Weekend Listen: Why Private Credit Got Entangled With Insurance

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17:17Pranjal Drall:So one of the questions then is, how much competition is there among insurers to gather assets? Because it's like, okay, here is insurance company A, and they're going to pay me$5 ,000 a month for life because I've bought this annuity every month for the rest of my life after I turn X age. And here is another one. But this one is paying all these IT services and all these little things that maybe like come out of the return, et cetera. Does the end market of insurance purchasers have much clarity on what they're buying and the economics of two different policies?

17:54Andrew Granato:It's a hard empirical question. So there's this thing in finance called the annuity puzzle, where in theory, annuities are the perfect investment, but society as a whole underbuys them. And a lot of finance professors have spent decades puzzling out why that is the case. So we're not going to solve it here. But one of the lessons from that literature is that people are going to invest in annuities because they don't get a good deal. Prices are too high. The policies aren't that good. There's competition, but the end consumer doesn't get a great deal or they at least perceive they're not getting a good deal.

18:24Andrew Granato:So there's always been this concern that for some reason, the annuity market isn't very competitive. Now, you might imagine if an insurer is owned by a PE shop and they make a lot of money on the private credit liquidity and all this, you know, because high returning and all this stuff and they earn fees. So in some ways, a PE shop that owns an insurer might offer better terms to policyholders because they have all these other ways to make money from the business. So we've seen some empirical data that like the PE owned insurance companies compete better in the product market. So you can imagine that consumers might benefit.

19:00Andrew Granato:The problem there is, of course, that, you know, you might get a good deal in the short run, but, you know, decades down the line when things come due, there might be problems.

19:08Pranjal Drall:If I'm in the market for an annuity, should I or do I have any capacity to take into account credit risk? As someone who grew up or became an adult kind of during the GFC, I was like, I don't know, like I'm going to retire in like 20 years. Who knows who's going to be around? To what degree either does that or should that be part of the information that the purchase of the annuity has?

19:31Andrew Granato:Yeah, so it's very difficult, I think, for retail policyholders to meaningfully grasp the degree of solvency risk that the kind of counterparty annuity provider or life insurance provider has. And so something that we think is really fundamental is that, you know, the investors in, say, a private credit fund, nonprofits, you know, endowments, big institutional investors, pension funds, they're in a very different position than just like normal people who like don't know about anything, you know, what this insurer is doing with all of the money. as far as they know, they just bought a life insurance policy.

20:07Andrew Granato:And I'm willing to bet most people haven't even thought about what happens like kind of on the other side of that balance sheet. And that asymmetry is what drives a lot of the like, I think the results that we're going to speak about.

20:18Pranjal Drall:Yeah. So, okay. Speaking of asymmetry, the McKinsey's of the world out there who will talk about this being a virtuous flywheel where, you know, PE slash PC gets access to these big pools of permanent capital. And then the insurers themselves maybe get access to higher yielding. assets that then generate better returns for investors, better products, etc. On the other hand, you also have critics of this practice who will point out that because of the nature of private credit, because these aren't publicly traded bonds with, you know, double A, I guess now, or maybe triple A ratings for some corporates, you don't necessarily have the level of insight into what these things are and what their true riskiness is.

21:00Pranjal Drall:Talk to us about what we know about the actual private credit assets on insurer balance sheets and what regulators can actually see and know about these things.

21:10Andrew Granato:So this has been a topic of discussion for the last two years, almost. I feel like this almost obsession of how much should we trust private credit valuations? And this is a problem in BDCs, which are like publicly traded, and you can see the quarterly marks on these loans. And you can see there's a privately traded BDC and there's a public traded BDC, and the public one trades at a discount. So there's always been this concern that the valuations aren't kosher or they're overvalued in some ways. So those same kind of intuitions apply here, except the crucial difference is the regulator, in case the NAIC, which is an association of regulators, essentially has visibility on an insurer's balance sheet.

21:52Andrew Granato:And they look at everything they invest in. This could be equity, cash, safe bonds, whatever that means, and private credit bonds. And all the insurer regulator sees is the value reported to them, which is usually outsourced to a third party rating agency. And then they see like this private credit loan is valued. It's like a double A. And then they give you a notch on a scale of one to 10. And you get this picture as an insurer. These private credit assets are X amount of safe. These private credit assets are less safe. And there's like a spectrum. And then the regulator says, this is a good portfolio.

22:29Andrew Granato:It's safe.

22:30Pranjal Drall:And like banks, they have to hold certain amounts of capital against the portfolio.

22:33Andrew Granato:There's a whole risk rating regime through the NAIC that is like somewhat analogous to that of banks. And I think a lot of the concern applies here as well, too. Like there were concerns in 2008 about what are the incentives of the credit rating providers. The incentives for what are often called private letter ratings for life insurance are kind of particularly skewed. These are ratings where the rating itself is actually not kind of publicly visible. So a credit rating agency, someone like Egan Jones might report to the NAIC, you know, here is our rating for this asset. And, you know, how was that rating obtained?

23:11Andrew Granato:Can anybody else like investigate? Is there any sort of track record to compare this against? It's just extremely difficult. And so there's a variety of new empirical literature and economics that's coming out basically every week where people will do various sorts of tests and they'll just continually find overvaluation in a lot of these assets.

23:29Pranjal Drall:Since we're talking about 2008 for a second, one of the sub dramas with the bank bailouts was this idea that the bondholders of banks didn't take any haircuts. And so it was like there were losses, quite substantial losses, but they were all born on the equity side. And we saw like how the city groups of the world like not lost 95 percent of their money. Was part of the reason that regulators or policymakers were so reluctant to let some of the bondholders take losses is because you just described the classic normie insurance holding. I'm sure in 2006, you know, it's like, oh, yeah, we have a highly rated bond from a city group in our portfolio.

24:09Pranjal Drall:It's like the equivalent of the AT &T bond. Was part of the concern with bondholder haircuts essentially that then it could create an issue with the insurance channel?

24:17Andrew Granato:Yeah, I think that a lot of the same logic applies. What insurance has that banking doesn't have is essentially is a different form of a public backstop that implicates different kinds of agency problems and also a differing way that taxpayers and kind of other like non-investor actors can be put on the hook for an insurer's losses. So all of that interacts in very complex ways with the actual direct capital structure of the insurer, which is partially these policyholders who are technically creditors to the insurer. They show up as liabilities on the insurer balance sheet. And then there's also kind of direct creditors to insurers.

25:01Andrew Granato:They're not covered by the socialized backstop, but there is this kind of like endless relationship that keeps shifting when you have what we call like or what is that an insurance guarantee fund? Yeah.

25:14Pranjal Drall:So this is actually the real subject of the paper. As much as we talk about ratings, arbitrage and opacity of private credit assets and things like that, the point that you make is that because of the way that insurers are regulated and, I guess, administered when they go belly up, although they don't really go through traditional corporate bankruptcy proceedings, but the way they're dealt with if there's a failure is fundamentally different to the way banks are dealt with in our system. Talk about those differences for us.

25:45Andrew Granato:Yeah. So I think when people think about what does a public backstop look like, if they're familiar with one, they're familiar with federal deposit insurance. And federal deposit insurance is a pre-funded risk-based system. So if you're a bank and your depositors get federal deposit insurance, every quarter you get an assessment from the FDIC, which basically says you have to cough up some money as a kind of risk premium. The FDIC has a deposit insurance fund, which holds that money. And in the event that a bank ever goes down and payouts ever need to be made to keep depositors whole and to administer the insolvency of a bank, they spend down that fund.

26:26Andrew Granato:And in the event that that fund is ever fully depleted, there is the kind of full faith and credit backstop of the United States government. So that would be truly a kind of taxpayer funded bailout. In 2008, we also had, of course, like TARP. So that was, you know, like legislators had to go and vote, say, okay, we're going to individually appropriate money, we're going to appropriate loans, we're going to appropriate all sorts of investments, because like the scale of the problem was just too large to deal with through the FDIC on its own. Insurers are subject to a different form of public backstop that we argue in the paper is kind of essentially structurally worse.

27:09Andrew Granato:The way that a guarantee fund works is if a life insurer goes bankrupt, it does not go into bankruptcy, similarly to how a bank does not go into bankruptcy. Instead, the domiciliary state of that insurer takes the lead on a simultaneous insolvency proceeding across every single state. Insurance is regulated at the state level. There is no kind of federal regulator of insurance. There is no equivalent to the FDIC. You just go into state court, and then we have to resolve this across every state simultaneously. And within every single state, there's a guarantee fund that says, you know, if you are a policy holder of this insurer, we're going to guarantee that you get up to some statutory cap of your money.

27:57Andrew Granato:Similarly to how for the FDIC, you get up to$250K. In theory, potentially, it could be far more. But statutorily, you get your first$250K and every account is insured. It depends on the state law for each individual state coverage, but you can think of it as being roughly$300K. So if I have a life insurance policy that's supposed to pay out for$200 ,000 when I die, and my insurer goes down, I can just keep paying premiums and the policy backstop fund will make sure that I get or that my beneficiary gets 200k in the event that I die and that I've maintained my end of the contract. The way that a guarantee fund pays for this protection in the first instance is by levying an assessment on every surviving insurer in that state.

28:49Andrew Granato:But this assessment is only levied after the insolvency has already happened. So if I'm the insurer that went down, I've actually contributed$0 of my own.

29:01Pranjal Drall:It's very ironic for insurers themselves to not be like paying something towards insuring their own debts. Yes. Yeah.

29:08Andrew Granato:So like you, well, of course, you know, the company has gone down, so it's not a happy ending for them. But like, they don't have to cough up anything. Meanwhile, you know, some other random insurer who had nothing to do with this, they have to pay some sort of bill. And that bill is weighted by the percentage of premiums that they sold in recent years in that line of business. So, you know, the other life insurers in the state of Oregon, or whatever, if I have a life insurance policy, and I'm in Oregon, like they have to pay up. But then what happens afterwards, depends on the state exactly. But in the vast majority of states, you can, as the insurer, get a tax credit against that assessment liability.

29:52Andrew Granato:And in about 34 states, you get a full tax credit that you can take 20 % a year over five years. And then in another 10 states, it's roughly 10 years. It's only about six states where you don't get any tax credit. So of course, if you have a fully offsetting tax credit, this is economically equivalent to a taxpayer bailout of the insurance policyholders. But nobody ever votes on this. There just happens automatically by operation of law. And the insurer is stuck with losing what we might call it kind of just like time value of money because they have to like float this in the meantime. But it is a stealth taxpayer bailout.

30:30Andrew Granato:And beyond the sort of structural issues, you might imagine some practical problems with this setup. Number one, the statutory cap in FDIC is$250 ,000, which is considered a fairly high amount for just someone having a checking account. In this case, close to$300 ,000 for life insurance. That's about the 40th percentile of life insurer policies. A lot of policies are way bigger than that. As you can imagine, people who usually buy life insurance are usually richer and they're putting a lot of money into premiums. So the coverage of this bailout is way lower than bank failure. And the other big concern is that just practically speaking, Iowa and Oregon and New York and Tennessee sort of doing this at the same time is a very challenging task.

31:19Andrew Granato:We haven't really had major insurer failure in this way. Like in 2008, obviously, EDGE was bailed out. So the idea is that -

31:26Pranjal Drall:Have we ever had a big insurance failure? Not on this scale.

31:29Andrew Granato:So it's actually, it's completely untested to have a large national insurer with assets and something like, you know, the hundreds of billions of dollars range go and solve it in a way that would require administration through the guarantee fund.

31:44Pranjal Drall:So is it fair to say it's like structurally suboptimal on multiple levels? So it's suboptimal in the sense that there is this implicit taxpayer backstop in a way that's a little different from the FDIC. But it's also suboptimal that the backstop isn't actually that good for the policy holders potentially, because it's like, all right, if we're going to have a backstop, at least we can rest easy that the policyholders like maybe there's a little bit of misalignment. The backstop encourages the insurer to take undue risk. But look, it's OK. It's good in the end, because at least policyholders can sleep easy.

32:17Pranjal Drall:What you're saying is we don't even have that. We have the taxpayer part and we don't really even have the FDIC equivalent that can make everyone sleep easy.

32:26Andrew Granato:Exactly. And since you're not paying as your solvent, you're paying post-insolvency, one more thing that the regime encourages is as you head into distress, you want to take on more risk.

32:39Pranjal Drall:It seems good for an immoral insurer, right? Just a self-irrational insurer.

32:44Andrew Granato:Right. It's like a Holmesian bad man insurer is going to just simply invest more risky things, try to give really good deals to policyholders to make premiums today. Oh, yeah. You're not paying for it. Because you're not paying for it in the end. So at least in like a equilibrium sense. And, you know, the rivals knowing that one of my rivals is going to go bankrupt soon, they're going to want to pull out.

33:07Pranjal Drall:Because with FDIC deposit insurance, they put a cap on how much rates you can offer. Like that's part of that trade so that you can't a desperate bank can't say, oh, we're paying 15 percent on savings accounts right now. But there's no in insurance that mechanism doesn't exist. Exactly.

33:55Pranjal Drall:We'll be right back.

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35:42Pranjal Drall:So you suggest in the paper that this might be the real reason that private equity slash private credit has been so interested in the insurance space, because it provides them an avenue to basically a socialized backstop, which makes sense. But I guess I wonder, in the course of your research and actually talking to private equity and private credit, how aware are people of the current regulation scheme for bankrupt failed insurance? Does it come up a lot?

36:12Andrew Granato:I think one of the main ways that this ends up playing out is that what people are often thinking about is, you know, turning back to the permanent capital angle. Am I allowed to just like make my investments without somebody yelling at me about them? And one of the reasons why if you have a life insurer, you can make kind of whatever investments you want without like nominally the creditors of your company or the investors in your company coming and yelling at you is because you have not having people yell

36:42Pranjal Drall:at you is like a very underrated incentive in the world. But I think it's one that probably is very important.

36:48Andrew Granato:Yeah, is that you have this widely dispersed retail base of policyholders, a large fraction of whom are totally insured. And so even you can do whatever you want. And like, in theory, they shouldn't care because no matter what, they have full coverage. Obviously, that's not true for everyone. But it's just the level of kind of examination that you're going to get from your creditors is so much lower. if you are running the private credit through the life insurer balance sheet rather than through kind of a standard private credit fund. One more point I want to make is that I've spoken to some people who work in this space, and one thing they say is that, say there's a good insurance manager and a bad insurance manager that both use private credit.

37:34Andrew Granato:One of them uses investment-grade private credit on the balance sheet. The other one uses rating-inflated bad private credit. And since the valuation regime is sort of opaque and sort of hard to tell what's like a truly good private credit loan versus not, it actually penalizes in equilibrium sort of good asset managers because they might have access to like AT &T private credit. And if they're getting the same ratings from Egan Jones as someone who's investing in like a middle market SaaS company in Chicago, obviously those two are extreme examples. They get different notches in the NAIC system.

38:10Andrew Granato:But you can imagine at the margin, the high quality private credits also suffer just by ratings inflation because you're not just hiding risk. You're also competing in this dynamic market. So the insurer who has access to investment, get private credit might also suffer. And the design of the guarantee funds actually amplifies this problem, because in banking, the assessment premiums that banks pay are risk-weighted. They're not purely size-weighted. Obviously, size is a major important component of risk. But for guarantee funds, it's purely the premium volume. So you can imagine two identical insurers with the same premium volume, except that one of them, you know, invests very conservatively.

38:49Andrew Granato:The other one invests, you know, like a madman. You know, the expected value of the public backstop is much greater, you know, for one than the other. And so you have this kind of implicit subsidy that is being routed through this like underlying backstop.

39:03Pranjal Drall:In the event of like a failure, like there is not, you know, as you said, it's only the 40th percentile policyholders. There are a lot of potential losses. Because in the literature, in your work, et cetera, is there a certain expectation that there exists in the world certain other implicit backstops that aren't formalized in law for those premium holders? Or could it only be the type of thing where it's like if they're going to get, quote, bailed out, unquote, it would be some sort of tarp-like vote again where politicians would have to stick their necks out?

39:33Andrew Granato:I think that's the exact way to think about it. So this, the 40th percentile person is just by operation of law going to get a bailout. And then you can imagine politicians, especially local politicians, you might imagine, don't want their state's policyholders to lose out on, you know, people who have life insurance policies and their insurer goes insolvent are some of the most sympathetic people on the planet. So I'm assuming that would be an easy yes at the state level to make them whole. Obviously, it's impossible to predict the future, but it's almost hard to imagine them not getting some protection in the future.

40:07Andrew Granato:There's also the potential, especially in states that actually don't have the tax credit for a perverse feedback loop. So if there is a bad macroeconomic environment and some large insurers go down, that levies assessments on other insurers that are already hurting. And that comes at the worst possible time. And if that pushes other insurers into insolvency, you know, then you have this very vicious cycle. That cycle is ameliorated, of course, by the fact that in most states you do have these like tax credits. But also, you know, if interest rates are spiking during this time, then you run into kind of more serious time value of money problems with the fact that the tax front has to be taken over five to 10 years.

40:50Pranjal Drall:Can we just do a quick history detour for a second? Because hearing you describe this system, it does not sound ideal, to say the least. How did we end up with this particular, like, organizational structure for regulating insurers?

41:05Andrew Granato:So the kind of history of state-based regulation of life insurers goes back to when the Supreme Court had a much kind of stricter interpretation of the Commerce Clause. And so it did, in like a famous case in the 1800s, the Supreme Court said that insurance did not constitute commerce for the purposes of the Interstate Commerce Clause. In the 1940s, the Supreme Court reversed that decision as part of its general trend towards being more permissive of federal regulation. But Congress immediately disclaimed its new power to regulate life insurers in an act called McCarran-Ferguson. And McCarran-Ferguson says that unless Congress explicitly passes a law that says we're regulating insurers, all other regulatory authority is reserved to the states.

41:54Andrew Granato:So it's just pretty much been like that the whole time. There are periodic waves in which there's like activism for federal insurance regulation, usually because of a wave of insurer insolvencies or some other like, you know, alleged malfeasance in the industry. And then what will typically happen is that the NAIC, which is the kind of association of state regulators that formerly operates actually through a nonprofit, it's not formally a public entity at all, will act to try to forestall that federal push by kind of doing it on its own. And that's what happened with guarantee funds in the 1960s and the 1970s.

42:32Andrew Granato:There was a wave of insolvencies and property and casualty insurance, and there were bills introduced in Congress to create a federal backstop that was kind of similar to the FDIC. And the NAIC and various states quickly responded to create these state-level backstops instead. And one of the interesting ways the NAIC operates is that most states actually defer rulemaking to the NAIC fully into the future. So I think Indiana is one of these states where they self-incorporate the model law that the NAIC puts out, even prospective changes.

43:10Pranjal Drall:Oh, so they just like cede control entirely. Yeah.

43:13Andrew Granato:So there are state laws that say if the NAIC says this, it will be automatically incorporated into our own state law, which is like a very distinctive arrangement.

43:22Pranjal Drall:So it occurs to me there is one difference between banks and insurance is that banks have the possibility of correlation on two fronts. So all the loans, if you're here to think banks make a lot of housing loans, like banks all could go, the loans could all go sour at the same time. But then also their depositor base could be correlated. Right. We saw this with SVB, but you could also just imagine in any other environment, people get anxious about a bank and they all withdraw their deposits. That can't quite happen the same way with an insurance company, at least if we're talking about vanilla insurance, where you only get paid out either on an event or retirement or something like that and you stagger it.

43:59Pranjal Drall:Does that change the dynamics or the fact that insurers could still have correlated failure? They're all maybe making loans to software companies at the same time, but they don't really have the risk of correlated withdrawals in the same way that a bank would.

44:15Andrew Granato:Great. That's a pitch for our next paper. That's the follow up that we're running on now. You can imagine conceptually there's runs on the asset side of the liability side. I'll speak a little bit about the assets, and Andrew is more an expert on the differences in policies and liabilities. But on the asset side, as you said, all of them make loans to Chicago SaaS company in the middle market, and then they all go calling back and there's not enough cash flows. So in that paradigmatic sense, since banking has very good, you know, like on the floor of a bank, there's officials from the federal government that say, don't invest in this type of risky asset, usually about credit, but also I'm sure they're thinking about industry risk.

44:57Pranjal Drall:Yeah, we're watching your SaaS exposure. Yeah, something like that.

45:01Andrew Granato:And insurance, since that regime is much weaker because it's dispersed, the NAIC is less, they have way less resources and power than the federal government. So just on the asset side, the monitoring is much worse. So you might imagine there's more possibility of correlated exposure than there is in banking. And you can imagine, you know, like the last year or so, a lot of the private credit pain has been due to a very specific kind of exposure. Insurers are something like 15 % of the assets are in private credit, 10 to 15, depending on how you measure. And the idea that a third of private credit is software, it's not a stretch.

45:37Andrew Granato:So you can imagine like, you know, 30 % of that 15 % is in one industry. Again, I don't have the specific numbers because they also do infrastructure and all these longer term things. But the idea is like it's more possible in the insurance context of banking. And the liabilities is a completely different answer. Yeah, liabilities is fascinating. And that's going to be like one of the primary subjects of our next article. So like one preview would be if things depend a lot on the kind of life insurance policy that you hold. So, for example, you could have, let's say, if you hold a whole life policy and you have a cash value reserve account inside of that policy, this is like essentially a tax preferred, you know, kind of a Roth IRA thing that's inside of a life insurance policy.

46:17Andrew Granato:And you have rights of withdrawal on that account. And so that is demand deposit like. And so if you had a life insurer that had sold a ton of cash value life policies and people tended to store a lot of money in those policies, you know, you can run on that.

46:35Pranjal Drall:To be clear, would you say that historically, since these are sort of more exotic flavors of insurance, that regulators have approached this industry as one in which, quote, runs aren't a phenomenon the same way we associate them with banking?

46:49Andrew Granato:And banking runs is like the primary concern. It drives everything. And in insurance, I do think, you know, kind of per the permanent capital hypothesis, you're structurally...

47:01Pranjal Drall:The asset liability mismatch. Yeah.

47:03Andrew Granato:Like you, there are good reasons to think that insurers are structurally less vulnerable to runs on average, but it depends a lot on the nuances. And there have been runs on life insurers before. So executive life in the early 1990s was a life insurer that was really struggling and there was a run on the insurer. Now, executive life was, you know, a few billion dollars worth of assets. This is not something that it's going to cause the financial system to collapse. And so I think we've been very lucky that we have not had a situation like that happen with a very large life insurer.

47:39Pranjal Drall:Well, OK, speaking of cascading risks, one thing I never understand when it comes to insurance is reinsurance, because it's just like you have the insurers and the reinsurers insure them. And then do you have like re-insurers who insure the reinsurers? It's insurance all the way down. But you talk a little bit about this concept in your paper of shadow reinsurance. What exactly is that?

48:02Andrew Granato:Yeah, shadow reinsurance. So if you are an insurer, and you would like to transfer some of the risk off of your balance sheet, there are various ways that you can do this. You can reinsure with a totally independent entity. So you'll say like, you're going to take on these liabilities, and I'm going to transfer you these assets. Or you could do this with a captive, like subsidiary reinsurer. and that captive subsidiary reinsurer can be anywhere. And so we can have different kind of corporate or state law or tax law that applies to it. So one of the main ways that life insurers and particularly private equity backed life insurers like to reinsure is that they use captives that are in Bermuda or that are in certain states that have tried to compete with Bermuda like Iowa or Vermont.

48:52Andrew Granato:And these are places where the tax rates are very low. And also there is no balance sheet visibility into the reinsurance balance sheets through the prism of the primary insurer. So if I were to reinsure all these assets and liabilities, I give up all the stuff off my balance sheet, and then it disappears into the reinsurer balance sheet. And on a quarterly level, you could go into the NAIC data and you can see actually at a QSIP level what the life insurer holds in the US, that data quality is extremely high. But once that is reinsured into one of these quote unquote shadow reinsurers, you lose all visibility into what's going on.

49:33Pranjal Drall:I don't want this to be the typical odd lots episode where we talk about a problem and then just go off agreeing that it can never be solved because part of your paper actually talks about regulatory suggestions for how you might fix some of these issues or at least try to make them better. What do you think can be done here?

49:51Andrew Granato:I think there's a variety of options that the NAIC can undertake, you know, in the first instance, that align the downside risk with the controllers. So you can imagine, like, step one could be something like valuation based reforms. I think a lot of people agree at this point that the over optimism in valuation is a structural problem, that private letter ratings are too generous. And that also just that there is an issue with trying to value private credit in the first place, because these are non-tradable loans that have these bespoke terms. And so you can do a Pigouvian tax on opacity itself, where you say like, oh, if certain kinds of assets are just structurally hard to value, then we're going to impose a regulatory capital surcharge on that complexity.

50:41Andrew Granato:We're not going to look at any of the individual underlying assets because that's extremely resource intensive to do. That's just not feasible to do, especially if you have, you know, a private equity insurer with billions and billions of dollars of these assets on your balance sheet. But we're just going to just say like, you know what, you're just going to have to pay that surcharge. You can also move to the guarantee fund level. You can end the tax credits that insurers get for the guarantee funds. You can move to pre-funding. Essentially, you could transform it into a federal deposit insurance-like system.

51:13Andrew Granato:And then you can also borrow other ideas from areas in banking. For example, we talk about this kind of theory in banking law that has not actually been operationalized very much, but it's called the source of strength doctrine, where if a bank goes down, in theory, under the source of strength doctrine, you could go to the affiliates of that bank at a bank holding company and say, look, time to pay up, because the rest of us have to pay up and so do you. And you could apply a similar concept to an insurance holding group. So you could go to the other affiliates in any insurance group, whether it's private equity or not, and say, you know, you have to be responsible for, you know, X percent of the payouts that have to go from the guarantee fund.

51:58Andrew Granato:And that would align incentives in this insolvency scenario.

52:02Pranjal Drall:Source of strength doctor. Yeah, I like that. That's good. Yeah, that's a good name. It has a sort of like Chinese governmental ring to it. The intention is stated up front. I just say, it feels like it should be something that's about something bigger than banking regulation. It's like I subscribe to the Source of Strength doctrine. It's like, oh, it's about banking regulation. All right. Andrew and Pranjal, thank you so much for coming on Odd Law. It's a great paper. Really appreciate you being here.

52:28Andrew Granato:Thank you. Thanks so much.

52:41Pranjal Drall:So, Joe, I found that really fascinating. I do think like the relationship between private equity slash private credit and insurance is kind of an underdiscussed one. It's only just starting to get a lot of attention. And again, going back to the whole original impetus for private credit becoming a thing, which was to get some of this risky stuff out of the regulated banking system. It doesn't seem great if it's just landing in another different kind of regulated financial industry. Totally. I mean, on the sort of like, OK, core asset asset liability management. It's a beautiful synergy. Right.

53:16Pranjal Drall:I felt the need multiple times in that conversation to say not all private credit. All right. No, no. Not all private credit. But it is a beautiful symmetry. Yeah, that's what I'm saying. You have this sort of pool of they're not depositors. We call them policyholders who really are. They are not expecting to get their money back for a very long time. They can only get their money back on certain rules, et cetera. It truly does solve that. It makes a lot of sense to pair that with certain types of assets whose value emerges because it can be held for a very long time and perhaps held through a drawdown.

53:52Pranjal Drall:So that makes total sense. Of course, though, the question that arises is, well, A, like how much then becomes the sort of quasi regulatory arbitrage? It's sort of a looser environment. How do we even know these are quality assets that will satisfy the policyholders and so forth? And I found that to be very eye opening to sort of like how just loose it all seems. How just sort of like held together by scotch tape. And also this idea that we've never actually had a major insurance failure. And so you could see that, well, you know, maybe one of the reasons it's all held together with scotch tape is because it's never been an issue before because we haven't had a failure because insurers have been investing in really boring IG rated bonds.

54:35Pranjal Drall:But if that's changing, then maybe we need to start thinking harder about this. The one other thing I'll say, we're recording this on July 30th and private credit. It's been in the news, you know, for the past year or so for various reasons. But it's in the news again because we have federal prosecutors apparently investigating Mark Walters, who, in addition to being the owner of the L.A. Dodgers, also has Guggenheim. And Guggenheim has affiliated insurers, Delaware Life, and I think the other one was called Clear Lake or not Clear Lake, Clear Spring. something clear clear in a body of water yeah but of course the irony is that maybe it's not so clear because it put out a revised financial disclosure saying that the number of affiliated assets on its balance sheet so these are assets that come basically via guggenheim or that are under common control by guggenheim they had reported them previously as something like three to five percent of delaware life and clear whatever total assets and then they went back as a result of this investigation and checked, put out a revised statement.

55:41Pranjal Drall:What do you think the proportion of affiliated assets is now? Tell me. 40%. There you go. So you moved from three under additional scrutiny. It moved from three to 40%. So these are the kind of concerns that I think are starting to bubble up. Totally. But in the meantime, shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Yalaway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our producers, Kerman Rodriguez at Kerman Armand, Dashiell Bennett at Dashbot, Kale Brooks at Kale Brooks, and Kevin Lozano at Kevin Lloyd Lozano.

56:15Pranjal Drall:And for more OddLots content, go to Bloomberg.com slash OddLots. We have a daily newsletter and all of our episodes. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash OddLots. And if you enjoy OddLots, if you like it when we talk about insurance regulation, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

57:03Thank you.

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