Representatives of the multitrillion-dollar insurance industry are hurling criticism at a proposal that could make it harder to invest in deals sold in fast-growing private markets that offer higher yields but often bring added risks.
The proposal by a unit of the National Association of Insurance Commissioners, a consortium of state regulators that sets standards for the industry, would allow the group to override credit ratings assigned to some deals, in turn affecting how much money insurance companies could allocate to those deals. The NAIC group says it’s necessary in part because more deals are being done in little-regulated private markets.
Money managers and other industry groups are staunchly opposed. The impacts are already being felt, they say, as some insurance firms place moratoriums on certain deals until there’s more clarity.
“The current NAIC proposals have already had a major market disruption as word of the impending proposal permeates all levels of the insurance industry,” according to a letter by Jacques de Saint Phalle, head of debt capital markets at Piper Sandler. His opinion was read aloud at a Monday meeting in Seattle to discuss the plan.
The proposal under discussion would allow the NAIC’s Securities Valuation Office to override the credit ratings assigned to deals in which its own risk assessment is three or more notches different than the one assigned by an official credit rating organization, such as Kroll Bond Rating Agency and Egan-Jones Ratings Co. As a result, an increasing number of insurance companies have instituted a moratorium on purchasing Kroll and Egan-Jones rated transactions in these markets, according to Piper Sandler.
“Egan-Jones has a leading market position in private debt in part as a result of our excellent performance,” said Eric Mandelbaum, deputy general counsel at Egan-Jones, in emailed comments. “In 2022 we only had one default (compared to 50+ implied by our rating levels) and it was a ‘soft’ default for a covenant violation (and not payment) and in 2020 no defaults.”
Representatives for the NAIC declined to comment. Kroll didn’t immediately respond to requests for comment.
Industry criticisms of the proposal center on the fact that the SVO, which has a far smaller staff than any of the national ratings companies, would effectively be assigning its own ratings in cases where it chose to do so. It isn’t itself a ratings firm and isn’t regulated like one, critics said.
“The NRSROs are subject to a robust regulatory regime and have transparent methodologies which are available on their website for investors,” Mandelbaum said, using an acronym to refer to the nationally recognized statistical rating organizations, which includes Egan-Jones.
The proposed change could have big implications for US insurance companies, which reported $8.2 trillion in total cash and invested assets at the end of 2022. They’re closely bound by rules that limit the size of their investments in riskier assets. If the credit ratings of some deals are rejected in place of lower ratings by the NAIC group, then it could limit participation from the industry.
The SVO says the policy is necessary in order to protect against too much reliance on traditionally assigned ratings, in part by bringing transparency to less-regulated private markets. Evidence of some the risks emerged in 2022, when a new regulatory requirement brought to light a number of examples in which deals executed in private markets received substantially different ratings from different credit graders, said Charles Therriault, the director of the SVO, at the meeting.
“We have observed growing and often material discrepancies between the ratings provided by competing NRSROs for the same security,” said Therriault. “The rating exceptions identified by the SVO to the task force only came about because of the requirement for increased regulatory transparency into these non-public transactions. Otherwise, the task force would continue to be completely blind to these issues.”
A decade of low interest rates has drawn many insurers away from traditional public markets toward non-traditional and private markets, increasing the need for careful assessments of risk, NAIC’s president and president-elect wrote recently in a letter to members of Congress who had objected to the proposed rule.