Given the potential for yield and capital efficiency, residential whole loan mortgages have been the fastest growing asset class in life insurers' investment allocations in recent years.
Regulatory realignment
In the world of insurance regulation, change has historically been slow, maybe even glacial. Recently, however, regulatory anxiety has heightened, caused by rapid changes in insurers' investment allocations and led by new, non-traditional entrants into the insurance space. Financial innovation in certain structured securities has also contributed to concerns.
As a result, the National Association of Insurance Commissioners (NAIC), the main U.S. insurance regulatory body, has moved more rapidly than historic norms on a number of themes. The NAIC is now seeking to:
- Redefine the classification of assets to better categorize their risk characteristics;
- Re-evaluate the ratings of certain assets to consider default and investment return risk;
- Revisit the capital charge factors used in setting capital standards for certain asset classes such as collateralized loan obligations (CLOs) and residual tranches.
In the NAIC's 2023 report titled "Framework for Regulation of Insurer Investments—A Holistic Review", it laid out the blueprint to revamp their entire regulatory framework. The NAIC recognizes the industry has accelerated certain financial innovation, such as rated notes, to address inconsistent capital/risk-based capital treatment of funds—which typically receive a high equity charge regardless of the underlying investments.
Funds with underlying investments such as private credit should ideally receive capital treatment commensurate with their fixed income risks. Rated notes help to improve this capital charge, but they involve added complexity that would be unnecessary if the NAIC were to allow proper look-through treatment. Currently, Statutory Accounting Principles allow capital look-through treatment for a limited set of asset types—including residential whole loan (RWL) mortgages.