• Blog
  • 2 Min Read
  • May 2, 2023

How Insurers are Maximizing Returns with Mortgage Loan Capital Structures

In recent years, insurers have been structuring private mortgage loans into a senior note and a junior note to create a more capitally efficient investment that takes advantage of NAIC Risk Based Capital requirements. This approach has become increasingly popular with insurers who are seeking ways to optimize their capital usage and increase their investment returns.

To protect against unexpected losses, the NAIC has established rules for how insurers must calculate their capital reserves. These rules consider the credit risk associated with different types of investments, taking into account how higher-risk investments require higher capital reserves.

By dividing private loan deals into a senior loan and a junior loan, insurers can take advantage of the low RBC charge for high quality mortgage loans while still maximizing their allocation to private markets and the higher yields produced by these assets.

For example, consider an insurer who wants to invest in a private mortgage loan that has a total value of $10 million. Rather than utilizing a $10 million whole loan, lenders are increasingly structuring the deal as an $8 million senior loan and a $2 million junior loan. Because the senior loan has a lower loan-to-value ratio and stronger debt service coverage ratio, it would require a smaller capital reserve than the entire $10 million loan. The remaining $2 million junior loan now must take a higher RBC charge due to the subordinated status and weaker debt service coverage ratio, but it earns a higher spread for the same reasons.

This strategy has become increasingly popular, but it is important to note that this approach is not without risk. Investing in riskier loans can lead to higher losses if the loans default, and insurers must be careful to manage their risks appropriately. Having access to fast, accurate data is more important than ever with the quickly changing capital markets and increasing complexity in investment structures.

To learn more about industry trends and concepts, schedule a call to speak with a Clearwater expert today.

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