex instruments.
The working group of the NAIC is set to discuss the capital charges associated with collateralised loan obligations, or CLOs, that bundle multiple corporate loans and sell in tranches that range in rating from AAA down to high yield and equity.
The current risk-based capital regime, the NAIC noted, allows for an “arbitrage” opportunity for the holder of a CLO loan. A B-rated corporate loan owned by an insurer has to set aside equity of 9.5 per cent. However, a CLO created from a package of B-rated loans with six tranches would have a blended capital charge of just 2.9 per cent.
This story originally appeared on: Financial Times - Author:Antoine Gara
