Introduction
Insurance companies, especially life and annuity insurers, have an extensive amount of assets under management to support liability needs. As of year-end 2023, the U.S. insurance industry had $8.5 trillion of reported total assets, which is equivalent to approximately 40% of assets held by all U.S. commercial banks.1
Heavy capitalization has attracted seasoned investors such as private equity firms to invest their capital in the life insurance sector. Investors acquire insurers’ blocks of businesses to manage large pools of underlying assets and boost asset returns through their specialized investment skill sets and asset origination capabilities. Some transactions that have occurred over the last three years are shown in Figure 1. Life insurers have increased allocations to illiquid investments, such as complex structured products, as well as private real estate and infrastructure funds. Reinsurance is also actively deployed to reduce non-asset-related risks such as longevity or mortality risks, which often further releases more capital for the insurer to invest in specialized assets. This has also prompted more traditional life insurers to seek and invest in these highly specialized asset types to maintain their market competitiveness.
The rapid influx of new entrants and consequent evolution in asset allocation and the investment strategies of life insurance companies has caught the attention of regulatory bodies and prompted proposals of several new rules on the management and reporting of assets held by insurance companies that enhance the clarity and understanding of these complex assets and their risk profiles. This article explores trends observed in the asset mix of life insurers, as well as regulatory initiatives from the National Association of Insurance Commissioners (NAIC).
Figure 1: High-profile U.S. life insurance mergers and acquisitions (M&A) transactions, 2021-2023
Investment strategies of U.S. life insurers
The rise of private credit
Private credit, particularly direct lending, has been gaining momentum since the global financial crisis of 2008-09. There is increased attention on this particular asset class as fixed income interest rates continued to decrease and remain low until the Fed’s rate hikes starting in Q1 2022. As of year-end 2023, private bonds are 46% of the total bond holdings of life insurance companies, up from 29% in 2014. Private equity and asset management firms have contributed to the trends of increased usage of private credits. As of 2023, 61% of the bonds held by private equity firms are private bonds, in contrast to only 45% for all U.S. life insurance companies. Private credits often have variable interest rate structures, and the current high-interest-rate environment has put strains on borrowing companies. However, the ability to renegotiate the terms with a smaller group of these investors keeps loss given defaults for private credits lower than public assets.
Figure 2: Asset holdings, top 30 U.S. life insurers
Data sourced from S&P and calculated by Milliman.
Figure 3: Public vs. private bonds, top 30 U.S. life insurers
Data sourced from S&P and calculated by Milliman
The evolution of structured assets
Securitized mortgage loans, residential mortgage-backed security (RMBS), and commercial mortgage-backed security (CMBS) have historically been popular forms of structured products for life insurance balance sheets. In the past decade, securitized products such as collateralized loan obligations (CLOs) and other asset-backed security (ABS) structures have been gaining scale. As of year-end 2023, other loan-backed structured securities account for 55% of the structured asset holdings for the top 30 life insurers in the United States.
Figure 4: Asset holdings – structured products, U.S. life insurers
Regulatory proposals
To address the increased complexity of asset types on life insurers’ balance sheets, the U.S. and Bermudian regulators have imposed regulations around asset reporting and risk monitoring. A timetable of recent regulatory developments is shown in Figure 5.
Figure 5: Regulator timetable
1. Structured assets and private assets risk assessment
1.1 Residual Tranche C-1 increase and RBC methodology for structured assets
There has been an increasing usage of asset securitization, given the higher NAIC risk-based capital (RBC) efficiency compared to holding the direct investment of the underlying pool of assets. Figure 6 is an illustration of how the securitization can lower the overall C-1 charges of the underlying bonds.
Figure 6: Securitization can lower C-1 charges
To properly address the underlying risk of the structured products and maintain consistency between capital charges across assets with the same risk level, NAIC has formed Risk-Based Capital Investment Risk and Evaluation (E) Working Group, and updated the C-1 charge of the residual tranche from 30% to 45% for the 2024 year-end reporting. The increase in the C-1 charge of the residual tranche serves as an interim update, while the working group works with the American Academy of Actuaries toward a long-term approach for modeling all CLO tranches for RBC purposes. The plan is to present the initial proposal at the fall 2024 national meeting in November. The Risk-Based Capital Investment Risk and Evaluation (E) Working Group envisions the CLO methodology will provide a pathway for other structured assets.
1.2 SVO authority to model CLO
The NAIC Valuation of Securities (E) Task Force adopted a revision in the Purposes & Procedures (P&P) manual in August 2024 to require the Securities Valuation Office (SVO) to model CLOs and assign NAIC designations. Consequently, CLOs will no longer be broadly exempt from filing with the SVO based on credit rating provider ratings. The onset of CLO modeling by SVO is postponed until the end of 2025 to allow more time to develop a comprehensive modeling methodology.
1.3 Private assets re-rating by SVO
A proposal under discussion would allow the NAIC’s Securities Valuation Office (SVO) to override the credit ratings assigned to assets in which the SVO’s own risk assessment is three or more notches different from the one assigned by a nationally recognized statistical ratings organization (NRSRO), such as AM Best Rating Services, S&P Global Ratings, Moody’s Investor Service, and Fitch Rating. This is targeted on investments sourced from nontraditional and private markets.
2. Principle-based bond definition
Special purpose vehicles (SPVs) have been widely used to convert underlying equity-like investments into debt instruments. The NAIC will be enforcing a principle-based bond definition driven by the substance of the investment design instead of the legal form. The principle-based bond definition (PBBD) will take effect in January 2025. All debt securities must qualify under the PBBD to be reported in Schedule D as bond or ABS. Debt securities that do not qualify as bonds shall be reported as an acquisition on Schedule BA and may be subject to higher C-1 charges as a result. Assets do not qualify as bonds, including principal protected notes and structured notes, where interest rates and principal repayment are contingent on the performance of underlying assets. Asset classes with major potential impacts include collateralized fund obligations, feeder funds, and sustainability-linked bonds.
Figure 7: Bond principles flowchart
3. Negative IMR approval
With the Fed interest rate hikes in 2022 and 2023, many insurance companies are facing big losses in existing asset portfolios. In March 2023, a proposal from the Statutory Accounting Principles Working Group that allows a net negative interest maintenance reserve (IMR) up to 10% of capital and surplus was temporarily approved to address this. The approval is set to expire in January 2026. So far, there has been no proposal on lifting the 10% negative IMR allowance.
4. AG53 update
For the year-end (YE) 2023 AG53 filing, a standardized template has been introduced. The Valuation Analysis (E) Working Group (VAWG) has reviewed the 2023 YE submissions from life insurance companies and has commented on the observations regarding projected equity allocation, the usage of nontraditional assets, and reinsurance collectability. The Actuarial Guideline 53 (AG53) template was updated and enhanced in 2023 and has remained unchanged for the year of 2024.
5. VM-22 adoption
NAIC is conducting an industry field test on VM-22 (requirement for non-variable annuities) in Q3 2024. Potential revisions will be made through Q1 and Q2 2025 based on the results and industry feedback. The expected VM-22 optional effective date is set to be January 2026, with a mandatory effective date of January 2029.
6. GOES adoption
The second Generator of Economic Scenarios (GOES) field test was performed from April to July 2024, based on the valuation date of year end 2023. Unlike the first field test in 2022, the 2023 results will not be aggregated and shared with the public. Instead, confidential presentations will be held between participants and regulators. The next steps are to conclude the field test and recommend the final VM-20 stochastic exclusion ratio test methodology. The planned adoption date is January 1, 2026.
7. Reinsurance collectability and counterparty risk in its asset adequacy analysis
In 2024, the Life Actuarial (A) Task Force (LATF) has been reviewing a proposal that will require gross reinsurance testing to be performed by the Appointed Actuary. The aim of the proposal is to ensure that the counterparty has a high enough liability and creditworthiness on an assumed basis to meet the asset adequacy requirements The current goal of LATF is to have an Actuarial Guideline in place for year-end 2025.
Final remarks
As the life insurance sector increasingly incorporates complex investments, regulatory frameworks – both onshore and offshore – are undergoing significant transformations to keep pace with the changes. Regulators are diligently emphasizing the importance of assets backing liabilities, striving to ensure that sufficient reserves are maintained to meet future obligations to policyholders. The regulatory landscape continues to evolve in response to shifting macroeconomic trends changes and the investment strategies employed by market participants. Vigilance in monitoring these areas will be crucial for stakeholders to navigate the dynamic environment effectively. The interplay between regulatory adjustments and industry innovations will likely shape the future of life insurance, making it essential for all involved to remain well-informed and adaptable.
1 Wong, M. U.S. Insurance Industry’s Cash and Invested Assets Rise to $8.5 Trillion at Year-End 2023. NAIC Capital Markets Special Report. Retrieved November 13, 2024, from https://content.naic.org/sites/default/files/capital-markets-special-reports-asset-mix-ye2023.pdf.