Thoughts What is the Quality of Investments Made by Life Insurance Companies After a Decade of Ultra-Low Interest Rates?

When was the last time life insurance made the front page of The Wall Street Journal?   On December 28^th, 2021, an article on life insurance was the number two headline on the front page, which got my attention because life insurance is normally page five reading for die-hard industry professionals.  I will comment on the article itself in a minute.   

First, I want to raise an issue that will give the WSJ article some context:  How long can life insurance companies keep paying out higher rates than they earn on their top-rated investments, and how will advisors continue providing competitive solutions for their clients? 

We know life insurance companies are struggling to invest new premium dollars someplace that will provide competitive returns.  The difficulty is the National Association of Insurance Commissioners (NAIC) regulations limit investment allocations to conservative fixed-rate instruments.  In broad terms, carriers are required to keep at least 80% of assets in the highest-rated investment class, such as Aaa bonds that offer safety but lower yields.  Moody’s Seasoned Aaa Corporate Bond Yield averaged 3.78% over the last 10 years.  Adjusted for inflation, the net return on Aaa bonds is approximately 1.85%.¹    

This puts the spotlight on “alternative” asset classes and brings us a step closer to the WSJ article.  In general, insurer’s assets allocations are limited as follows: 

1. No more than 3% per investment vehicle ² 

2. 80% in High grade investments ³ 

3. 20% in Medium (10% Low) grade investments ³ 

The analysis that determines an asset’s rating for insurance purposes is made by the Securities Valuation Office (SVO), a small division within the NAIC.   

Insurance companies have always sought diversification and higher returns from alternative investments.  In December of 2020, Mass Mutual purchased $100 MM in Bitcoin, and its investment tripled in less than a year.⁴  From a regulator’s standpoint, $300 MM in Bitcoin is high risk, but it’s less than 0.25% of Mass Mutual’s policy reserves, and not large enough to jeopardize the carrier’s overall financial strength. ⁵  This is a good example of a carrier taking some risk to make up margin.  Alternative investments are not a problem…unless they are disguised as something else. 

This brings us to the December 28^th WSJ article titled “Regulators Seek Ratings Details for Privately Issued Bonds Held by Insurers,” that reveals insurers have more than doubled their stake in privately traded bonds from 2018 to 2021.⁶  This raises an important question for the life insurance industry:   Is the trillion or so dollars insurers currently hold in private bonds High, Medium, or Low-grade investments?   

This should sound familiar because inflated bond ratings helped trigger the last financial crisis in late 2008 when alleged Aaa debt offerings were really a pyramid of sub-prime (junk) bonds.  The WSJ article goes on to describe how the NAIC is going to increase scrutiny of private placement bonds beginning in January of 2022.  Uh oh, this sounds bad.  Could the life insurance industry be the catalyst for the next financial crisis?  Front page mystery solved. 

Let’s take a closer look at this asset class: Insurers are drawn to private placement debt (bonds) because they pay a premium for additional risk.   I would like to know if the additional risk is based on credit worthiness or the liquidity of a privately traded asset?  “Private” does not necessarily mean sub-prime, but the higher yield implies a risk/reward trade-off that is commonly found in lower-rated corporate bonds.  The real danger here is a mismatch between the private bond rating and the quality of the underlying assets.  In short, some insurers may have more than 20% exposure to Medium and Low risk investments. 

Despite similarities to the 2008 sub-prime crash, I do not anticipate anything nearly as dramatic.  If the NAIC determines that these private bonds contain some Medium and Low-quality assets that were mis-represented as High quality, there will be some fallout, but I believe it will be industry specific not a Main Street economic event.  Some smaller insurers could see a ratings downgrade depending on their exposure.  Larger carriers will simply re-balance their investments and move on.   

I am not overly concerned because Insurance companies are not banks.  They do not borrow money to lend money.  They are reserve lenders with much higher liquidity ratios than banks.  If carriers infringe on regulations, it needs to be corrected, but it’s a long way from the insolvency highly leveraged banks faced in 2008.   

From 2008 through November 2011, a total of 13 small, regional life and health carriers went into liquidation compared to almost 400 commercial banks, thrifts, and investment banking firms.  The total liability of those thirteen carriers was just $900 MM. Recovery and payment of policy claims from carrier insolvencies are made by the guaranty associations that comprise The National Organization of Life and Health Insurance Guaranty Associations (NOLHGA). Between 1991 and 2009, NOLHGA-involved average recoveries on life claims exceeded 96%.⁷

The 52-member guaranty associations provide a financial backstop for consumers (policy holders) that is much more robust than the FDIC.  The impact of insurers who fail is tiny compared to the systems financial capacity to pay claims. 

Regarding the private bond issue, the best outcome is that the underlying assets are not overrated in terms of credit worthiness.  They may be harder to trade (buy-sell) because the private market is smaller, but this would justify the higher yield.  Private bonds may be a fine example of how carriers can expand their top-tier investment opportunities with a minimal increase in risk.  I look forward to watching this issue unfold over the next year. 

Speculating in the broadest terms possible, I think carriers have weathered the worst of ultra-low interest rates.  The net effect of changes to IRC 7702 was a boost to carriers in the form of higher margins going forward.  In addition, 2022 looks like the start of a rising interest rate cycle and the end of Federal bond purchases that kept interest rates artificially low.  Finally, I would say carrier product innovation has done an excellent job of bridging the gap for the last 10 years.  I’m looking forward to seeing what 2022 will bring. 

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Insurance products offered through Schechter are issued by various third-party carriers.  Investment advisory services are offered through affiliate SEC registered investment advisers Schechter Investment Advisors, LLC (“SIA”) and Schechter Private Capital (“SPC”).  Securities offered & sold by Schechter employees who are registered representatives (“RRs”) of third-party broker dealer Kingswood Capital Partners, LLC, member FINRA, SIPC.   

The views and opinions expressed herein are those of the author(s) and do not necessarily reflect the official views of Schechter or its representatives. 

The information and opinions expressed herein neither involve the rendering of personalized investment advice, nor an offer to buy or sell, or a solicitation of any offer to buy or sell, securities.  No investment is free of risk and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of future results.  The insurance and investment opportunities referenced herein may not be suitable for all individuals.

Sources: 

1. Moody’s Seasoned Aaa Corporate Bond Yield [AAA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AAA. Accessed January 5, 2022. 

2. NAIC Model Laws, Regulations, Guidelines, and Other Resources, 3^rd Quarter 2001, Article II, Section 10, Parts A 1-3 

3. NAIC Model Laws, Regulations, Guidelines, and Other Resources, 3^rd Quarter 2001, Article II, Section 10, Parts B 1-3. 

4. Namcios, Bitcoin Magazine, Mass Mutual Bitcoin Investment Has Tripled in Dollar Value, October 15, 2021. 

5. Mass Mutual 2020 Annual and Corporate Responsibility Report, Mass Mutual Life Insurance Company, Springfield, MA 01111 

6. Scism, Leslie, 12/28/2021, Regulators Seek Ratings Details for Privately Issued Bonds Held by Insurers, Markets, The Wall Street Journal, p.3. 

7. Testimony for The Record of The National Organization of Life and Health Insurance Guaranty Associations, Before the House Financial Services Subcommittee on Insurance, Housing and Community Opportunity, November 16, 2011. 

8. Special thanks to my Schechter Wealth colleagues: Kevin Giganti, Colin Steinberg, Aaron Hodari, Joe Opiela, and Jordan Smith.