What Actually Happens When a Life Insurer Fails (It's Worse Than a Bank) | Pranjal Drall and Andrew Granato on How Private Equity Turned Life Insurance Into a Taxpayer Backstop

0:00an exceptionally important conversation joined today by Andrew Granato, Assistant Professor of Law at the University of Texas at Austin and Prawnjall, DRAWL, JDPHD candidate at Yale. They are the co-authors of a paper called Private Credit State Backstop, how private equity socializes risk through insurers. Gentlemen, welcome to monetary matters. Thanks for having us. Tell us about this paper. You write in the beginning that what we have now is a system that socializes losses more sharply than banking federal deposit insurance. In other words, the life insurance industry is increasingly getting to a state where if private equity and private credit are owning these companies, these life insurers companies, and profiting from them, obviously. And if things go bad, the bailout system is one where the losses will be socialized, privatized gains, and potentially socialized losses.

1:00Prawnjall, tell us about that. So the basic picture of the paper is that there's been a lot of concern about private credit, both valuations, and how the asset class is doing as a whole. Underlying that worry is that valuations don't keep up with reality. So since these assets aren't publicly traded, it's hard to ascertain how impaired some of the loans are given certain kinds of shocks. Given that worry, simultaneously there's been a big trend in insurance, where insurance companies are increasingly owned by private equity companies, and they increasingly invest in private credit. So one way of thinking about the paper is that in a normal finance 101 land, if a loan or an asset goes bad, the investors bear the losses. So if like a sophisticated investor is making a bunch of private credit loans, and they end up going to zero, the investor loses a lot of money, but no one, the public rich large doesn't bear the cost.

2:04Our paper sort of points to a setting where that is not the case. So life insurance is sort of this very conservative business, historically. You collect a bunch of premiums from policyholders invested in traditionally investment grade assets, and then earn a spread, and you pay out the policyholders over time. Increasingly, since these insurance are investing in private credit, the public is exposed to the risk of private credit through insurance. And the most shocking, a notable part of the story is that when insurance company goes under, the policyholders are bailed out by its rivals. So if the insurance company is in Iowa, insurance company A goes under insurance company B has to pay the money for the policyholders up to a statutory cap. And whatever they pay to bail out the policyholders, you get they get tax credits for. So it can be written off

3:08over, you know, depending on the stage, five to 20 years. So the basic idea is ultimately taxpayers around the hook for insurance insolvency, which might be driven by excess exposure to private credit. And just set the stage, the private equity ownership of life insurance by assets was about 23 billion in 2009 by the end of 2024. That was about 700 billion. So it's done like a 35x, 30 to 35x at that growth of private equity ownership of life insurance. And that as of 2024, private equity owned life insurers had between 8 to 14% of life insurance assets. So decent decent chance that you know, people watching this now that definitely some percentage of of their life insurance assets are owned by private equity companies. And Andrew, why would why would private equity companies want to own life insurance companies? Yeah, so the theory that

4:12various companies have a spouse is something that they call permanent capital. If you want to conduct private equity's traditional business, which are these buyout funds, you know, purchases of companies that you are then trying to, you know, flip and resell at higher valuations involves a lot of leverage. You have to take out a lot of money and loans to conduct these purchases. And so you can look to external financing for these, but increasingly what these P firms have preferred to do is try to finance them internally. So we'll have a different part of the firm issue alone to the, you know, to the companies that are being bought out. There are multiple ways that you can try to do this. What a lot of private equity firms have done is they have set up private credit funds. So they are, you know, they're the GP in the P fund, and then they're the general partner in the private credit funds as well. They get backing from institutional investors

5:17in both settings to do this sort of work. But what you could also do is you could buy a life insurance company. And life insurance has various features that make it theoretically attractive for these purposes. What policy holders do is they pay a lot of money up front. And they have expect to receive payouts on the back end. So, you know, if you buy like a turnlight for cash value life policy, you as a policy, what I might be paying premiums in for years. And, you know, some fraction of those policies will pay out to the beneficiaries, but they won't pay out until this, you know, long tail because of, you know, the simple actuarial math of like people, you know, die later. So the insurer has all of this money up front that they, you know, eventually will need to like gradually pay out in the cycle while they're still receiving more payments later.

6:20But unlike a fund, they do not have this fixed end date in which all of this capital has to be returned to these institutional investors. So owning a life insurer creates a lot of flexibility. And it, you know, has all of these nice theoretical synergies when you're trying to invest the balance sheet of that life insurer in highly illiquid and opaque assets like, you know, private credit or, you know, ABS or other kinds of structured products. And so you end up with this kind of like tripartite business model where you have the buyout funds that are accepting loans for often from the the private credit funds. And then the private credit funds loans can be sold to the in-house life insurer. And so the private credit is ultimately not held on the balance sheet of one of these fixed duration funds. It's held on the balance sheet of a life insurer, which is backed not

7:22by the institutional investors, but by this mass, you know, dispersed retail base of policyholders. Yeah, one more way to think about the synergy is that, you know, historically insurance companies were owned by people like Warren Buffett or Alliance, big asset managers that, you know, there's an actual synergy where an insurance company has to make a lot of investments. Making investments is a hard business. And it is natural to think that some of the best investing companies on the planet, namely, you know, big private equity alternative asset managers have the expertise of the economies of scale and the skill to do so. So it makes sense for them to use that expertise to invest insurance company assets as well. And, you know, if they're able to earn a better return than sort of like traditional mom and pop insurer or like met life, then they should, then they'd be able to offer better products, lower prices for consumers and policyholders.

8:24So you can imagine this is a sort of, let's say, a positive story where there's, it makes a lot of sense for the best asset manager, investor manager, the work to like own and ensure because they have so much expertise to invest money in. And, you know, private assets are like a big, big asset class now. So it also makes sense that insurance company assets go through some of these private assets as opposed to just investment grade credit because maybe there's not enough investment grade credit to go around for the balance sheet of all kinds of entities. So, you know, there's like a conceptual story you can tell which is makes it out of sense from like a market sort of 2026 landscape which don't involve anything like nefarious. So you can tell both stories. Yeah. So, so that is the good side and it is real that, you know, Blackstone and Apollo have very good investors. They have good deal flow and they have the scale to make these loans where they're, you know, at attractive prices that theoretically could be passed on to the

9:27life insurance clients. That's, you know, I'm not, we're not saying that it's fake. Let's explore the bad side. I guess there's two things. One is what happens if something goes wrong. If a life insurance company literally goes bankrupt and this, this, I'll spoil the answer for our for our audience here is that it's impossible for them to go bankrupt that, well, we'll get into that. And the second is the incentive, this sort of the slippery slope of if a private equity company, oh, alternative asset management company owns this life insurance companies, they can do various things that increase their take or their profits and they are not incentivized to not do those things. It's kind of a race to the bottom because of the the way that these the wind down policy goes. Tell us what happens if a insurance company goes, goes bust. Yeah. So as, as, as Prawnville was alluding to earlier, there is a unique system for managing the insolvency of a life insurer. And I think the best way to explain it is by analogy to a system that people

10:30might be more familiar with, which is banks. Like banks insurers cannot enter the bankruptcy process. What happens in a baked insolvency is that, you know, if the FDIC thinks like, okay, like the ship is going down, there is an issue, which is that there's a special class of creditor to a bank that we often don't even think of as being a creditor at all. And that is a bank depositor. If you have a checking account, savings account, whatever, out of bank, what you show up as on a bank's balance sheet is a liability because you have loaned money to this bank. And so in a bankruptcy, if there was no special regime, you would have to fight it out with all the other creditors to try to get your money back. And that's not desirable for a whole host of financial stability reasons. So instead, the FDIC has this special resolution regime, where the FDIC, if they see

11:34that the banks going under, they'll take over the bank, and then they have special insurance on the first $250,000 and Silicon bank value bank showed potentially a lot more in some circumstances, where you will receive a guarantee that that money is safe if you are a bank depositor. Now, this system is funded in the first instance by so-called assessments that insured banks pay to the FDIC every quarter in order to participate in this insurance system. So if they have to make these payouts to keep bank depositors whole, every bank has to pay a risk weighted, they have a sum, every quarter to the FDIC, and then they maintain that fund, and that fund is paid out. So it's initially an industry funded regime. And then in the event that that fund is ultimately not adequate to fix the situation, there is ultimately the full faith and credit of

12:38the United States, which is this broad public backstop that the government is going to stand behind the FDIC and make sure that all depositors get their money up to the statutory caps. What an insurer heads into insolvency. There is a somewhat similar system, but with potentially more bizarre incentives. So when the insurer goes insolvent, all insurers are regulated at the state level, rather than at the federal level. And so if you have an insurer that operates in multiple states, then they will simultaneously enter an insolvency proceeding in each of those individual states. The state insurance regulators for all of those states they'll coordinate and they will simultaneously try to administer that insolvent insurer. And if you're a policy holder at one of those insurers, there's also this concern that there's no special regime.

13:41You're also in a sense a creditor to that insurer and you'd have to fight it out to get your money back. And we don't want to put people in that position, especially if they've been paying premiums diligently to this insurer for many years. And they were counting on this payout to their families. Yeah, especially if they, you know, it's probably some guy about the policy and he died and it's his wife or his kids getting, you know, well, you don't want to unnecessarily burden them in an extra way. Yeah, this is like financial security for a lot of these families. And so what each state does is that also sets a cap, often about 250,000 or 300,000. And says you're going to have insurance on your insurance, where if the, if the, you know, company that's all you, this policy goes under and they don't have the assets to make the payout as necessary, you know, this insurance guarantee fund is the name, the guarantee fund will step in and make that payout to your beneficiary. And the way

14:46that they fund that payout is that they build every surviving insurer in the state in proportion to their premium volume in that state. So if you sell like 1% of the premiums in, you know, Ohio of life insurance, premiums in Ohio and in that year or recently, and then an insurer goes under in Ohio, then you're going to get 1% of the bill to bail out these policyholders. So initially the burden falls and all these other insurers who had nothing to do with this situation. But then you know, as as Pronjal said in 44 states, there are tax credits that insurers can take to alleviate the economic burden of these assessments. In 34 states, they can take that tax credit over five years and then another 10 they can take it over longer periods of time. But what these tax credits do is that they essentially change the reality of who is bearing the cost of bailing out these policy

15:52holders and they shift it from the insurer who has to front this money to the taxpayers who ultimately pay for it in the form of reduced tax revenue over the course of the next several years. And so this is in effect, a taxpayer bailout, but it's not one that ever needs to get voted on. It just happens automatically. Okay. And the assessment for the money to pay a newitance or clients customers, that is up to 250,000 or is it in excess of 250,000 or is it just if it's over 250,000 you're kind of screwed. There's no insurance for that. It's up to 250,000. Let's say I have a term life policy that is the death benefit is $200,000, then I'm totally covered. But if I have a death benefit that is $500,000 and only part of it is going to be guaranteed. So for a large swath of people, they have total insurance

16:59under this system. But for people who have relatively large policies, they may not be covered. And if you have extremely large policies, maybe like a $5 million dollar life insurance policy, $10 million, et cetera, then this system is not going to do very much for you. If that's entirely concentrated in a single policy, you have a single insurer. So there's no government protection for policies over 250,000 or over 300,000? It's the first 250,000. That's going to be covered. But above that, nothing. As you can imagine, the insurance companies still have a bunch of assets even if they're like ill-equated and hard to unwind and kind of like a normal bankruptcy, they might be able to recover a bunch more assets that can be distributed to Arata. So you can imagine recovery is being high, but there's no guarantee that you get more than the 300k statutory minimum gap. Okay, so Pronjal, Andrew kind of gave us the raw fact

18:05but explain precisely why the following sentence that you write in your paper is true based on what Andrew said, that compared to federal deposit insurance for banks, the guarantee funds for insurance socializes risk more sharply and lack comparable risk regulation infrastructure. Explain just why that's true. So in that story, the sort of the first thing that should be bizarre is that the insurance company that actually goes insolvent hasn't paid a dime. So in banking, the banks are paying into a fund quarterly and these assessments are being made quarterly based on the riskiness of their portfolio. In insurance, the regulator waits for someone to go under and makes the assessments on rival insurers based on premium volume. So again, not on risk. So the first thing to notice that the system is completely sort of not focusing on the riskiness of an insurance company. So both the one that's going under and the rivals.

19:08So Pronjal, if you have an insurance company and you literally bought the safest asset to possible AAA treasuries, I won't be not AAA, but treasuries and I just deployed 100% into junk. The state insurance regulators would treat us the same. So they wouldn't penalize me for taking additional risk and they wouldn't reward you for taking less risk. In the case of the insolvent, the exactly right. Now again, we should be very careful here. Like banking, the NAC, the state regulators try to make sure that insurance companies holding adequate amounts of safe assets. And so there is there is risk-based regulation of what the insurance company holds, kind of like banking. But in the paper, we try to argue that this regime is proven in the effective in the face of private credit. But let's put that aside for a second. So the sort of first thing is just that, you know, the regime does not penalize risk, riskiness of insurance adequately. And the second sort of way to think about it is like you're putting all the costs

20:15onto rivals and all of its funded exposed. So in banking, there's this idea that, you know, there's a federal regulator on the bank floor making sure I'm not investing in crazy things. In insurance, the regime that police is how risky the investments are is just simply has less capacity and less policing power. So that leads to insurers having greater ability to invest in riskier things. And over time, essentially, great incentives for the insurer did not adequately take precaution. Because the idea is like, okay, I know I might go bankrupt in the future. I can now sort of start doing things that are I'm not going to take adequate precaution by like, okay, I was like start offering even better deals for my policy orders, even better prices so that I can sign up even more people. And so I can keep paying the old people, the old policy holders,

21:18and keep collecting more and more premiums today just because I know I'm going insolvent in like a decade or something. So the idea is that the incentives for a failing insurer are perverse in that they want to sign up more customers, invest in even more risky things so they can pay claims today and avoid insolvency. And the state-based regulatory regime is ineffective, relatively ineffective compared to the banking regime in monitoring such such behavior. Right, so you argue that as a result of this, conservatively managed insurers functionally are subsidizing aggressive ones. So that is what we laid it out in theory. Now, tell us about what's actually happened in practice and the ways that private equity firms, alternative asset management firms have powerful incentives to exploit this and the various ways that they exploit this Andrew. Yeah, so private equity is leading the way in a transformation of both the asset and the liability side of these insurers. And a lot of

22:23traditional insurers are gradually converging over to this new business model as well. So let's start with private equity. What private equity does when they take over one of these life insurers is that they immediately reallocate a substantial portion of the life insurers portfolio away from these you know, traditional corporate bonds that are investment grade very highly rated, you know, you can think just like pouring a ton of money into like Apple or something like that. And instead what they do is they reallocate that money into making a liquid private credit style loans often to you know, affiliated companies that are held by the P firms by outfonds. They also invest more in structured products like CLOs, you know, a lot of low- and low-no applications, asset-backed securities, yep. Yeah, and so all of these products are much more difficult to value.

23:29Now that doesn't mean that they're inherently bad. Something because something being complicated doesn't make it you know inherently a worse financial product. There's plenty of financial engineering that is quite successful. But all of these assets have to be rated by credit ratings agencies that then make reports to the insurance regulators and who have to attest to the level of risk that the insurer is taking on. And if it's much more difficult to observe the level of true risk that's being taken on, that's being taken on, there's a lot of opportunity to arbitrage these rating systems. And that's precisely what's what's been documented by a lot of economists in studies of ratings of private assets, where equivalently rated public and private loans will default at differential rates. And the private ones are defaulting a lot more than they

24:31should, you know, relative to their risk rating. And the reason why we argue is because of the classic, you know, problem of risk align incentives that was much discussed in 2008 when there was a lot of issues with the credit ratings agencies at the heart of the banking crisis. These ratings agencies are paid by the insurers to, you know, conduct valuations. And because of this risk rating regime, all of these agencies know and everyone understands that the if you say an asset is risk here, and you report it to the regulator is being risk here, that will result in a regulatory penalty in what's called the risk-based capital regime. So if the insurer has the opportunity to, you know, shop around for between different the rating agencies, then they, you know, everyone understands kind of what the insurer might want out of this. There's been a particular, I think,

25:34scandal around a relatively small ratings agency called Egan Jones, which has become known for putting out a tremendous volume of notably industry-friendly ratings. But this, like, system of incentives applies to, you know, really the entire enterprise. And so this overall shift in the balance sheet that that that private equity brings, you know, moves the insurance industry into, you know, more and deeper and deeper waters that are untested. So the same ratings inflation flywheel that we saw that led up to 2008, is that play now? Yeah. And in some cases, it's literally the same ratings companies. In general, it's just the same incentive issue where, you know, we need some way to try to say how risky is this asset? And if there is, if the asset is publicly traded, when we have pretty good data then on how this asset is doing, we can track these

26:40sorts of assets pretty well. But if the assets that the insurer are holding are private credit, they're not traded, they're highly illiquid, they have highly bespoke terms, it's much more difficult to say, like, oh, is this risk rating appropriate? And amplifying this problem is something called a private letter rating, which is a rating that is made of these assets that is not disclosed at all to the public. It remains private to the insurance company that commissioned the reading and the regulator. And so there's all these, like, escalating layers of opacity, which make it very difficult to tell, you know, what sort of things we should be looking at. And the moral past either is the more capacity there is for gamesmanship. And so, so, yeah, Egan Jones, Wall Street Journal, Egan Jones rating firms accused of great inflation vouched for 40 billion

27:44dollars of insurance debt. And like, mass mutual owns 7% of the assets that mass mutual owns have Egan Jones rated debt. And that's for TIAA, that's 18%. Principal financial group 20%. I don't mean to cause any worry, but it's gone to the point where actually, Bermuda regulators have said that they were no longer accept Egan Jones ratings, which is a frankly incredible statement to make, because Bermuda is at the heart of the liability side transformation that these private equity and owned insurance companies are doing. So, you know, on the asset side, what these, you know, P is moving all these assets into private credit, into, you know, opaque products, into affiliated loans. And on the asset side, on the liability side, what they're often doing is they're pursuing an aggressive form of re-interest transactions,

28:44often called shadow re-insurance in the industry, where the idea is an insurer can create a subsidiary re-insurance company that is just completely owned by the mothership insurer, and they can locate it in a jurisdiction like Bermuda, which does not have transparency requirements. And then you can offload some of your assets and some of your liabilities into that re-insurer, and then effectively arbitrage around the disclosure regime that US insurance regulators have for the, you know, mothership insurance companies in, you know, empirical evidence has shown that P-linked insurers are much more likely to use this form of re-insurance, which again, amplifies the risk that is building up in the system that is not being tracked by the conventional data sources. So the insurance companies are not just owned by private equity and owning the assets

29:44that private equity makes and originates, but they're also buying re-insurance from themselves. Yeah, so they'll set up a subsidiary re-insurer in Bermuda, or actually some US states have tried to get in on this as well, like Iowa and Vermont, and they will shift the assets out of the parent company into the subsidiary re-insurer, and because the assets are formally held on the balance sheet of this, you know, re-insurance company, rather than the mothership insurer, they can evade all of the disclosure requirements that are associated with being a mainline insurer. They also, like, get plenty of tax cuts for doing so as well. Other than the conflict of interest, what is wrong about this and what is the risk of this? So if I'm an insurance company and you are a re-insurance company, I buy re-insurance from you, that re-insurance is an asset on my balance sheet, a liability on your balance sheet. The fact that this is all done internally within one parent company,

30:47one structure, you know, net net, what does that mean? That the re-insurance company is under capitalized, what does it mean? Often yes. So re-insurance in general, in the abstract, is a totally legitimate transaction. You might say, like, oh, well, I want to offload these, you know, uncertain payouts that I would have to make these beneficiaries. I want to pay another insurance company to take on that risk. And if that insurance, other insurance company was independent, then what you would do is you would negotiate out a deal about, like, how much money, you know, you'd have to pay them in order to take on this additional risk. But if you have a, what's called a captive re-insurer or a subsidiary re-insurer, this is just part of your own company, but it's a different legal entity. So you're moving the money and the risk out of one of your pockets and putting it into another of your pockets. But if you keep it in the main pocket, you're subject to disclosure requirements. And if you put it into this other pocket, you're not subject to these

31:51disclosure requirements. This is one of the aspects of this that I find most egregious and calling, which is that this sort of thing is somehow legal. You're able to, you know, move your assets into these jurisdictions where, you know, among other things, you also have much more lenient capital requirements that allow you to increase the leverage of that company much more. And insurers in the US are already pretty, life insurance are already pretty levered. But in Bermuda re, you can lever far more. And just how leverage are life insurance companies, at PE owned life insurance companies? Well, that's a great thing is that it's hard to even tell in, in theory, but, you know, in some, some news reports I've read have suggested think numbers on the order of magnitude of 50 to one. Yeah, which is, it's just kind of incredible. It's a very thin capital buffer. That is, Pranjal. Yeah, that, I mean,

32:54I'm not working on a separate paper that tries to think about this more carefully, but yeah, the way the leverage plays out is hard to calculate and think about partly because insurance is such a unique business. So yeah, like Andrew, I've seen news reports from like anywhere from 30 to one to 51, but it's, you know, like translating that into like how risky that is is a complicated question. So I'm not going to take a, like a stab at that. We'll leave it for another day. And just what is the risk of a systemic event? Because I think for property and casualty, like you could have a hurricane Katrina or something even worse, where literally like nature, and you know, an act of God has just declared that you suddenly owe $300 billion or something, you know, through the insurance system own something. But with life and health, life insurance, and then annuities, they are extremely at scale, like law of large numbers, easy to model, right? Like the odds that every single 81 year old person is going to die on Tuesday is basically

33:59zero, you know, what is the risk there? Maybe other than the fact that because it's so easy to model, people have just juiced up the leverage and risk immensely. Exactly. So that's exactly. So one way to think about it is like there's the lack of the sort of belief in predictability makes you want to invest in riskier and riskier things because you know that like look we're going to be fine and we can earn an access spread. Now to answer your question more directly, this is a big follow up paper we're working on, but like we'll just give you the pitch now. So you can imagine there's two ways an insurance company could be a run on it or they could be like sort of this cascading failure situation. So I'll give you the acid side. So like, you know, one way to think about it is like private credit has some relationship to triple A bonds and some relation to junk bonds. So like when there's like a big credit event, if junk bonds have a default probability of 15% or 20%, what is the probability for private credit? Like that number is a little bit unknown and

35:03hard to estimate, but the basic idea is that there's definitely some correlation there obviously. It's just you know, they're usually I'm not saying private credit is junk or private credit is triple A, but like there's going to be some empirical correlation of private credit to these assets. So in any sort of major credit event, we're going to see valuations come down and we're going to see defaults, which is totally normal. Now the question is the share of insurance balance sheets holding private credit is up significantly. It's like 15% as we describe it the paper. The sensitivity of an insurance company to a major credit event might have gone up in ways that are not reflected in the letter ratings or in the valuations because of as Andrew was describing earlier, the opacity makes it really hard to tell how risky a particular private credit now that might turn out to be safer or as safe as you can jones thinks or that turn out to be like much riskier and they have default probabilities much higher than anticipated. So you can imagine like

36:07you know it's 15% of the balance sheet is private credit. There's some default probability that like I don't know three or four percent of those assets become heavily impaired, hard to sell and like essentially like a big zero on the balance sheet conceptually. Now is that enough to sort of make a major life insurance company go under? That's another sort of hard empirical question, but that's like one way to think about asset side run risk. And then there's other sort of fab ends and other sort of funding commitments that insurance companies make, which could also create separate kinds of run risk. So that is all asset side and then I'll let Andrew do the libraries. Yeah, so on the liability side there's fragility that can come in multiple different ways. So there's what Prungel is talking about with fab ends is so this is something called a funding review back note. These became notorious because of a particular type of fab end

37:12and I think it was called an X-Fan end. Also I mean, I mean you read these terms. So I I apologize if I'm like saying it incorrectly. That's quite possible I am, but what a lot of these terms of these like loan structures have are like withdrawal or like demand rights by the creditors. Andy, let me just jump in. So I learned of these like a month ago just from actually reading you know like Apollo's investor presentation is pretty remarkable. I was surprised that basically these funding agreement back notes, fab ends and then funding agreement backed repos or repurchase agreements FAB Rs or something. Basically it allowed institutional investors basically net net net are lending money to private equity companies and and should be a private equity owned insurance companies. But the private equity the insurance companies treat it as if they're like a life insurance policy. So it's like you have a bunch of grandmas and grandpas who have a life insurance policy and then

38:13you have Harvard who lent you know and a poll you know a theme of Apollo's own insurance company like at 5% but legally they get to kind of pretend that it's that that Harvard is just a million grandmas lumped together in a room. Yeah a lot of this financial engineering is based around yeah creating a situation where you know the bankruptcy term will be like creating a liability that's party pursue with policyholders which is to say having like kind of same a legal nature the same kind of legal claim. And so if you have these like institutional forms of debt a lot of these fabens particularly during the financial crisis era had features that allowed creditors to call in that debt on demand. So you know if there were to be a fire sale and the way that Pondel is describing and some of these creditors got worried like hey like the ship is sinking here

39:17you know we want our money I'm pretty in particular we want our money out of here before anybody else has the idea of trying to demand their money out of here then you know we got to you got a race and everybody tries to withdraw their money all at the same time and then that is a big run but but it happens to a life insurance company and you know the degree to which that's possible depends on you know what percentage of the insurance funding comes through these types of structures what percentage of the insurance funding comes through these you know demandable loans and you know the the thesis right of of permanent capital is that this shouldn't happen is that the funding source for the life insurance is you know to a first approximation perfectly stable or at the very least stable for a term that is longer than like any asset that we like have on our books but it's possible for life insurers to you know take on sources of

40:23funding that are one might say less than permanent potentially much less than than permanent and so the degree to which I'm sure experiences this kind of fragility you know depends on to what degree they stray from making their capital like like permanent permanent and and instead relying on sources of funding that have withdrawal rights so FABNs have withdrawal rights like you can with yeah so there's there all very disc folk products so it's very hard to like make a blank statement but you can like there's every insurance might have several fabans that could be negotiated individually some of them come with x percent withdrawal right like 30% or some of them come with 100% but it really depends on the contract some of these are disclosed publicly so we're looking at that it like trying to give an empirical estimate for the ones that are publicly disclosed but so but it's just like a more like a conceptual idea that like look there's kinds of policies that no one can sort of demand their premiums there's kinds of policies that you

41:29can actually very easily demand your premiums and then there's FABNs which are like that on steroids in that it's on an individual it's like you know hundreds of billions of dollars in some cases or like at least tens of billions of dollars in some cases that can be demanded in a downturn the the sort of conventional picture of an insurance company is that like no one can I get their money back in a quench and I think that picture might not hold empirically with the new structures that are happening now yeah I mean it is it is true like directly that like life insurance funding is quite stable like if this wasn't true at all then the permanent capital idea would just be garbage but there have been you know some instances in the past the most maybe the most famous in recent years might be executive life where this life insurance invested a ton of money in junk bonds you know and this is back in the Michael Milk in days and you know there was

42:34true a genuine run on the insurer where policyholders were just canceling their contracts on mass you know one they they paid attention to what happened they often took heavy hits in terms of what are called surrender penalties like contractual penalties for canceling their contracts but they were full stop just going like we want out and the insurer collapsed now that was in the early 1990s you know that was a long long time ago and the you know a good one reason why I'm I'm talking about example from the early 1990s is because that in general life insurers are pretty stable but if we enter into this new world in which the the asset side of life insurance balance sheet is much riskier than we thought it was much more of a liquid than we thought it was and that also on the liability side leverage is a lot higher than we thought it was because all of these insurers are are doing mass shadow re-insurance transactions in Bermuda you know then we

43:38we have to start asking well like can we you know how how far do we want to push our luck yeah so one thing which is I you know Apollo is the pioneer of this they did have a a video come out saying does private equity own insurance and they said this is quote fake news and I guess we can all agree that the following statement private equity owns insurance companies is technically an incorrect or imprecise language less the private equity management company and the insurance company are both owned by parent entities by by one parent entity and then the private equity private credit alternative asset asset management business those loans a lot of them go into the private into the insurance companies books so that is what's literally happened so just want to you know give a yeah yeah yeah yeah the creators at Apollo who you know made it made it you know they're in the game we're all doing content creation we're all in the game but yeah a theme

44:41which is the insurance company owned by Apollo so it was actually not Apollo's investor presentation but a themed fixing investor presentation that they they showed just what their decade of dominance across organic inflow channels how they have retail annuities flow reinsurance pension group annuities and then funding agreements which include funding agreement back notes FABN and they say they have number one market share over the last 12 months in the FABN market share so they in 2025 they did 35 billion dollars worth of funding agreements which is quite similar to borrowing money it I believe I believe that's an accurate statement you know yes yeah these are these are liabilities to the insurer yeah so they're they're raising money through these vehicles in which you know money is being extended to them through institutional investors through this highly complex you know structure but you you at the end of the day this is

45:47a a creditor relationship yes and I think actually the Apollo's a themes also a borough through the federal home loan bank system which is a large lender to the banking system and it's for home loans to support that mission so people could say oh Apollo is perverting that mission I actually will say that Apollo is a giant mortgage lender Athene is you know they they own a lot of those loans and I actually think that there are things that are further from the FHLB mission that are done in banks like Silicon Valley bank was a giant borrower from the FHLB system and you know I interviewed some of these people and they were like well like Silicon Valley bank they did so much for community development and low income housing and they did like one billion dollars in low income housing which obviously is a lot of money but relative to the vast sums that they were borrowing or relative to the bat like they had more loans out to wineries in California than they had so I think that there's a lot of nonsense for the FHLB lending that's like not Apollo so I think it actually is a

46:50reasonable claim of like hey like Athene is a massive owner of mortgage loans so I actually think it's not a crazy thing yeah and I think going back to your conceptual point about does be actually own insurance companies I think it's exactly right to say that the holding company owns both the asset management business and the insurance company and that's how Alliance did it with PIMCO and and all of that I think conceptually makes sense I think the question that we have in mind is that whose incentives are sharper so the idea is when a P there's a holding company and there's two lines of business insurance and P slash private credit the P and private credit clients are institutions like Yale pension funds sovereign wealth funds and really sophisticated high net worth individuals and they want they are better monitors of performance and of things like fees and and through side letters like better like contractual provisions and contractual rights

47:55so meanwhile the insurance companies to the creditors or like clients are like policyholders who don't really know whose policy they hold they don't know what the insurance company invests in so yes there's like in a like a corporate law sense there's separate entities but the incentives are much sharper on the Pee side and the private credit side and that's what makes the I that's what like animates the paper with the idea is like the Pee side of the business is able to extract value today in ways that regulators don't see or evaluate properly while some of the losses are being transferred to the insurer in expectation again like if everyone gets paid out 50 years from now yes there's the losers but the point is if there's things happening today that are transferring value from a future bad state of the world to present state of the world where

48:55the the P equity holders the Pee part of the business is equity holders are benefiting today that is a direct like transfer from the insurance side of the business to the to the Pee side of the business and that doesn't require some complete ownership I think that like you don't need to like own the insurer to do any of the things we describe in the paper to add on to that you know the the staff that you know Pee owns you know this 700 billion dollars of insurers they also exercise control over some estimates say maybe another 300 billion dollars or so of insurance assets not because they own or not because the the holding company of the Pee firm owns the insurer but they have contractual arrangements with a lot of insurers where they can control a lot of the asset management strategies and do things like give you know the insurer you know right of first refusal

49:56on new private credit loans that are being you know originated by one of the funds that you know this holding company all you know also has and then is looking to sell off so there is a wide spectrum of different arrangements that you know these these firms can have with these insurers and what's relevant to our purposes is that is the degree to which they can control what the insurer is doing because if they can direct the asset management decisions of the insurer then you know as as a primal notes they have the ability to stand on both sides of the transaction and ask themselves who should we get the the better end of this deal to a fund in which we have institutional investors who we want to keep happy who monitor us regularly and who you know will potentially come back to be limited partners and future funds that we have or you know this insurer whose creditors

51:01are these policy holders who don't even notice what we're doing and I think that that incentive you know that's not to say that you know policy holders will always be exploited by this but this this is just something that exists in the background of every such transaction so there's two types of ways at least two types of ways where alternative asset managers have have relationships with insurance companies one is they literally own them so Apollo owns a theme KKR owns insurance companies and then there is they just have agreement so Blackstone has agreements with insurance companies Blue Al has an agreement with Kuvarra which is a insurance company so they own Kuvarra's asset management company but they don't own the insurance company so even if they don't own the insurance company they have they have relationships yeah so they they have the ability to influence what the insurer is doing by you know running the asset management side of the

52:05business so what do you think is wrong about the current legal system them whether it's formal rules or informal rules and practices both in terms of what's allowed what's permissible but also what is transparent versus hidden so you know we talked about what you think is wrong but you know where what what reforms would you like to see in this going forward because that's kind of like the the last part of the paper I can't talk about the sort of let's call it ex-anti reforms where the insurance companies alive and what should the regulator do to make sure things are better so the number one thing that we focus on and I think the one takeaway we have for the audience is that holding private credit assets in itself is totally fine it's a big asset class there's only so many investment grade loans to go around if an insurance company wants to invest in private assets conceptually there's no problem with that the problem comes from the inherent

53:09difficulty in valuing private loans and the incentives that exist for private letter agents private ratings and rating agencies who are being paid by the insurance company and they have an incentive to sort of grade inflate so to speak now the regulator faced with this problem so there's two problems one is the inherent difficulty in valuing in liquid opaque assets number two is the incentive that the rating agencies have in this relationship what they should do in face of that is is what we sort of focus on so number one is the first sort of simplest thing they can do is to tax capacity itself so the idea is we you see a private credit loan and you know inherently that it's hard to value so you at the margin penalize owning such assets just because it's hard for the regulator to check the rating it's hard for the regulator to verify how how risky this particular loan is so

54:15just you tax the capacity itself without thinking about the riskiness in order to deter an insurance company from owning things that are hard to verify for the regulator so that doesn't happen already no so right now all the regulator right now does is each asset gets a rating like a notch like a grade one two ten and the regulator basically says you should hold 10% of your assets in things that are rated 10 out of 10 safe you're allowed to hold 10% of your assets in assets that are rated five out of 10 safe so that's all the regulators doing but once you obtain a rating saying this asset is 10 out of 10 safe the regulator has no ability to tell you that you cannot hold the asset even if it's a private credit loan or it's like a triple A loan to 80 it's if once you get that rating saying it's like a 10 out of 10 safe asset from the regular point of view they're both equal and in the paper we propose like until we figure out how ratings are being inflated or how to do better

55:21valuations if there's two assets and they both get the same risk rating but one of them happens to be more opaque or illiquid you should tax that you should discourage investing in that in that asset after that's like one sort of meta idea without like having to like fix the valuation regime which you know it's the second thing is to sort of disallow private letter ratings and have every time an insurance company gets a rating it should be public and it should be easy to verify academics or researchers or journalists who can look at look eagony Jones gave this loan a triple B three years ago here's how it's fairing today now again it's still private and marks the hard to come by but the idea is if the loan was to go to truly go to zero we'd be able to observe that and police sort of great inflation that way so that's like sort of the things the regulator can do today that are before insolvency before anything goes wrong and I'll let Andrew get to

56:23the things that we can do better once there's insolvency yeah so one thing we're interested in doing is you know in our dream world getting rid of the current the existing insurance guarantee fund system and replacing it with a insolvency regulation system that is much more like federal deposit insurance where insurers you know pre fund the guarantee fund and also the amounts that the insurers have to pay are not based solely on the premium volumes like the amount of business they're doing but also taken to account the level of risk that the insurer is contributing to the system now that requires us to you know succeed on step one which is you know fixing these these valuation issues because if we don't fix the valuation issues then the risk weights are not going to mean anything and risk weights are never going to be perfect they're certainly not perfect in

57:24banking they've never been perfect in any setting what they've been tried but they are at least you know a directional attempt should try to say if you if insurer A is contributing more risk to the system by investing in you know Bitcoin then insurer B who is investing you know in 80 and T-bonds you know we should find a way to to to incorporate that into what these insurers owe to the backstop system and then the the last bucket that we want to talk about is trying to align the incentives of the controllers of these insurers with the you know incentives of the overall system so you know the the basic principle of corporate law is limited liability where you know if if something goes down you can only be liable for what you put in this principle is

58:30of course very important but it means that if you have a public backstop for a system you know this you incentivizes you to enact in ways that are consistent with what economists call moral hazard you take on too many risks because you get to keep the upside if the risks go well but somebody else has to pay for it if the risks go poorly so we propose that you know insurance holding companies which would include you know in the case of private equity you know the the broader asset management platform that owns the insurer big they should be liable for part of the guarantee funds assessments that are you know like required of all the insurers in the system on the principle that you know if everybody else has to pay for this and ultimately under the current system taxpayers have to pay for this you two should be on the hook for part of these losses and so this will also

59:37incentivize these companies to act you know pre-insulvency in ways that are consistent with the fact that they are going to bear some of the cost post-insulvency so right now the holding companies of these insurance companies that also own the alternative asset management firms you know Apollo KKR you're saying that if the insurance entity you know dissolved and went went essentially bankrupt even though they don't go bankrupt that KKR Apollo or the parent company would have no obligation to make things whole is that what you're saying they they have zero obligations to make things whole and you can see that in a tea investor presentation so that's like yeah that's just basic corporate law and then that there's separate entities yeah interesting was that also true about bank holding companies like the Lehman holding company that owned Lehman bank was that also true or now yeah so banking banking is an interesting case so the short answer to this question is

1:00:42they also don't have an obligation but in banking specifically there has long been this doctrine that is more theoretical than real called the source of strength doctrine where you know the idea is that if a bank is going down that the rest of a bank holding company should act as a source of strength for this struggling bank and contribute you know money contribute capital injections to stabilize the bank technically this this idea was codified into law in Dodd-Frank but what Dodd-Frank did is it essentially charged you know regulators with coming up with a way of of of making this like systematic and to this day like more or less is not used so you know none of the recent bank failures another bank failures of recent years that have had bank holding

1:01:44companies like no regulator has gone knocking on the door to be like all right guys like time to cough up so in a sense our proposal is it is a modified version of this of this same principle which is you know under the normal setting you know your company does not get a public backstop but you get limited liability now in this you know in this specialized setting like an insurance you get a public backstop that's a deep privilege and with that privilege should come some responsibility and you know right now we've been trying to enforce our responsibility through this financial regulatory regime that is being systematically gained another way of trying to to enforce it more directly would be to say like okay you you do not get the full privilege of limited liability so what you're saying basically and this isn't oversimplification but what you're saying is that the finance people gained banking regulation before 2008 and after 2008 great financial crisis

1:02:50we had a tons of regulation that's very very difficult to do but now there's in there's loopholes in insurance regulation that are allowing potentially shady things to occur that you want a remedy yeah I I think they're you know some of the parallels with 2008 or a bit eerie I don't want to overstate the parallels and you know like the funding system of of banks is much more subject to runs structurally you know on average than than life insurance do but there are all sorts of things like for example you know banking used to be famously this very boring business model and all this risk was injected into the banking system by you know sophisticated you know asset managers who you know said like well we can arbitrage around bank capital rules you know we can rash up the level of risk in the system without that risk being fully accounted for you know this

1:03:51will increase our profits and expectation at the cost that there's this downside risk that you know we won't fully bear and then low and behold that risk was not fully born and everybody else paid for it that was an incredibly dramatic way that that happened in 2008 because there was you know our gargantuan run on repo that that caused the entire banking system to almost collapse in the course of a couple weeks and kicked off a gargantuan recession and I'm not making you know the claim that that sort of thing you know is kind of imminently you know on the horizon but but it is the case that we are ratcheting up the risk in the life insurance system greatly and a lot of the similar tools that socialize risk are present in modified forms in the insurance industry as well you're not predicting a wildfire you're just pointing to some dry kindling I hope that in 20 years

1:04:53I am not a you know on a documentary as a talking head saying oh well you know we saw the signs and and then you know we had time to act to try to reduce some of the risk that was building up in the system and we just you know didn't take advantage of it and then some sort of large macro of occurred and there was a downturn and then it turned out that some of these insurers were just too highly levered and they'd taken on too many risks and then they blew up and then taxpayers ended up footing the bill but I think that if we continue on the same path that we're going the probability of that scenario is going to increase when it increases every year because every year we hit new highs in the levels of you know assets that are being managed by you know these fee linked holding companies new highs and the percentage of insurer assets that are going into these highly opaque

1:05:57asset classes and new highs and the amount of shadow re-insuring and the amount of life insurance and annuity policies that are going to be issued in the in the future years is almost guaranteed to continue to grow just looking at the demographic pyramid of how old people are getting and stuff totally end and the insurance companies around the record saying we're going to increase exposure to private credit and ABS and so it's both both the aging demographics and increasing sort of dominance of private credit. Andrew a key question we referenced it so far and I talked about it with the previous guest, Manik Nemeth who's very alarmed about private credit and its connection with with life insurance is the surrender ability of life insurance assets. So everyone knows if you have a bank deposit you can pull it basically at any time unless it's a CD and that creates enormous risks because if if people reasoned new to this article about this bank collapsing everyone is going to pull their money at the same time but life insurance policy oh it's permanent capital blah blah blah but I actually didn't know until speaking to Nick like

1:07:00a month ago that you actually can pull your life insurance policy and often it is subject to a surrender penalty but it is allowed so just speak to us about that risk you referenced it earlier. Yeah so life insurance policies are contracts and in those contracts you can specify the cost of surrendering and a lot of these contracts have significant surrender penalties but those surrender penalties often vary they vary by how long the the policy has been in existence they vary by which you know insurer is issuing the policy we have frankly a lack of good policy level data to try to analyze you know how these truly book on a macro level but part of the next project that Prondyl and I are pursuing is about the degree to which policyholders can you know if they really want to cut off and insure right now you know as per the the Prondyl idea it's very rare for

1:08:08there to be you know systematic rises in in surrenders and responses to stimuli but we're not convinced that that's always going to be true okay let's just take Andrew tell us about the amount of shenanigans let's call them that you think are potentially being played by people who are not the most conspicuous biggest firms like we're all talking about Apollo because it basically created the idea and was the pioneer in it and it's a publicly traded company but you know Apollo has said that number one they use Bermuda but they don't use Cayman and they take some some things are going wrong and Cayman that Bermuda is good Cayman not so much they also said that they they don't use egan jones that rating insurance so it seems like whatever you know because we're talking about Apollo because the biggest one but that there are companies that I've never heard of and almost all of our viewers have never heard of that are probably doing things that are potentially shadier if that's the correct term yeah I mean until a couple weeks ago I had never heard of

1:09:12Delaware life or clear springs and you know then we learned that you know they had been reporting their affiliate under reporting their affiliated assets by an order of magnitude for years and right now they're the you know the current subject of a massive wave of corporate transactions where their ultimate owner you know Mark Walter is doing things like trying to sell the lakers in order to stabilize these insurers and get them back into compliance so I think that this this problem of a lack of scrutiny public is systemic and you know one reason to think that you know the largest scale players you know might be you know not the most aggressive ones is that they do have a lot of eyes on them there's a lot of eyes on the feed I don't believe there are a lot of eyes on clear spring or Delaware life and you know it's just it's very difficult to

1:10:12observe all of these things on a macro level and that might get worse with some of these smaller insurers so that is a recent news story on on Bloomberg tell us about Delaware life tell us about clear spring tell us about the lakers tell us about Guggenheim what is the connection there either of you whoever wants to take it sure I can try to give the big picture over it there's been a lot going on but the basic idea is Mark Walter runs or go found it or overseas Guggenheim and a big very large private equity company he also owns two or has controlling stakes in two life insurers clear spring and Delaware life he also owns the Dodgers and until recently the lakers and the basic idea is that he used insurance company assets premiums collected from policyholders to start making loans to entities that are related to the Dodgers and in one specific loan to

1:11:15Lebron James directly that was backed against his future earnings. I'm $300 million dollars yes so when Lebron signed his max deal with the lakers you know that money comes over I think it was like a five year deal instead of earning that money over five years he got an insurance company a loan from an insurance company controlled by Mark Walter so I have to get that money today and to invest it the loan was backed against Lebron's future earnings I think in particular non NBA earnings but like off the few earnings regardless a loan to Lebron while owning the lakers is obviously an affiliated transaction in that Mark Walter owns the lakers owns the insurance company and he's making loans to Lebron who is very closely tied to the lakers he's on the roster so it's the same thing with the Dodger entity loans some of these entities were called Dodger's tickets LLC and the idea is all of these are obviously

1:12:17affiliated but when reporting to the regulator whether or not these transactions were affiliated I think they failed to do so and the number was 3% the reported 3% of their insurance assets are affiliated with Mark Walter that number after the correction turned out to be I think 42% which is you know a crazy high number that is close to half of the entire insurance companies assets being invested in things that are closely tied to the owner so once that was disclosed almost like a month ago I think six weeks ago when Mark Walter has been unwinding some of these transactions directly paying the insurance company and taking the loan off the balance sheet and to do so you need liquidity and one of the ways he's sort of become more liquid is by simply selling the lakers which he bought almost a year ago to Jared Kushner and Bob Eiger and since it's the lakers it's very easy to sell you know and he sold a 2.5 billion profit so

1:13:25in Enter and I wrote a piece for Bloomberg where we try to explain you know this in some ways is like a rosy scenario in that the lakers are a very good asset to sell even if it's in liquid yeah in that you know even as a fire sale you could imagine people lining up to buy the Los Angeles acres but if it was instead of the affiliated entity being things like the lakers of Dodgers and they were like loans to a middle market software company those would be hard to sell or hard to get out of in a crunch so you can imagine scenario going poorly depending on what the loans were invested to yeah Mark Walter appears to be stabilizing the insurers by selling off his own personal assets and then using that money to repay the insurers you know if the insurers instead we're trying to sell off these assets that are now under a cloud of suspicion to third parties third parties might

1:14:27insist on steep discounts you know because of all of these concerns and so that would be a situation in which you could end up in a fire sale is a you know a p backed life insurer trying to get out of a of a dire situation but being but that situation also impairing their ability to sell highly a liquid and assets where the valuation is contestable so you have a loan into Guggenheim universe that plunged to as low as 73 cents on the dollar not something you want to see but you think it could be stabilizing well what does it say about the entire universe we've been talking about private equity private credit insurance this whole issue this whole you know brew ha ha with Guggenheim and the lakers the first might be take away was just that the fact that the affiliate transaction share can be off by you know 30% is kind of insane

1:15:31the regulators are supposed to be checking these transactions to make sure they aren't affiliated now the onus is on the insurance company disclose this one is an affiliate one I'm disclosing that or reporting that but the fact that you can sort of just by not saying no on that form you can sort of go by years can go by and you can keep making these affiliate investments without anyone checking in if itself shows that the regime is not doing a good job of policing the affiliate transactions and these are not sort of complicated or hard to see I mean Mark Walter owns the insurance company owns the lakers and he's making loans to like LeBron so like these are not some super opaque AVS securities where the ownership is hard to track so so the first thing to think about is just the existing regime is not inspiring confidence if it cannot police affiliate transactions of this kind now they've made strides to make the reporting better but and this happened I think

1:16:33before that but still the idea is that at bottom the regulator is not doing enough to to identify the paper is private credit state backstop how private equity socializes risk through insurers we will link to that as well as your profiles on on LinkedIn X and another reporting on this guys thanks so much thank you everyone for watching please leave a rating and review for monetary matters on our youtube channel and also on apple podcast and Spotify thank you thank you so much Jack thanks for having us