WEBVTT - Why Private Credit Got Entangled With Insurance 0:00:02.720 --> 0:00:17.079 Bloomberg Audio Studios, Podcasts, radio News. 0:00:18.520 --> 0:00:21.320 Hello and welcome to another episode of The Odd Lots Podcast. 0:00:21.400 --> 0:00:23.560 I'm Tracy Alloway and I'm joll Wisenthal. 0:00:23.840 --> 0:00:24.160 Joe. 0:00:24.600 --> 0:00:28.800 There's a key tenant of finance and investing, and I 0:00:28.800 --> 0:00:31.960 think it's like essentially the thing that makes finance and 0:00:32.040 --> 0:00:35.800 investing work go on. It is the idea that you 0:00:35.840 --> 0:00:39.240 can invest in pretty much anything, the world's most stupid thing, 0:00:39.560 --> 0:00:43.920 I don't care, doge coin, whatever. But the key thing 0:00:44.080 --> 0:00:46.680 is if you do that and the investment doesn't work 0:00:46.720 --> 0:00:51.240 out and it goes belly up, you should bear that loss. 0:00:51.560 --> 0:00:51.800 Yeah. 0:00:51.960 --> 0:00:56.240 I think that's rightly. 0:00:54.800 --> 0:00:56.840 Ideally by the way you invest in something that doesn't 0:00:56.840 --> 0:01:00.400 have negative externalities for other people. But you know, let's 0:01:00.440 --> 0:01:02.800 just focus on the lost portion for a second. Yeah. 0:01:02.840 --> 0:01:04.920 I like this framing. I think the way you could 0:01:04.959 --> 0:01:09.880 say that financial structures overall, whether we're talking about a bank, 0:01:10.040 --> 0:01:13.919 whether we're talking about a multi strategy, multiplatform hedge fund, 0:01:14.120 --> 0:01:18.520 whether we're talking about whatever, is an exercise in trying 0:01:18.520 --> 0:01:21.880 to establish this purpose, right, because everyone wants to make 0:01:21.880 --> 0:01:24.000 the investment that they don't bear the loss in, right, 0:01:24.040 --> 0:01:26.560 That's like and we should all to some extent. We 0:01:26.600 --> 0:01:29.920 should all be striving for that constantly. You want to 0:01:29.959 --> 0:01:33.800 build up these things that more or less create that 0:01:33.800 --> 0:01:37.320 that happens principle, agent alignment problems and so forth. 0:01:37.480 --> 0:01:40.120 Right, and so when you get moments in financial history 0:01:40.160 --> 0:01:44.400 where losses are not purely born by investors, yeah, people 0:01:44.440 --> 0:01:47.880 often get very upset. And as you know, two thousand 0:01:47.880 --> 0:01:49.760 and eight was one of those moments. 0:01:49.880 --> 0:01:50.080 Right. 0:01:50.240 --> 0:01:52.160 One of the reasons the two thousand and eight financial 0:01:52.200 --> 0:01:54.840 crisis was such a huge deal was because we had 0:01:54.880 --> 0:01:57.000 banks who made a bunch of risky investments and then 0:01:57.240 --> 0:02:00.640 ended up getting effectively bailed out by tax payers, even 0:02:00.640 --> 0:02:03.840 though taxpayers arguably we're not the ones deciding to invest 0:02:03.880 --> 0:02:06.000 in synthetic CDOs and things like. 0:02:05.920 --> 0:02:10.160 That totally, even in the absence of bailouds. This always 0:02:10.160 --> 0:02:13.920 bothers people. When someone makes money on a risk and 0:02:13.960 --> 0:02:17.160 then someone else holds the bag from the bailoud example, 0:02:17.320 --> 0:02:20.400 to people who promoted SPACs and made a lot of 0:02:20.480 --> 0:02:24.720 money just on the transaction but didn't participate in the downside. 0:02:24.960 --> 0:02:27.680 It upsets people, right, And so all across finance you 0:02:27.680 --> 0:02:30.680 see in situations where people are upset when it turns 0:02:30.720 --> 0:02:33.519 out that the person doesn't have the requisite quote skin 0:02:33.600 --> 0:02:34.400 in the game unquote. 0:02:34.440 --> 0:02:37.400 No one wants to be an unwilling bag holder. That 0:02:37.480 --> 0:02:42.440 sounds bad, but I want everyone else to be like, Okay, okay, 0:02:42.480 --> 0:02:44.519 but wait. The reason I bring up two thousand and 0:02:44.560 --> 0:02:47.200 eight is because it's actually a very important component of 0:02:47.240 --> 0:02:49.799 this conversation because we're going to be talking about private credit, 0:02:49.840 --> 0:02:53.959 and private credit to a large extent, has grown into 0:02:54.000 --> 0:02:56.440 this massive industry. And the reason it's grown so much. 0:02:56.480 --> 0:02:59.240 One of the reasons is because after two thousand and eight, 0:02:59.600 --> 0:03:01.600 after the banks went belly up and had to be 0:03:01.639 --> 0:03:04.600 bailed out, et cetera, you had policymakers make an active 0:03:04.600 --> 0:03:07.400 decision saying that they wanted to move risk out of 0:03:07.440 --> 0:03:12.720 the regulated banking system into investment vehicles, where if things 0:03:12.760 --> 0:03:16.280 went wrong, the investment vehicles themselves would bear the losses 0:03:16.400 --> 0:03:22.080 without having those losses socialized through deposit insurance or taxpayer 0:03:22.080 --> 0:03:25.600 funded bailouts and all of that. And that's what basically happened, right. 0:03:25.880 --> 0:03:28.079 Yeah, I would say there are sort of in the 0:03:28.160 --> 0:03:32.080 financial system we have sort of I would say, two 0:03:32.240 --> 0:03:35.120 types of creditors, like we're cool with like people losing 0:03:35.160 --> 0:03:37.600 their money when they give money to an institution, they 0:03:37.600 --> 0:03:40.480 take a risk. But I think there's essentially two types 0:03:40.520 --> 0:03:43.360 of entities for which we don't find that to be 0:03:43.560 --> 0:03:46.600 fully acceptable. We don't find it to be fully acceptable 0:03:47.160 --> 0:03:49.600 when someone deposits their money in a bank and we 0:03:49.760 --> 0:03:51.800 you know, we could say this is a loan, right, 0:03:52.080 --> 0:03:54.280 but we don't really want to accept that this is 0:03:54.480 --> 0:03:56.440 a loan, Like we don't we want people to have 0:03:56.520 --> 0:03:58.480 the confidence they're putting money in the bank. I'm not 0:03:58.520 --> 0:04:00.200 really making a loan to the bank. And then I 0:04:00.240 --> 0:04:03.320 would say the other category is insurance holders, and we 0:04:03.360 --> 0:04:05.600 don't really like the idea. And as someone who owns 0:04:05.600 --> 0:04:08.480 a policy, it's a little bit different than a loan. 0:04:09.120 --> 0:04:11.840 But I think the idea of like an insurance holder 0:04:11.880 --> 0:04:14.880 as a bag holder does not sit well with people 0:04:15.800 --> 0:04:18.039 at a sort of democratic, sort of societal level. 0:04:18.120 --> 0:04:21.200 All right, you have totally anticipated the next thing I 0:04:21.240 --> 0:04:23.880 was going to say, which was we moved risk out 0:04:23.880 --> 0:04:27.640 of the regulated banking system into private credit. Yeah, which 0:04:27.680 --> 0:04:32.400 seems fine, Like, all right, risky loans, all that middle 0:04:32.600 --> 0:04:36.480 company deposit holders don't have to worry, right exactly if 0:04:36.560 --> 0:04:40.520 risk is now migrating back into another regulated financial industry 0:04:40.640 --> 0:04:43.240 that we do care about for the reasons you just stated, 0:04:43.320 --> 0:04:46.599 which would be insurance. That doesn't seem ideal either, right, 0:04:47.040 --> 0:04:50.880 having credit risk migrate out of the banks into private credit, 0:04:50.960 --> 0:04:53.799 and then having private credit migrate into insurers. 0:04:54.160 --> 0:04:56.919 Yeah, and you know, like I think, insurers and banks 0:04:56.960 --> 0:04:59.880 aren't really that different. It's sort of the difference is 0:05:00.080 --> 0:05:03.440 the timing and the liquidity with which you can get 0:05:03.440 --> 0:05:06.839 the money back out of your whether if you're a depositor, 0:05:07.040 --> 0:05:09.400 can you get your money out on demand, if you're 0:05:09.400 --> 0:05:12.320 a policy holder, can you get your money out either 0:05:12.360 --> 0:05:15.720 at a certain time or on an event in which 0:05:15.800 --> 0:05:18.880 the policy triggers. But fundamentally, I've always thought it is 0:05:18.960 --> 0:05:21.599 kind of the same different the same business with a 0:05:21.680 --> 0:05:23.279 different sort of redemption schedule. 0:05:23.520 --> 0:05:26.000 There are differences between insurers and banks, which we're going 0:05:26.040 --> 0:05:27.679 to talk about for sure, But one thing I should 0:05:27.680 --> 0:05:30.279 just say is we have discovered in the course of 0:05:30.279 --> 0:05:32.800 this podcast that one of the driving forces behind the 0:05:32.800 --> 0:05:36.800 private credit boom has been its linkages with insurers for 0:05:36.880 --> 0:05:38.880 some of the reasons that you just said. So, insurers 0:05:38.880 --> 0:05:44.159 famously have long dated liabilities, right, they have patient capital. 0:05:44.320 --> 0:05:46.560 They can take in a liquid asset and sit on 0:05:46.640 --> 0:05:49.719 it for ages and ages and capture that illiquidity premium, 0:05:49.720 --> 0:05:52.159 that higher yield, so they would seem to be a 0:05:52.240 --> 0:05:55.520 natural place for private credit to actually end up. But 0:05:55.960 --> 0:05:58.640 as we mentioned before, it does open up this whole 0:05:58.680 --> 0:06:01.919 new can of worms about losses and who actually bars 0:06:01.960 --> 0:06:05.080 those losses. So this is what we're going to be discussing, right, 0:06:05.120 --> 0:06:09.800 the insurance private equity private credit nexus in excruciating detail. 0:06:09.839 --> 0:06:11.839 And I'm very happy to say that we do, in 0:06:11.880 --> 0:06:14.200 fact have the perfect guests. We're going to be speaking 0:06:14.240 --> 0:06:16.960 with Andrew Gnado. He is assistant Professor of law at 0:06:17.040 --> 0:06:19.640 UT Austin as well as Pranjel Drawl. He is a 0:06:19.760 --> 0:06:23.800 jd PhD Candidate in financial economics at Yale University, and 0:06:23.839 --> 0:06:26.520 they just published a really good paper. It is called 0:06:26.600 --> 0:06:32.120 Private Credit State Backstop. How private equity socializes risk through insurers. 0:06:32.720 --> 0:06:35.560 So truly the perfect guests. Andrew and Pronjall, thank you 0:06:35.600 --> 0:06:37.080 so much for coming on all thoughts. 0:06:36.960 --> 0:06:38.440 Thanks for having us, thanks for having us. 0:06:38.560 --> 0:06:42.240 So we know that insurance has teamed up with private 0:06:42.279 --> 0:06:46.240 equity in various ways. Some private equity firms own insurers outright, 0:06:46.320 --> 0:06:49.839 others have like minority investments or like different business relationships. 0:06:50.480 --> 0:06:54.560 What is the attraction or the allure of insurers for 0:06:54.800 --> 0:06:56.200 private credit slash pe. 0:06:56.560 --> 0:06:59.240 Yeah, so you can think of this as being so 0:06:59.400 --> 0:07:02.560 McKinsey's this a flywheel. So imagine you have like a 0:07:02.560 --> 0:07:06.760 private equity firm with three subsidiaries. You have a traditional 0:07:07.040 --> 0:07:10.200 like buy out subsidiary that buys up companies and uses 0:07:10.280 --> 0:07:13.160 leverage to do so, you have a private credit fund 0:07:13.200 --> 0:07:16.160 which issues these high risk, high yield loans, and then 0:07:16.200 --> 0:07:20.600 you also have a life insurance entity. There are theoretically 0:07:20.600 --> 0:07:23.840 all these different synergies between all of these actors. So 0:07:23.880 --> 0:07:25.440 if I go and I need to buy some sort 0:07:25.440 --> 0:07:27.920 of company, well, someone has to issue debt in order 0:07:27.960 --> 0:07:30.120 for me to be able to do that. Maybe a 0:07:30.160 --> 0:07:32.960 different part of my p firm can issue that debt 0:07:32.960 --> 0:07:35.400 and maybe I can get better terms that way. But 0:07:35.440 --> 0:07:37.680 then there's also this aspect of you know, if I 0:07:37.720 --> 0:07:40.840 have a private credit fund, you know, these are funds 0:07:40.880 --> 0:07:43.840 where you know, I have LPs, we're constantly you know, 0:07:43.840 --> 0:07:47.160 making demands off for returns. But if I have a 0:07:47.200 --> 0:07:50.760 life insured I have these very long dated liabilities where 0:07:50.920 --> 0:07:53.640 arguably the capital is like what we're told is permanent. 0:07:54.280 --> 0:07:57.920 So if you can hold these private credit loans that 0:07:58.000 --> 0:08:01.520 are highly liquid on the balance of the life insurer 0:08:01.880 --> 0:08:05.600 that you're issuing to other firms in your portfolio. You 0:08:05.640 --> 0:08:08.120 can imagine that this is like a scenario in which 0:08:08.120 --> 0:08:11.040 you kind of theoretically get the best of all three worlds. 0:08:11.280 --> 0:08:13.520 One more way to think about it is that private 0:08:13.560 --> 0:08:16.800 credit has become a large asset class. Insurers warn't access 0:08:16.840 --> 0:08:19.560 to that private credit, and instead of having an in 0:08:19.600 --> 0:08:23.480 house team that just learns how to do private credit investment, 0:08:23.720 --> 0:08:26.960 they go outsource that to a big pe shop which 0:08:26.960 --> 0:08:30.200 has developed this business over two decades in some cases, 0:08:30.680 --> 0:08:35.400 and essentially outsource and use these economies of scale to 0:08:35.440 --> 0:08:37.440 outsource part of the lending so they can still do 0:08:37.520 --> 0:08:41.280 the you know, publicly traded sort of boring credit that 0:08:41.360 --> 0:08:44.200 they've always done, and outsourced part of the lending do 0:08:44.360 --> 0:08:45.520 more specialized shops. 0:08:45.600 --> 0:08:49.160 Well, this sort of realization that these things could merge 0:08:49.280 --> 0:08:51.959 has just made people an extraordinary amount of money. It 0:08:52.000 --> 0:08:54.439 should be noted, you know, one of the most infamous 0:08:54.440 --> 0:08:59.640 investors of all time, Warren Buffett, utilize this core insight 0:09:00.080 --> 0:09:03.479 an insurance having an insurance arm would be an extraordinary 0:09:03.520 --> 0:09:05.760 source of patient capital. You know, we talked like mutual 0:09:05.800 --> 0:09:07.800 fund managers and one of the questions we always ask 0:09:07.840 --> 0:09:09.839 them is like, isn't it tough that at a market 0:09:09.920 --> 0:09:12.439 draw down you can't actually hold it because your clients 0:09:12.440 --> 0:09:14.560 all move on to the next fund. I mean, this 0:09:14.760 --> 0:09:16.960 is already for a very long time, just been an 0:09:17.000 --> 0:09:19.400 extraordinary fruitful partnership. 0:09:19.880 --> 0:09:23.520 Yeah, it's not something that's new. What's new about private 0:09:23.559 --> 0:09:26.720 equity in the last fifteen years or so is the 0:09:26.840 --> 0:09:29.320 degree to which that they have kind of ramped up 0:09:29.320 --> 0:09:32.719 the aggression of the investment strategy that they are pursuing 0:09:33.000 --> 0:09:36.240 with one by purchasing these life insurans at such high volumes. 0:09:36.720 --> 0:09:39.439 Recent estimates have maybe like something like seven hundred and 0:09:39.520 --> 0:09:42.480 fifty billion dollars or so of life insurance assets kind 0:09:42.480 --> 0:09:45.440 of within private equities purview. And then the degree to 0:09:45.440 --> 0:09:49.960 which they are shifting the portfolios of their life insurance firms. 0:09:50.520 --> 0:09:54.440 Until quite recently, life insurans were famous for having these 0:09:54.520 --> 0:09:56.920 you know, protrects says, very kind of stodgy triple A 0:09:57.040 --> 0:10:02.000 rated AT and T bond portfolios. And that becomes less 0:10:02.040 --> 0:10:05.440 and less true across the industry in general. And that's 0:10:05.559 --> 0:10:08.600 a trend that's being led by private equity, particularly with 0:10:08.640 --> 0:10:11.440 regard to these like affiliated private credit investments and their 0:10:11.480 --> 0:10:12.760 other portfolio companies. 0:10:13.080 --> 0:10:14.960 Yeah, so this is the key thing. I think. So 0:10:15.559 --> 0:10:20.120 insurance has transformed private credit by supercharging its growth, but 0:10:20.160 --> 0:10:23.319 at the same time, insures themselves are being transformed by 0:10:23.440 --> 0:10:26.959 private credit. Can you talk about exactly, like, what does 0:10:27.000 --> 0:10:31.640 that relationship look like in practice? So you mentioned affiliated assets, 0:10:31.679 --> 0:10:34.400 which have been in the news recently for reasons we 0:10:34.480 --> 0:10:38.319 can definitely get into. But if I'm a private credit 0:10:38.520 --> 0:10:41.720 you know, originator, and now I have bought an insurer, 0:10:42.760 --> 0:10:46.080 what does that relationship look like. Am I dictating that 0:10:46.440 --> 0:10:49.079 am I telling them what they actually need to buy? 0:10:49.559 --> 0:10:52.720 Am I making polite suggestions? Am I making sales pitches 0:10:52.760 --> 0:10:55.679 and saying, well, you got first crack at these very elite, 0:10:56.360 --> 0:10:58.440 previously exclusive private assets. 0:10:58.600 --> 0:10:59.360 That's a great question. 0:10:59.440 --> 0:11:01.480 So, as you can imagine, there's a lot of nuance 0:11:01.520 --> 0:11:05.599 there where certain asset managers. So just to set the 0:11:05.600 --> 0:11:09.560 stage a bit, Alliance for example, owns Pinco and Alliance 0:11:09.640 --> 0:11:12.320 to insure and this happened in like thirty two thousand. 0:11:12.720 --> 0:11:15.280 So the idea of having an asset manager make investments 0:11:15.320 --> 0:11:17.720 on the behalf of the insurer, it's not new. The 0:11:17.800 --> 0:11:20.560 second point there is there's a lot of variation in 0:11:20.600 --> 0:11:23.839 how that contract works out. So the most in our 0:11:24.160 --> 0:11:28.240 parlance problematic or concerned we should be is about when 0:11:28.360 --> 0:11:32.079 the insure balance sheet is effectively in control of a 0:11:32.120 --> 0:11:35.840 bigger asset manager. So the idea there would be that 0:11:35.840 --> 0:11:41.360 the insurer doesn't have as much discretion, they're just at 0:11:41.400 --> 0:11:45.000 the behest of the broader asset manager. Or you can 0:11:45.040 --> 0:11:48.199 imagine an insurer goes out shopping. I want the best 0:11:48.320 --> 0:11:51.280 private credit shop to invest money on my behalf so 0:11:51.320 --> 0:11:54.840 I can make capture the liquid premium, offer better terms 0:11:54.880 --> 0:11:57.480 to my policy holders by making more money. And in 0:11:57.520 --> 0:12:00.480 that case, you know, there's like a lineup of really 0:12:00.520 --> 0:12:03.840 sophisticated pe shops that will like try to earn that business. 0:12:04.200 --> 0:12:06.640 And in that case, you can imagine the this called 0:12:06.640 --> 0:12:08.959 like a third party agreement where you're outsourcing party of 0:12:08.960 --> 0:12:11.720 balance sheet to an assa manager, and that's totally like 0:12:12.080 --> 0:12:14.440 you can imagine a very competitive marketplace for that service, 0:12:14.440 --> 0:12:17.760 because insures, as you said, manage large pools of money. 0:12:18.120 --> 0:12:21.400 So there's like a big spectrum there, one where the 0:12:21.400 --> 0:12:23.960 insurer has effectively given up full control of the balance 0:12:24.040 --> 0:12:26.920 sheet and the other where the insurer is thenually looking 0:12:26.920 --> 0:12:29.720 for who's going to offer me the best terms to 0:12:29.800 --> 0:12:33.360 invest my money in this very specific segment. And you 0:12:33.360 --> 0:12:36.480 can imagine a spectrum of possible arrangements there. 0:12:36.559 --> 0:12:40.079 So if I'm an insurer who's owned by a pe shop, 0:12:40.480 --> 0:12:43.200 I'm paying them management fees as well for those assets. 0:12:43.280 --> 0:12:46.120 Right, that's right, Okay, And you're so you're paying management 0:12:46.160 --> 0:12:49.760 fees in both cases. Usually it's just in the third 0:12:49.760 --> 0:12:53.200 party context, since you don't own the insurer, you'd imagine 0:12:53.200 --> 0:12:55.600 the insurer has better bargaining incentives exactly. 0:12:55.800 --> 0:12:59.440 Oh yeah, And there's also many cases where the insurer 0:12:59.559 --> 0:13:02.640 is part of a private equity kind of like sponsored 0:13:02.640 --> 0:13:05.440 platform is not just paying out fees for management, but 0:13:05.440 --> 0:13:07.640 it's also paying out fees for essentially all sorts of 0:13:07.679 --> 0:13:11.199 other affiliated services, like you know, you could imagine accounting, 0:13:11.559 --> 0:13:15.520 you can imagine valuation, consulting, all sorts of things where 0:13:15.559 --> 0:13:18.760 the it t Yeah, where like the insurer is kind 0:13:18.800 --> 0:13:21.040 of like the balance sheet of the insurre is a 0:13:21.080 --> 0:13:23.360 holding pen for a lot of the assets, but all 0:13:23.480 --> 0:13:26.480 the action is actually outside of the insurance corporate form 0:13:26.520 --> 0:13:28.280 and the rest of the kind of keys. 0:13:28.080 --> 0:13:48.000 Author So one of the questions then is how much 0:13:48.000 --> 0:13:53.240 competition is there among insurers together assets because it's like, Okay, 0:13:53.280 --> 0:13:56.480 here's insurance company A, and they're going to pay me, 0:13:57.160 --> 0:14:00.240 you know, five thousand dollars a month for life, because 0:14:00.240 --> 0:14:02.360 I've bought this annuity every month for the rest of 0:14:02.400 --> 0:14:05.320 my life after I turn x age. And here's another one, 0:14:05.520 --> 0:14:08.240 but this one is paying all these like it services 0:14:08.280 --> 0:14:10.520 and all these little things that maybe like come out 0:14:10.559 --> 0:14:13.600 of the return, et cetera. Does the end market of 0:14:13.720 --> 0:14:19.000 insurance purchasers have much clarity on what they're buying and 0:14:19.040 --> 0:14:20.960 the economics of two different policies. 0:14:21.080 --> 0:14:22.280 It's a hard empirical question. 0:14:22.680 --> 0:14:25.200 So there's this thing called in finance called the annuity puzzle, 0:14:25.520 --> 0:14:29.360 where imperiannuities are the perfect investment, but society as a 0:14:29.360 --> 0:14:31.800 whole under buys them. And a lot of finance professors 0:14:31.800 --> 0:14:35.040 have spent decades puzzling out why that is the case. 0:14:35.320 --> 0:14:36.480 So we're not going to solve it here. 0:14:36.520 --> 0:14:38.640 But the one of the lessons from that literture is 0:14:38.640 --> 0:14:41.600 that people aren't invest in annuities because they don't get 0:14:41.600 --> 0:14:44.160 a good deal. Prices are too high, the policies aren't 0:14:44.200 --> 0:14:48.280 that good. There's competition, but there's the end consumer doesn't 0:14:48.280 --> 0:14:50.040 get a great deal, or they at least perceive they 0:14:50.040 --> 0:14:51.960 are not getting a good deal. So there's always been 0:14:52.000 --> 0:14:55.120 this concern that for some reason, the annuity market isn't 0:14:55.200 --> 0:14:55.840 very competitive. 0:14:56.240 --> 0:14:56.840 Now, you might. 0:14:56.720 --> 0:14:59.440 Imagine if an insurer is owned by a p shop 0:14:59.560 --> 0:15:01.920 and they make a lot of money on the private 0:15:01.960 --> 0:15:04.800 credit in liquidity and all this, you know, because high 0:15:04.840 --> 0:15:07.280 returning and all this stuff, and they're in fees. So 0:15:07.480 --> 0:15:10.600 in some ways a PE shop that owns and ensure 0:15:11.040 --> 0:15:14.440 might offer better terms to policyholders because they have all 0:15:14.520 --> 0:15:17.720 these other ways to make money from the business. So 0:15:17.880 --> 0:15:20.920 we've seen some averacle data that like the be owned 0:15:21.000 --> 0:15:24.880 insurance companies compete better in the product market, so you 0:15:24.920 --> 0:15:27.880 can imagine the consumers might benefit. The problem there is, 0:15:27.880 --> 0:15:29.840 of course, that you know, you might get a good 0:15:29.880 --> 0:15:32.240 deal on the short run, but you know, decades down 0:15:32.280 --> 0:15:35.240 the line when things come due, there might be problems. 0:15:35.360 --> 0:15:38.720 If I'm in the market for an annuity, should I 0:15:39.320 --> 0:15:42.520 or do I have any capacity to take into account 0:15:43.120 --> 0:15:46.160 credit risk. As someone who grew up became an adult 0:15:46.240 --> 0:15:48.200 kind of during the GFC, I was like, I don't know, 0:15:48.280 --> 0:15:50.080 like I'm going to retire in like twenty years. Who knows? 0:15:50.120 --> 0:15:52.920 Who's going to be around to what degree either does 0:15:52.920 --> 0:15:56.120 that or should that be part of the information that 0:15:56.160 --> 0:15:58.360 the buyer the purchase of the annuity has. 0:15:58.600 --> 0:16:02.480 Yeah, so it's very difficult, I think for retail policy 0:16:02.480 --> 0:16:06.840 holders to meaningfully grasp like the degree of solvency risk 0:16:07.080 --> 0:16:10.240 that the kind of counter party annuity provider or life 0:16:10.280 --> 0:16:14.320 insurance provider has. And so something that we think is 0:16:14.320 --> 0:16:17.960 really fundamental is that, you know, the investors in say 0:16:17.960 --> 0:16:23.080 a private credit fund, nonprofits, you know, endowments, big institutional investors, 0:16:23.120 --> 0:16:26.080 pension funds, they're in a very different position than just 0:16:26.120 --> 0:16:29.240 like normal people who like don't all about anything, you know, 0:16:29.280 --> 0:16:31.400 what this insured is doing with all of the money. 0:16:31.680 --> 0:16:33.160 As far as they know, they just bought a life 0:16:33.200 --> 0:16:36.080 insurance policy, and I'm willing about most people haven't even 0:16:36.120 --> 0:16:38.440 thought about what happens like kind of on the other 0:16:38.520 --> 0:16:41.680 side of that balance sheet. And that asymmetry is what 0:16:41.920 --> 0:16:44.320 drives a lot of the like I think the results 0:16:44.320 --> 0:16:45.240 that we're going to speak about. 0:16:45.360 --> 0:16:49.360 Yeah, so, okay, speaking of asymmetry, the McKinsey's of the 0:16:49.360 --> 0:16:51.120 world out there, who will talk about this being a 0:16:51.200 --> 0:16:56.120 virtuous flywheel where you know, pe slash PC gets access 0:16:56.200 --> 0:16:58.680 to these big pools of permanent capital, and then the 0:16:58.720 --> 0:17:02.520 insurers themselves maybe get access to higher yielding assets that 0:17:02.600 --> 0:17:05.960 then generate better returns for investors, better products, et cetera. 0:17:06.800 --> 0:17:09.280 On the other hand, you also have critics of this 0:17:09.440 --> 0:17:12.399 practice who will point out that because of the nature 0:17:12.400 --> 0:17:16.760 of private credit, because these aren't publicly traded bonds with 0:17:17.040 --> 0:17:19.600 you know, double A I guess now, or maybe triple 0:17:19.640 --> 0:17:23.320 A ratings for some corporates, you don't necessarily have the 0:17:23.400 --> 0:17:26.080 level of insight into what these things are and what 0:17:26.119 --> 0:17:29.160 their true riskiness is. Talk to us about what we 0:17:29.240 --> 0:17:32.639 know about the actual private credit assets on insurer balance 0:17:32.640 --> 0:17:36.520 sheets and what regulators can actually see and know about 0:17:36.520 --> 0:17:37.040 these things. 0:17:37.359 --> 0:17:39.680 So this has been a topic of discussion for the 0:17:39.720 --> 0:17:43.119 last two years. I feel like this almost obsession of 0:17:43.200 --> 0:17:47.640 how much should we trust private credit valuations. And that's 0:17:47.680 --> 0:17:50.000 a problem in BDCs, which are like, you know, publicly 0:17:50.040 --> 0:17:53.080 traded and you can see the quarterly marks on these 0:17:53.160 --> 0:17:56.200 loans and you can see, you know, there's a privately 0:17:56.240 --> 0:17:59.560 traded BDC and the public traded BDC, and the public 0:17:59.600 --> 0:18:02.199 one trades at a discount. So there's always been this 0:18:02.320 --> 0:18:06.760 concern that the valuations aren't kosher or they're or valued 0:18:06.800 --> 0:18:10.080 in some ways. So those same kind of intuitions apply here, 0:18:10.600 --> 0:18:14.159 except the crucial difference is the regulator in case, NAISE, 0:18:14.320 --> 0:18:18.080 which is an association of regulators, essentially has visibility on 0:18:18.240 --> 0:18:21.520 insurer's balance sheet and they look at everything they invest in. 0:18:21.520 --> 0:18:25.000 This could be equity, cash safe bonds whatever that means, 0:18:25.000 --> 0:18:28.879 and private credit bonds, and all the insure regulator sees 0:18:29.280 --> 0:18:33.520 is the value reported to them, which is usually outsourced 0:18:33.520 --> 0:18:36.280 to a third party rating agency. And then they see, 0:18:36.320 --> 0:18:39.720 like this private credit loan is valued. It's like a 0:18:39.760 --> 0:18:41.919 double A, and then they give you a notch on 0:18:41.960 --> 0:18:44.640 a scale of one to ten, and you get this. 0:18:44.840 --> 0:18:48.480 Picture as an ensure, these private credit assets are x 0:18:48.520 --> 0:18:49.360 amount of safe. 0:18:49.640 --> 0:18:52.720 These private credit assets are less safe, and there's like 0:18:52.720 --> 0:18:55.240 a spectrum, and then the regulator says, this is a 0:18:55.280 --> 0:18:56.160 good portfolio. 0:18:56.359 --> 0:18:57.720 It's safe, and like. 0:18:57.720 --> 0:18:59.840 Banks, they have to hold certain amounts of capital. 0:19:00.680 --> 0:19:03.800 There's a whole risk rating regime through the NAIC that 0:19:03.960 --> 0:19:06.720 is like somewhat analogous to that of banks. And I 0:19:06.760 --> 0:19:09.720 think a lot of the concern applies here as well 0:19:09.760 --> 0:19:11.600 to like you were concerns two thousand and eight about 0:19:11.600 --> 0:19:15.840 what are the incentives of the credit rating providers. The 0:19:15.880 --> 0:19:19.359 incentives for what are often called private letter ratings and 0:19:19.400 --> 0:19:22.679 for life insurance are kind of particularly skewed. These are 0:19:22.800 --> 0:19:25.800 ratings where the rating itself is actually not kind of 0:19:25.840 --> 0:19:30.320 publicly visible. So a credit rating agency, someone like Egan 0:19:30.440 --> 0:19:33.360 Jones might report to the nai C, you know, here 0:19:33.400 --> 0:19:36.960 is our rating for this asset, and you know, how 0:19:37.119 --> 0:19:40.800 was that rating obtained? Can anybody else like investigate is 0:19:40.800 --> 0:19:43.159 there any sort of track record to compare this against? 0:19:43.160 --> 0:19:45.920 It's just extremely difficult, and so there's a variety of 0:19:46.240 --> 0:19:49.160 new empirical literature and economics that's coming out basically every 0:19:49.200 --> 0:19:51.840 week where people will do various sorts of tests and 0:19:51.880 --> 0:19:55.479 they'll just continually find over valuation and a lot of 0:19:55.480 --> 0:19:56.359 these assets. 0:19:56.680 --> 0:19:58.480 Just we're talking about two thousand and eight for a second. 0:19:58.480 --> 0:20:01.440 You know, one of the sub dramas with the bank 0:20:01.480 --> 0:20:05.160 bailouds was this idea that the bond holders of banks 0:20:05.280 --> 0:20:07.399 didn't take any haircuts, and so it was like there 0:20:07.440 --> 0:20:10.400 were losses that quite substantial losses, but they were all 0:20:10.440 --> 0:20:12.680 born on the equity side, and we saw like how 0:20:12.720 --> 0:20:14.200 you know, the city groups of the world like not 0:20:14.359 --> 0:20:17.320 lost ninety five percent their money was part of the 0:20:17.359 --> 0:20:22.600 reason that regulators or policymakers were so reluctant to let 0:20:22.640 --> 0:20:26.520 some of the bondholders take losses is because you just 0:20:26.640 --> 0:20:30.560 described the classic normy insurance holding. I'm sure in two 0:20:30.640 --> 0:20:32.679 thousand and six you know it's like, oh, yeah, we 0:20:32.720 --> 0:20:35.159 have a highly rated bond from a city group in 0:20:35.200 --> 0:20:37.720 our portfolio. It's like the of the AT and T 0:20:37.880 --> 0:20:41.639 bond was part of the concern with bondholder haircuts essentially 0:20:41.680 --> 0:20:45.000 that then it could create an issue with the insurance channel. 0:20:45.280 --> 0:20:48.879 Yeah, I think that a lot of the same logic applies. 0:20:49.400 --> 0:20:53.840 What insurance has that banking doesn't have is essentially is 0:20:53.880 --> 0:20:58.399 a different form of a public backstop that indicates different 0:20:58.480 --> 0:21:01.720 kinds of agency problems and also a differing way that 0:21:02.560 --> 0:21:06.360 taxpayers and kind of other like non investor actors can 0:21:06.400 --> 0:21:09.320 be put on the hook for an insurer's losses. So 0:21:09.480 --> 0:21:12.480 all of that interacts in like kind of very complex 0:21:12.520 --> 0:21:15.560 ways with the actual direct capital structure of the insurer, 0:21:15.840 --> 0:21:19.919 which is partially you know, these policy holders who are 0:21:19.960 --> 0:21:22.359 technically you know, creditors to the ensure they show up 0:21:22.359 --> 0:21:24.760 with liabilities on the insurer balance sheet, and then there's 0:21:24.840 --> 0:21:29.240 also kind of direct creditors to insurers, they're not covered 0:21:29.280 --> 0:21:32.359 by the socialized backstop, but there is this kind of 0:21:32.400 --> 0:21:37.960 like endless relationship that keeps shifting when you have what 0:21:38.040 --> 0:21:40.680 we call it or what is that uninsurance guarantee fund. 0:21:41.040 --> 0:21:44.720 Yeah, so this is actually the real subject of the paper. 0:21:44.760 --> 0:21:48.320 As much as we talk about ratings, arbitrage and opacity 0:21:48.480 --> 0:21:50.920 of private credit assets and things like that, the point 0:21:50.920 --> 0:21:53.840 that you make is that because of the way that 0:21:53.960 --> 0:21:58.280 insurers are regulated and I guess administered when they go 0:21:58.640 --> 0:22:01.560 belly up, although they don't really go through traditional corporate 0:22:01.600 --> 0:22:04.640 bankruptcy proceedings, but the way they're dealt with if there's 0:22:04.680 --> 0:22:08.760 a failure is fundamentally different to the way banks are 0:22:08.920 --> 0:22:12.320 dealt with in our system. Talk about those differences for us. 0:22:12.600 --> 0:22:16.080 Yeah, So I think when people think about what does 0:22:16.080 --> 0:22:18.760 a public backstop look like, if they're familiar with one, 0:22:18.760 --> 0:22:22.680 they're familiar with Federal deposit insurance. And Federal deposit insurance 0:22:22.800 --> 0:22:25.840 is a pre funded risk based system. So if you're 0:22:26.040 --> 0:22:30.960 a bank and your depositors get Federal deposit insurance, every 0:22:31.040 --> 0:22:34.439 quarter you get an assessment from the FDIC, which basically 0:22:34.480 --> 0:22:36.399 says you have to cough up some money as a 0:22:36.520 --> 0:22:39.960 kind of risk premium. The FDIC has a deposit insurance 0:22:40.000 --> 0:22:43.040 fund which holds that money, and in the event that 0:22:43.080 --> 0:22:45.920 a bank ever goes down and payouts ever need to 0:22:45.960 --> 0:22:49.840 be made to keep a depositors whole and to administer 0:22:49.960 --> 0:22:52.800 the insolvency of a bank, you know, they spend down 0:22:52.800 --> 0:22:55.560 that fund, and in the event that that fund is 0:22:55.600 --> 0:22:59.080 ever fully depleted, there is the kind of full faith 0:22:59.119 --> 0:23:02.480 and credit backs of the United States government, So that 0:23:02.560 --> 0:23:07.480 would be truly a kind of taxpayer funded bailout. In 0:23:07.720 --> 0:23:10.359 two thousand and eight, we also had, of course, like TARP, 0:23:10.800 --> 0:23:13.160 so that was you know, like legislators had to go 0:23:13.200 --> 0:23:16.679 and vote say like hey, we're going to individually appropriate money, 0:23:16.720 --> 0:23:18.840 We're going to appropriate loans, we're gonna appropriate all sorts 0:23:18.880 --> 0:23:22.080 of investments, because like the scale of the problem was 0:23:22.240 --> 0:23:25.679 just too large to deal with through the FDIC on 0:23:25.720 --> 0:23:30.240 its own. Insurers are subject to a different form of 0:23:30.280 --> 0:23:33.680 public backstop that we argue in the paper is kind 0:23:33.720 --> 0:23:38.639 of essentially structurally worse. The way that a guarantee fund 0:23:38.680 --> 0:23:42.560 works is if a life insurer goes bankrupt, it does 0:23:42.600 --> 0:23:45.040 not go into bankruptcy, similarly to how a bank does 0:23:45.080 --> 0:23:49.840 not go into bankruptcy. Instead, the domiciliary state of that 0:23:49.880 --> 0:23:55.120 insurre takes the lead on a simultaneous and valuncy proceeding 0:23:55.160 --> 0:23:58.960 across every single state. Insurance is regulated at the state level. 0:23:59.240 --> 0:24:03.199 There is no kind of federal regulator of insurance. There 0:24:03.280 --> 0:24:05.879 is no equivalent to the FDIC. You just go into 0:24:06.080 --> 0:24:08.960 state court and then we have to resolve this across 0:24:09.000 --> 0:24:12.679 every state simultaneously, and within every single state, there's a 0:24:12.720 --> 0:24:16.239 guarantee fund that says, you know, if you are a 0:24:16.240 --> 0:24:20.360 policy holder of this insurer, we're going to guarantee that 0:24:20.400 --> 0:24:24.080 you get up to some statutory cap of your money, 0:24:24.359 --> 0:24:27.199 similarly to how for the FDIC you get up to 0:24:27.240 --> 0:24:29.720 two hundred and fifty K, and theory potentially you could 0:24:29.720 --> 0:24:32.800 be far more, but statutorily you get to your first 0:24:32.840 --> 0:24:34.760 two hundred and fifty K, and every account is insured. 0:24:35.720 --> 0:24:38.800 It depends on the state law for each every individual 0:24:38.800 --> 0:24:40.960 state coverage, but you can think of it as being 0:24:41.160 --> 0:24:43.800 roughly three hundred K. So if I have a life 0:24:43.800 --> 0:24:47.280 insurance policy that's supposed to pay out for two hundred 0:24:47.359 --> 0:24:50.800 thousand dollars when I die and my insurer goes down, 0:24:51.080 --> 0:24:56.040 I can just keep paying premiums and the policy backstop 0:24:56.119 --> 0:24:59.199 fund will make sure that I get or that my 0:24:59.240 --> 0:25:01.639 beneficiary gain that's two hundred K in the event that 0:25:01.680 --> 0:25:04.480 I die, and that I've maintained my end of the contract. 0:25:05.240 --> 0:25:09.600 The way that a guarantee fund pays for this protection 0:25:09.760 --> 0:25:12.800 in the first instance is by levying an assessment on 0:25:12.960 --> 0:25:17.800 every surviving insurer in that state. But this assessment is 0:25:17.840 --> 0:25:22.040 only levied after the insolvency has already happened. So if 0:25:22.119 --> 0:25:29.000 I'm the insurer that went down, I've actually contributed zero dollars. 0:25:27.760 --> 0:25:31.040 Of my very ironic for insurers themselves to not be 0:25:31.200 --> 0:25:34.600 like paying something towards ensuring their own deaths. 0:25:34.800 --> 0:25:37.000 Yes, fine, yeah, they so like you you know, well, 0:25:37.040 --> 0:25:38.760 of course you know, the company's gone down, so it's 0:25:38.760 --> 0:25:40.440 not a happy ending for them, but like, they don't 0:25:40.440 --> 0:25:43.239 have to cough up anything. Meanwhile, you know, some other 0:25:43.440 --> 0:25:45.920 random insurer who had nothing to do with this, they 0:25:46.040 --> 0:25:49.080 have to pay some sort of bill, and that bill 0:25:49.560 --> 0:25:53.040 is weighted by the percentage of premiums that they sold 0:25:53.480 --> 0:25:57.439 in recent years in that line of business. So, you know, 0:25:57.560 --> 0:26:00.440 the other life insurers in the state of Oregon or whatever. 0:26:00.480 --> 0:26:03.879 If I have a life insurance policy and I'm in Oregon, like, 0:26:03.920 --> 0:26:08.240 they have to pay up. But then what happens afterwards 0:26:08.680 --> 0:26:12.119 depends on the state exactly. But in the vast majority 0:26:12.119 --> 0:26:15.800 of states, you can, as the insurer, get a tax 0:26:15.880 --> 0:26:21.240 credit against that assessment liability. And in about thirty four 0:26:21.280 --> 0:26:24.840 states you get a full tax credit that you can 0:26:24.880 --> 0:26:27.280 take twenty percent a year over five years, and then 0:26:27.320 --> 0:26:30.320 in another ten states it's roughly ten years. It's only 0:26:30.359 --> 0:26:32.720 about six states where you don't get any tax credit. 0:26:33.240 --> 0:26:35.639 So of course, if you have a fully offsetting tax credit, 0:26:35.880 --> 0:26:39.679 this is economically equivalent to a taxpayer bailout of the 0:26:39.720 --> 0:26:44.080 insurance policy holders. But nobody ever votes on this. There 0:26:44.280 --> 0:26:47.720 just happens automatically by operation of law, and the insurer 0:26:47.760 --> 0:26:49.800 is stuck with losing what we might call it kind 0:26:49.840 --> 0:26:52.080 of just like time value of money because they have 0:26:52.160 --> 0:26:55.200 to float this in the meantime. But it is a 0:26:55.520 --> 0:26:56.880 stealth taxpayer bailout. 0:26:57.080 --> 0:27:00.600 And beyond the sort of structural issues, I imagine some 0:27:00.640 --> 0:27:04.960 practical problems with this setup. Number one, the statutory cap 0:27:05.000 --> 0:27:07.320 in fdi C is to fifty K is considered a 0:27:07.320 --> 0:27:10.440 fairly high amount for like just someone having a check account. 0:27:10.600 --> 0:27:12.280 In this case, you know, close to two hundred k 0:27:12.359 --> 0:27:16.280 for life insurance. That's about the fortieth percentile of life 0:27:16.320 --> 0:27:18.920 insuran policies. A lot of policies are way. 0:27:18.720 --> 0:27:19.240 Bigger than that. 0:27:19.359 --> 0:27:22.360 As you can imagine, people usually buy life insurance, are 0:27:22.440 --> 0:27:25.040 usually richer, and they're putting a lot of money into 0:27:25.160 --> 0:27:30.040 into premiums. So the coverage of this bailout is way 0:27:30.080 --> 0:27:31.080 lower than sort. 0:27:30.880 --> 0:27:31.560 Of bank failure. 0:27:31.880 --> 0:27:35.240 And the other sort of big concern is that just 0:27:35.359 --> 0:27:39.639 practically speaking, Iowa and Oregon and New York and Tennessee 0:27:40.160 --> 0:27:44.760 sort of doing this at the same time is a 0:27:44.880 --> 0:27:48.880 very challenging task. We haven't really had major insured failure 0:27:49.119 --> 0:27:52.040 in this way, like in obviously EDUS bailed out. 0:27:52.160 --> 0:27:53.280 So the idea is that. 0:27:53.359 --> 0:27:55.960 Have we ever had a big insurance. 0:27:55.640 --> 0:27:58.080 Not on the scale. So it's as actually it's completely 0:27:58.160 --> 0:28:03.120 untested to have a large, large national insure with assets 0:28:03.160 --> 0:28:06.000 and something like you know, the hundreds of billions of 0:28:06.040 --> 0:28:08.280 dollars range go in solvent in a way that would 0:28:08.280 --> 0:28:10.880 require administration through the guarantee fund. 0:28:11.040 --> 0:28:14.159 So is it fair to say it's like structurally suboptimal 0:28:14.240 --> 0:28:17.440 on multiple levels. So it's suboptimal in this sense that 0:28:17.760 --> 0:28:21.360 there is this implicit taxpayer backstop in a way that's 0:28:21.359 --> 0:28:25.000 a little different from the FDIC, but it's also suboptimal 0:28:25.040 --> 0:28:28.240 that the backstop isn't actually that good for the policy 0:28:28.280 --> 0:28:31.280 holders potentially, because it's like, all right, if we're gonna 0:28:31.280 --> 0:28:33.919 have a backstop, at least we can rest easy. That 0:28:33.960 --> 0:28:37.000 the policy holders like, maybe there's a little bit of misalignment. 0:28:37.080 --> 0:28:39.880 The backstop encourages the ensured to take on due risk. 0:28:40.120 --> 0:28:42.200 But look, it's okay. It's good in the end because 0:28:42.200 --> 0:28:45.680 at least policy holders can sleep easy. But you're saying, 0:28:45.760 --> 0:28:47.959 is we don't even have that. We have the taxpayer 0:28:48.600 --> 0:28:52.000 part and we don't really even have the FDIC equivalent 0:28:52.080 --> 0:28:54.000 that can make everyone sleep easy exactly. 0:28:54.040 --> 0:28:57.960 And since you're not being as you're solvent, you're paying 0:28:58.440 --> 0:28:59.360 post insolvency. 0:29:00.080 --> 0:29:00.200 More. 0:29:00.280 --> 0:29:04.680 Thing that the regime encourages is as you head into distress, 0:29:04.960 --> 0:29:06.360 you want to take on more risk. 0:29:06.720 --> 0:29:09.160 It seems good for an immoral insurer. 0:29:09.400 --> 0:29:12.320 Right, So there's self a rational sure, Right, It's like 0:29:12.320 --> 0:29:14.920 a homesy and bad man insure is going to just 0:29:14.960 --> 0:29:18.560 simply invest more risky, invest more risky things. Try to 0:29:18.600 --> 0:29:21.959 give really good deals to policyholders to make premiums. Today 0:29:22.160 --> 0:29:23.880 you're not paying for it because you're not paying for 0:29:23.920 --> 0:29:25.920 it in the end, so at least in like an 0:29:25.960 --> 0:29:30.320 equilibrium sense, and you know, the rivals, knowing that one 0:29:30.320 --> 0:29:33.760 of my rivals is going to go bankrupt soon, they're 0:29:33.760 --> 0:29:34.840 going to want to pull out. 0:29:34.880 --> 0:29:38.160 Because with FDIC deposit insurance they put a cap on 0:29:38.200 --> 0:29:41.680 how much rates you can offer, like that's part of 0:29:41.720 --> 0:29:45.280 their trade, so that you can't a desperate bank can't say, oh, 0:29:45.280 --> 0:29:48.520 we're paying fifteen percent on saving these accounts right now, 0:29:48.720 --> 0:29:52.400 but there's no in insurance. That mechanism doesn't exist exactly. 0:29:52.200 --> 0:29:52.520 I gues. 0:30:08.680 --> 0:30:12.360 So you suggest in the paper that this might be 0:30:12.440 --> 0:30:15.960 the real reason that private equity slash private credit has 0:30:16.040 --> 0:30:19.040 been so interested in the insurance space because it provides 0:30:19.080 --> 0:30:23.840 them an avenue to basically a socialized backstop, which you 0:30:23.880 --> 0:30:25.640 know makes sense. But I guess I wonder, in the 0:30:25.680 --> 0:30:28.720 course of your research and actually talking to private equity 0:30:28.760 --> 0:30:32.560 and private credit, how aware are people of the current 0:30:32.600 --> 0:30:37.400 regulation scheme for bankrupt failed insurance. Does it come up 0:30:37.400 --> 0:30:37.800 a lot? 0:30:38.240 --> 0:30:40.880 I think one of the main ways that this ends 0:30:40.960 --> 0:30:44.400 up playing out is that what people are often thinking 0:30:44.440 --> 0:30:47.640 about is, you know, turning back to the permanent capital angle, 0:30:48.320 --> 0:30:51.040 Am I allowed to just like make my investments without 0:30:51.080 --> 0:30:54.400 somebody yelling at me about them. And one of the 0:30:54.440 --> 0:30:57.680 reasons why if you have a life insured you can 0:30:57.760 --> 0:31:00.840 make kind of whatever investments you want without like nominally 0:31:00.880 --> 0:31:03.239 the creditors of your company or the investors in your 0:31:03.240 --> 0:31:06.880 company coming and yelling at you, is because you have not. 0:31:06.800 --> 0:31:09.840 Having people yell at you is like a very underrated 0:31:10.120 --> 0:31:12.680 incentive in the world, but I think it's one that 0:31:12.720 --> 0:31:14.840 probably is very important, yeah, is that. 0:31:14.760 --> 0:31:18.720 You have this widely dispersed retail base of policy holders, 0:31:19.120 --> 0:31:22.880 a large fraction of whom are totally insured, and so 0:31:23.240 --> 0:31:26.240 even you can do whatever you want and like in theory, 0:31:26.400 --> 0:31:30.400 they shouldn't care because no matter what, they have full coverage. 0:31:30.920 --> 0:31:34.280 Obviously that's not true for everyone, but it's just the 0:31:34.480 --> 0:31:37.720 level of kind of examination that you're going to get 0:31:37.760 --> 0:31:40.920 from your creditors is so much lower if you are 0:31:41.000 --> 0:31:43.960 running the private credit through the life insured balance sheet 0:31:44.440 --> 0:31:47.720 rather than through kind of a standard private credit fund. 0:31:48.320 --> 0:31:50.120 One more point I want to make is that I've 0:31:50.160 --> 0:31:53.280 spoken to some people who you know, work in this space, 0:31:53.320 --> 0:31:55.880 and one thing they say is that say there's a 0:31:55.920 --> 0:31:59.240 good insurance manager a bad insurance manager to both use 0:31:59.280 --> 0:32:02.240 private credit. One of them uses investment grade private credit 0:32:02.280 --> 0:32:05.560 on the balance sheet. The other one uses rating inflated 0:32:06.240 --> 0:32:10.280 bad private credit, and since evaluation regime is sort of 0:32:10.280 --> 0:32:12.960 opaque and sort of hard to tell what's like a 0:32:12.960 --> 0:32:16.440 truly good private credit loan versus not, it actually penalizes 0:32:16.440 --> 0:32:20.240 an equilibrium sort of good asset managers because they might 0:32:20.280 --> 0:32:24.160 have access to like at and T private credit, and 0:32:24.320 --> 0:32:27.520 if they're getting the same ratings for Megan Jones as 0:32:27.520 --> 0:32:30.320 someone who's investing in like a middle market SaaS company 0:32:30.360 --> 0:32:33.680 in Chicago, obviously those who are extreme examples they get 0:32:33.680 --> 0:32:36.360 different notches in the NIC system. But you can imagine 0:32:36.360 --> 0:32:40.480 at the margin, the high quality private credits also suffer 0:32:41.080 --> 0:32:44.080 just by ratings inflation, because you're not just hiding risk, 0:32:44.120 --> 0:32:46.960 you're also competing in this dynamic market. So the insurer 0:32:47.000 --> 0:32:50.560 who has access to investment get private credit might also suffer. 0:32:50.760 --> 0:32:54.040 And the design of the guarantee funds actually amplifies this 0:32:54.200 --> 0:32:58.440 problem because then banking, the assessment premiums that banks pay 0:32:58.480 --> 0:33:01.479 are risk weighted, they're not purely sized way to Obviously 0:33:01.520 --> 0:33:04.920 size is a major important component of risk, but for 0:33:05.000 --> 0:33:08.480 guarantee funds it's purely the premium volume. So you can 0:33:08.480 --> 0:33:12.280 imagine two identical ensures with the same premium volume, except 0:33:12.320 --> 0:33:15.720 that one of them, you know, invests very conservatively, the 0:33:15.800 --> 0:33:18.440 other one invests, you know, like a madman. You know, 0:33:18.480 --> 0:33:21.600 the expected value of the public backstop is much greater, 0:33:22.160 --> 0:33:23.640 you know, for one than the other. And so you 0:33:23.680 --> 0:33:26.320 have this kind of implicit subsidy that is being routed 0:33:26.520 --> 0:33:29.320 through this like underlying backstop. 0:33:29.160 --> 0:33:31.320 In the event of like a failure, like there is 0:33:31.360 --> 0:33:33.400 not you know, as you said, it's only the fortieth 0:33:33.400 --> 0:33:36.160 percentile policy holders. There are a lot of potential lawses 0:33:36.800 --> 0:33:40.840 in the literature, in your work, et cetera. Is there 0:33:40.880 --> 0:33:45.200 a certain expectation that there exists in the world, certain 0:33:45.360 --> 0:33:49.040 other implicit backstops that aren't formalized in law for those 0:33:49.200 --> 0:33:51.520 premium holders or could it only be the type of 0:33:51.560 --> 0:33:53.480 thing where it's like, if they're going to get quote 0:33:53.480 --> 0:33:56.240 bailed out unquote, it would be some sort of tarp 0:33:56.400 --> 0:33:58.960 like vote again where politicians have to stick their next out. 0:33:59.040 --> 0:34:00.680 I think that's the exact to think about it. 0:34:00.680 --> 0:34:05.400 So this the fortieth percentile person is just by operation 0:34:05.480 --> 0:34:08.000 of law, going to get a bailout. And then you 0:34:08.040 --> 0:34:12.160 can imagine particians, especially local potiticians. You might imagine don't 0:34:12.160 --> 0:34:15.839 want their state's policyholders to lose out on you know, 0:34:16.080 --> 0:34:18.879 people who are life insurance policies and their insurer goes 0:34:18.880 --> 0:34:21.360 insolvent are some of the most sympathetic people on the planet. 0:34:21.600 --> 0:34:24.879 So I'm assuming that would be an easy yes at 0:34:24.880 --> 0:34:27.920 the state level to make them hold. Obviously it's impossible 0:34:27.920 --> 0:34:30.840 to break the future, but it's almost hard to imagine 0:34:31.080 --> 0:34:33.000 them not getting some protection in the future. 0:34:33.120 --> 0:34:36.840 There's also the potential, especially in states that actually don't 0:34:36.840 --> 0:34:42.239 have the tax credit, for a perverse feedback loop. So 0:34:42.280 --> 0:34:46.640 you if there is a bad macroeconomic environment and some 0:34:46.760 --> 0:34:50.920 large insurers go down that Levy's assessments on other insurers 0:34:50.960 --> 0:34:53.800 that are already hurting, and that comes at the worst 0:34:53.840 --> 0:34:57.879 possible time, and if that pushes other insurers into insolvency, 0:34:58.200 --> 0:35:00.920 you know, then you have this very vicious se That 0:35:01.080 --> 0:35:03.520 cycle is ameliorated of course by the fact that in 0:35:03.800 --> 0:35:07.440 most states you do have these tax credits, but also 0:35:07.800 --> 0:35:10.440 you know, interest rates are spiking during this time. Then 0:35:10.440 --> 0:35:12.680 you run into kind of more serious time value of 0:35:12.719 --> 0:35:14.600 money problems with the fact that the tax front has 0:35:14.640 --> 0:35:16.520 to be taken over five to ten years. 0:35:16.800 --> 0:35:19.560 Can we just do a quick history detour for a second, 0:35:19.560 --> 0:35:23.560 because hearing you describe this system, it does not sound ideal, 0:35:23.880 --> 0:35:25.840 to say the least, How did we end up with 0:35:26.000 --> 0:35:31.120 this particular organizational structure for regulating insurers. 0:35:31.320 --> 0:35:35.200 So the kind of history of state based regulation of 0:35:35.280 --> 0:35:39.120 life insureds goes back to when the Supreme Court had 0:35:39.160 --> 0:35:43.200 a much kind of stricter interpretation of the Commerce Clause, 0:35:43.520 --> 0:35:45.960 and so it did in like a famous case in 0:35:46.040 --> 0:35:48.640 the eighteen hundreds, the Supreme Court said that insurance did 0:35:48.640 --> 0:35:52.800 not constitute commerce for the purposes of the interstate Commerce Clause. 0:35:53.440 --> 0:35:56.440 In the nineteen forties, the Supreme Court reversed that decision 0:35:56.440 --> 0:35:59.680 as part of its general trend towards being more permissive 0:35:59.680 --> 0:36:04.120 of or regulation. But Congress immediately like disclaimed its new 0:36:04.200 --> 0:36:07.160 power to regulate life insurans in an act called by 0:36:07.280 --> 0:36:11.440 Karen Ferguson and Mcaren. Ferguson says that, you know, unless 0:36:11.520 --> 0:36:15.799 Congress explicitly passes a law that says we're regulating insurers, 0:36:16.600 --> 0:36:20.600 all other regulatory authority is reserved to the states. So 0:36:21.000 --> 0:36:23.320 it's just pretty much been like that the whole time. 0:36:23.840 --> 0:36:27.759 There are periodic waves in which there's like activism for 0:36:27.800 --> 0:36:31.440 federal insurance regulation. Usually because of a wave of insurance 0:36:31.440 --> 0:36:34.840 solvencies or some other like you know, alleged mouthfeasance in 0:36:35.120 --> 0:36:38.239 the industry. And then what will typically happen is that 0:36:38.280 --> 0:36:41.960 the NAIICE and which is the kind of association of 0:36:42.000 --> 0:36:45.040 state regulators that formally operates actually through a nonprofit it's 0:36:45.080 --> 0:36:47.840 not it's not formally a public entity at all, will 0:36:48.080 --> 0:36:52.120 act to try to forestall that federal push by kind 0:36:52.160 --> 0:36:54.840 of doing it on its own. And that's what happened 0:36:54.840 --> 0:36:58.239 with guarantee funds. In the nineteen sixties and the nineteen seventies, 0:36:58.520 --> 0:37:01.960 there was a wave of insolvency and property and casualty insurance, 0:37:02.360 --> 0:37:04.719 and there were bills introduced in Congress to create a 0:37:04.719 --> 0:37:08.319 federal backstop that was kind of similar and you know 0:37:08.400 --> 0:37:13.120 to to the FDIC and the the NAIC and various 0:37:13.120 --> 0:37:16.640 states quickly responded to create these state level backstops instead. 0:37:17.000 --> 0:37:19.799 And one of the interesting ways the NIC operates is 0:37:19.840 --> 0:37:23.719 that most states actually defer rulemaking to the n C 0:37:23.880 --> 0:37:27.359 fully into the future. So I think Indiana is one 0:37:27.400 --> 0:37:31.680 of these states where they self incorporate the model law 0:37:32.239 --> 0:37:35.640 that the NIC puts out, even prospective changes. 0:37:36.040 --> 0:37:38.080 So they just like see control entirely. 0:37:38.360 --> 0:37:40.560 Yeah, So there's there's state laws that say if the 0:37:40.680 --> 0:37:44.120 nai C says this, it will be automatically incorporated into 0:37:44.160 --> 0:37:47.640 our own state law, which is like a very distinctive arrangement. 0:37:48.200 --> 0:37:48.880 So it the curse to me. 0:37:48.960 --> 0:37:52.040 There is one a difference between banks and insurance is 0:37:52.120 --> 0:37:55.959 that banks have the possibility of correlation on two front. 0:37:56.239 --> 0:37:58.200 So all the loan if you hear the sick banks 0:37:58.239 --> 0:38:00.200 make a lot of housing loans, Like banks all could 0:38:00.239 --> 0:38:02.520 go the loans could all go sour at the same time, 0:38:02.840 --> 0:38:05.680 but then also their depositor base could be correlated. 0:38:05.760 --> 0:38:05.880 Right. 0:38:06.120 --> 0:38:07.640 We saw this with s if you be but you 0:38:07.680 --> 0:38:10.319 could also just imagine in any other environment people get 0:38:10.320 --> 0:38:13.240 anxious about a bank and they all withdraw their deposits. 0:38:13.560 --> 0:38:16.440 That can't quite happen the same way with an insurance company, 0:38:16.520 --> 0:38:19.400 at least if we're talking about vanilla insurance where you 0:38:19.560 --> 0:38:22.800 only get paid out either on an event or retirement 0:38:23.200 --> 0:38:25.239 or something like that and you stagger it, does that 0:38:25.520 --> 0:38:29.600 change the dynamics or the fact that insurers could still 0:38:29.800 --> 0:38:33.440 have correlated failure. They're all maybe making loans to software 0:38:33.480 --> 0:38:36.279 companies at the same time, but they don't really have 0:38:36.440 --> 0:38:40.160 the risk of correlated withdraws in the same way that 0:38:40.200 --> 0:38:40.719 a bank would. 0:38:40.880 --> 0:38:42.880 Great, that's a pitch for our next paper. 0:38:44.320 --> 0:38:46.520 That's the fall up though, or insurance. 0:38:46.560 --> 0:38:49.440 So you can imagine conceptually there's runs on the acid 0:38:49.520 --> 0:38:52.360 side of the liability side. I'll speak a libout the assets, 0:38:52.640 --> 0:38:56.200 and Andrew's more an expert on the differences in possing liabilities. 0:38:56.480 --> 0:38:58.880 But on the asset side, as you said, all of 0:38:58.960 --> 0:39:02.200 them make loans to Chicago's SAS company in the middle market, 0:39:02.560 --> 0:39:05.080 and then they all go calling back and there's no 0:39:05.280 --> 0:39:07.759 you know, there's not not enough cashless. So in that 0:39:07.960 --> 0:39:12.440 paradigmatic sense, since banking has very good you know, like 0:39:12.520 --> 0:39:14.960 on the floor of a bank, there's officials in the 0:39:15.000 --> 0:39:18.560 federal government that say, don't invest in this type of 0:39:18.880 --> 0:39:22.080 risky asset, usually about credit, but also I'm sure they 0:39:22.160 --> 0:39:23.239 think about industry risk. 0:39:23.320 --> 0:39:25.680 Yeah, we're watching your SaaS exposure yeah. 0:39:25.840 --> 0:39:26.400 Or something like that. 0:39:26.560 --> 0:39:29.839 And insurance since that regime is much weaker because it's 0:39:29.840 --> 0:39:35.000 dispurs the NEIIC is less. They have way less resources 0:39:35.120 --> 0:39:37.880 and power than the federal government. So just on the 0:39:37.920 --> 0:39:40.480 asset side, the monitoring is much worse, So you might 0:39:40.560 --> 0:39:44.759 imagine there's more possibility of colorate exposure than there is 0:39:44.840 --> 0:39:47.680 in banking, and you can imagine, you know, like the 0:39:47.760 --> 0:39:50.080 last year or so, a lot of the private credit 0:39:50.520 --> 0:39:53.320 pain has been due to a very specific kind of exposure. 0:39:53.840 --> 0:39:56.160 Insurance or something like fifteen percent of the assets are 0:39:56.200 --> 0:39:58.520 in private credit ten to fifteen depending how you measure. 0:39:58.840 --> 0:40:01.719 And the idea that a third of private credits to 0:40:01.800 --> 0:40:03.920 software is not a stretch, So you can imagine, like 0:40:03.960 --> 0:40:07.759 you know, of that fifteen percent is in one industry. Again, 0:40:07.800 --> 0:40:09.400 I don't have the specific numbers because they also do 0:40:09.440 --> 0:40:12.439 infrastructure and all these longer term things, but the idea 0:40:12.520 --> 0:40:15.080 is like it's more possible in the insurance contestant banking, 0:40:15.320 --> 0:40:16.880 and the liabilities is a completely different end. 0:40:16.920 --> 0:40:19.600 Yeah, liabilities is fascinating and that's going to be like 0:40:19.640 --> 0:40:22.040 one of the primary subjects of our next article. So 0:40:22.160 --> 0:40:24.880 like one preview would be things depend a lot on 0:40:24.960 --> 0:40:28.000 the kind of life insurance policy that you hold. So 0:40:28.280 --> 0:40:30.879 for example, you could have let's say, if you hold 0:40:31.120 --> 0:40:34.200 a whole life policy and you have a cash value 0:40:34.239 --> 0:40:37.400 reserve account inside of that policy, this is like essentially 0:40:37.480 --> 0:40:40.120 a tax preferred you know, kind of a raw IRA 0:40:40.440 --> 0:40:43.239 being that's inside of a life insurance policy, and you 0:40:43.440 --> 0:40:47.560 have rights of withdrawal on that account, and so that 0:40:48.120 --> 0:40:50.719 is a demand deposit like and so if you had 0:40:50.760 --> 0:40:53.919 a life insurer that had sold a ton of cash 0:40:54.000 --> 0:40:57.480 value life policies and people tend to store a lot 0:40:57.520 --> 0:40:59.960 of money in those policies, you know you can run 0:41:00.080 --> 0:41:00.279 on that. 0:41:00.600 --> 0:41:03.440 To be clear, would you say that historically, since these 0:41:03.480 --> 0:41:07.640 are sort of more exotic flavors of insurance, that regulators 0:41:07.680 --> 0:41:11.520 have approached this industry as one in which quote runs 0:41:11.680 --> 0:41:15.239 aren't a phenomenon the same way we associate them with banking. 0:41:15.280 --> 0:41:19.720 And banking runs is like the primary concern. It drives everything. 0:41:20.320 --> 0:41:22.960 And in insurance, I do think, you know, kind of 0:41:23.040 --> 0:41:26.000 per the permanent capital hypothesis. 0:41:25.920 --> 0:41:27.920 Your stress and liability mismatch. 0:41:28.239 --> 0:41:31.759 Yeah, like you there are good reasons to think that 0:41:32.480 --> 0:41:36.400 insures are structurally less vulnerable to runs on average, but 0:41:36.560 --> 0:41:38.880 it depends a lot on the nuances. And there have 0:41:39.040 --> 0:41:42.400 been runs on life insureds before. So Executive Life in 0:41:42.480 --> 0:41:45.200 the early nineteen nineties was a life insured that was 0:41:45.280 --> 0:41:47.840 really struggling and there was a run on the insurer. 0:41:48.640 --> 0:41:52.160 Now Executive Life was you know, a few billion dollars 0:41:52.320 --> 0:41:54.600 worth of assets. This is not something that it's going 0:41:54.680 --> 0:41:57.360 to cause the financial system to collapse. And so I 0:41:57.440 --> 0:42:00.759 think we even very lucky that we have not had 0:42:00.800 --> 0:42:04.680 a situation like that happen with a very large life insurer. 0:42:05.080 --> 0:42:08.359 Well, okay, speaking of cascading risks. One thing I never 0:42:08.480 --> 0:42:11.600 understand when it comes to insurance is reinsurance because it's 0:42:11.640 --> 0:42:14.359 just like you have the insurers and the reinsurers insure them, 0:42:14.480 --> 0:42:16.919 and then do you have like re reinsures who ensure 0:42:16.960 --> 0:42:22.359 the reinsurance insurance all the way down. But you talk 0:42:22.400 --> 0:42:24.520 a little bit about this concept in your paper of 0:42:24.960 --> 0:42:27.640 shadow reinsurance. What exactly is that? 0:42:27.960 --> 0:42:32.440 Yeah, shadow reinsurance. So if you are an insurer and 0:42:32.560 --> 0:42:35.279 you would like to transfer some of the risk off 0:42:35.320 --> 0:42:37.759 of your balance sheet, there are various ways that you 0:42:37.840 --> 0:42:42.800 can do this. You can reinsure with a totally independent entity, 0:42:43.280 --> 0:42:45.440 so you'll say like you're going to take on these 0:42:45.520 --> 0:42:48.759 liabilities and I'm going to transfer you these assets. Or 0:42:48.840 --> 0:42:53.160 you could do this with a captive it's like subsidiary reinsure, 0:42:53.880 --> 0:42:58.040 and that captive subsidiary reinsure can be anywhere, and so 0:42:58.160 --> 0:43:00.759 we can have different kind of corporate, state law or 0:43:00.840 --> 0:43:02.960 tax law that applies to it. So one of the 0:43:03.080 --> 0:43:07.560 main ways that life insures and particularly private equity back 0:43:07.560 --> 0:43:10.919 to life insurres like to reinsure is that they use 0:43:11.040 --> 0:43:14.280 captives that are in Bermuda or that are in certain 0:43:14.320 --> 0:43:17.120 states that have tried to compete with Bermuda, like Iowa 0:43:17.360 --> 0:43:20.799 or Vermont, and these are places where the tax rates 0:43:20.840 --> 0:43:25.239 are very low. And also there is no balance sheet 0:43:25.400 --> 0:43:30.640 visibility into the reinsurance balance sheets through the prism of 0:43:30.719 --> 0:43:34.759 the primary insurer. So if I were to reinsure all 0:43:34.800 --> 0:43:37.200 these assets and liabilities, I give up all the stuff 0:43:37.200 --> 0:43:40.040 off my balance sheet and then it disappears into the 0:43:40.200 --> 0:43:43.719 reinsure balance sheet. And on a quarterly level, you could 0:43:43.760 --> 0:43:46.160 go into the naic data and you can see actually 0:43:46.200 --> 0:43:49.640 at ACUSIP level what the life insurre holds in the US. 0:43:50.160 --> 0:43:53.239 That data quality is extremely high. But once that is 0:43:53.520 --> 0:43:56.200 reinsured into one of these quote unquote shadow reinsures, you 0:43:56.280 --> 0:43:58.200 lose all visibility into what's going on. 0:43:59.239 --> 0:44:01.640 I don't want this to be the typical Audlots episode 0:44:01.719 --> 0:44:04.000 where we talk about a problem and then just go 0:44:04.200 --> 0:44:07.319 off agreeing that it can never be solved, because part 0:44:07.360 --> 0:44:11.239 of your paper actually talks about regulatory suggestions for how 0:44:11.360 --> 0:44:13.879 you might fix some of these issues, or at least 0:44:13.920 --> 0:44:16.239 try to make them better. What do you think can 0:44:16.280 --> 0:44:16.759 be done here? 0:44:17.160 --> 0:44:20.560 I think there's a variety of options that the nai 0:44:20.680 --> 0:44:23.399 C can undertake, you know, kind of in the first 0:44:23.480 --> 0:44:29.200 instance that align the downside risk with the controllers. So 0:44:29.600 --> 0:44:32.080 you can imagine, like step one could be something like 0:44:32.200 --> 0:44:35.560 valuation based reforms. I think a lot of people agree 0:44:35.600 --> 0:44:38.320 at this point that the over optimism and valuation is 0:44:38.480 --> 0:44:43.440 a structural problem, that private letter ratings are too generous, 0:44:43.880 --> 0:44:46.360 and that also just that there is an issue with 0:44:46.560 --> 0:44:49.800 trying to value private credit in the first place, because 0:44:50.120 --> 0:44:53.000 these are non tradable loans that have these bespoken terms, 0:44:53.600 --> 0:44:58.160 and so you can do a Pagouvian tax on opacity itself, 0:44:58.239 --> 0:45:00.720 where you say, like, oh, if certain kind of assets 0:45:01.120 --> 0:45:03.840 are just structurally hard to value, then we're going to 0:45:03.920 --> 0:45:07.480 impose a regulatory capital surcharge on that complexity. We're not 0:45:07.560 --> 0:45:10.280 going to look at any of the individual underlying assets 0:45:10.400 --> 0:45:13.800 because that's extremely resource intensive to do. That's just not 0:45:14.000 --> 0:45:16.320 feasible to do, especially if you have you know, a 0:45:16.400 --> 0:45:19.520 private equity back ensurre with billions and billions of dollars 0:45:19.840 --> 0:45:21.800 of these assets on your balance sheet. But we're just 0:45:21.840 --> 0:45:23.560 going to just say, like you know what, you're just 0:45:23.640 --> 0:45:25.160 you're just going to have to pay that surch charge. 0:45:25.640 --> 0:45:29.160 You can also move to the guarantee fund level. You 0:45:29.320 --> 0:45:32.400 can end the tax credits that ensures get for the 0:45:32.480 --> 0:45:35.520 guarantee funds. You can move to prefunding. You can essentially 0:45:35.560 --> 0:45:38.360 you could transform it into a federal deposit insurance like system. 0:45:38.880 --> 0:45:42.280 And then you can also borrow other ideas from areas 0:45:42.320 --> 0:45:46.440 in banking. For example, we talk about this this kind 0:45:46.480 --> 0:45:49.080 of theory in banking law that is, you know, has 0:45:49.120 --> 0:45:51.520 not actually been operationalized very much, but it's called the 0:45:51.640 --> 0:45:54.839 source of strength doctrine, where if a bank goes down 0:45:55.600 --> 0:45:58.399 in theory, under the source of strength doctrine, you could 0:45:58.480 --> 0:46:00.680 go to the affiliates of that bank and a bank 0:46:00.719 --> 0:46:04.200 holding company and say, look, time to pay up, because 0:46:04.600 --> 0:46:06.239 the rest of us have to pay up, and so 0:46:06.400 --> 0:46:09.160 do you. And you could apply a similar concept to 0:46:09.520 --> 0:46:11.520 an insurance holding group. So you could go to the 0:46:11.560 --> 0:46:15.520 other affiliates in any insurance group, whether it's private equity 0:46:15.600 --> 0:46:17.520 or not, and say, you know, you have to be 0:46:17.600 --> 0:46:21.759 responsible for you know, x percent of the payouts that 0:46:21.960 --> 0:46:24.680 have to go from the guarantee fund, and that would 0:46:25.080 --> 0:46:27.160 align incentives in this insolvency scenario. 0:46:27.920 --> 0:46:29.360 Source of Strength Doctor. 0:46:29.800 --> 0:46:30.279 That's good. 0:46:30.440 --> 0:46:32.960 Yeah, that's a good name. It has a sort of 0:46:33.160 --> 0:46:38.640 like Chinese governmental ring is stated up the front. 0:46:39.280 --> 0:46:42.040 It feels like it should be something that's about something 0:46:42.040 --> 0:46:45.720 bigger than banking. Subscribed to the Source of Strength doctor 0:46:45.760 --> 0:46:47.040 and it's like, oh, it's about. 0:46:46.920 --> 0:46:50.080 Banking regulation, all right, Andrew and pronjall, thank you so 0:46:50.239 --> 0:46:53.320 much for coming on Odd Laws scrape Paper. Really appreciate 0:46:53.360 --> 0:46:53.799 you being here. 0:46:54.160 --> 0:46:55.240 Thank you so much. 0:47:07.719 --> 0:47:08.080 So, Joe. 0:47:08.160 --> 0:47:10.320 I found that really fascinating. I do think like the 0:47:10.440 --> 0:47:14.800 relationship between private equity slash private credit and insurance is 0:47:15.239 --> 0:47:17.760 kind of an under discussed one. It's only just starting 0:47:17.840 --> 0:47:20.160 to get a lot of attention. And again going back 0:47:20.200 --> 0:47:23.759 to the whole original impetus for private credit becoming a thing, 0:47:23.840 --> 0:47:25.799 which was to get some of this risky stuff out 0:47:25.880 --> 0:47:28.920 of the regulated banking system. It doesn't seem great if 0:47:28.960 --> 0:47:33.520 it's just landing in another different kind of regulated financial 0:47:33.560 --> 0:47:34.480 industry totally. 0:47:34.960 --> 0:47:37.960 I mean on this sort of like okay, core asset 0:47:38.200 --> 0:47:41.640 asset liability management, it's a beautiful synergy. 0:47:41.800 --> 0:47:41.920 Right. 0:47:42.080 --> 0:47:44.680 I felt the need multiple times in that conversation to 0:47:44.719 --> 0:47:47.520 say not all private credit. All right, No, not all 0:47:47.680 --> 0:47:48.799 private credit private credit. 0:47:49.120 --> 0:47:51.279 But it is a beautiful symmetry, That's what I'm saying. 0:47:51.320 --> 0:47:55.680 They have this sort of pool of they're not depositors, 0:47:55.760 --> 0:47:59.200 we call them policyholders, who really are They're not expecting 0:47:59.239 --> 0:48:01.160 to get their money back for a very long time. 0:48:01.440 --> 0:48:04.000 They can only get their money back on certain rules, 0:48:04.040 --> 0:48:08.000 et cetera. It truly does solve that. It makes a 0:48:08.160 --> 0:48:11.680 lot of sense to pair that with certain types of 0:48:12.360 --> 0:48:15.640 assets whose value emerges because it can be held for 0:48:15.680 --> 0:48:18.080 a very long time and perhaps held through a draw down. 0:48:18.200 --> 0:48:21.600 So that makes total sense. Of course, though the question 0:48:21.920 --> 0:48:26.480 and that arises is well, a like how much then 0:48:26.560 --> 0:48:30.080 becomes the sort of quasi regulatory arbitrage. It's sort of 0:48:30.239 --> 0:48:32.960 a looser environment. How do we even know these are 0:48:33.080 --> 0:48:37.000 quality assets that will satisfy the policyholders and so forth? 0:48:37.280 --> 0:48:39.080 And I found that to be very eye opening to 0:48:39.160 --> 0:48:41.759 sort of like how just loose it all save how 0:48:41.960 --> 0:48:44.360 just sort of like held together by scotch tape. 0:48:44.520 --> 0:48:45.080 And also this. 0:48:45.160 --> 0:48:48.480 Idea that we've never actually had a major insurance failure, 0:48:48.719 --> 0:48:50.920 and so you could see that well, you know, maybe 0:48:51.040 --> 0:48:52.960 one of the reasons it's all held together with scotch 0:48:53.040 --> 0:48:56.000 tape is because it's never been an issue before, because 0:48:56.000 --> 0:48:58.520 we haven't had a failure because insurers have been investing 0:48:58.560 --> 0:49:02.880 in really boring ig rated bonds. But if that's changing, 0:49:03.200 --> 0:49:05.480 then maybe we need to start thinking harder about this. 0:49:05.920 --> 0:49:08.400 But one other thing, I'll say, we're recording this on 0:49:08.760 --> 0:49:12.480 July thirtieth and Private credit. It's been in the news, yeah, 0:49:13.040 --> 0:49:15.160 you know, for the past year or so for various reasons. 0:49:15.239 --> 0:49:18.000 But it's in the news again because we have federal 0:49:18.120 --> 0:49:23.160 prosecutors apparently investigating Mark Walters, who, in addition to being 0:49:23.280 --> 0:49:26.719 the owner of the La Dodgers, also has Guggenheim, And 0:49:26.800 --> 0:49:30.440 Gugenheim has affiliated insurers Delaware Life and I think the 0:49:30.520 --> 0:49:33.520 other one was called clear Lake or not Clear like 0:49:33.680 --> 0:49:37.160 clear spring, something clear, clear in a body of water. Yeah, 0:49:37.239 --> 0:49:39.120 But of course the irony is that maybe it's not 0:49:39.200 --> 0:49:42.600 so clear because it put out a revised financial disclosure 0:49:42.719 --> 0:49:47.120 saying that the number of affiliated assets on its balance sheet, 0:49:47.680 --> 0:49:51.000 so these are assets that come basically via Guggenheim or 0:49:51.160 --> 0:49:54.720 that are under common control by Guggenheim. They had reported 0:49:54.719 --> 0:49:57.120 them previously as something like three to five percent of 0:49:57.239 --> 0:50:02.160 Delaware Life and Clear whatever total assets, and then they 0:50:02.239 --> 0:50:04.920 went back as a result of this investigation and checked 0:50:05.320 --> 0:50:07.920 put out a revised statement, what do you think the 0:50:08.000 --> 0:50:11.800 proportion of affiliated assets is now? Tell me forty percent? 0:50:11.920 --> 0:50:15.520 There you go, so move from three. Under additional scrutiny, 0:50:15.600 --> 0:50:17.880 it moved from three to forty percent. So these are 0:50:17.920 --> 0:50:20.560 the kind of concerns that I think are starting to 0:50:20.680 --> 0:50:23.319 bubble up totally. But in the meantime, shall we leave 0:50:23.320 --> 0:50:23.480 it there? 0:50:23.560 --> 0:50:24.200 Let's leave it there. 0:50:24.400 --> 0:50:26.680 This has been another episode of the Odd Lots podcast. 0:50:26.800 --> 0:50:30.080 I'm Tracy Alloway. You can follow me at Tracy Alloway. 0:50:29.800 --> 0:50:32.320 And I'm Joe Wisenthal. You can follow me at the Stalwart. 0:50:32.400 --> 0:50:35.440 Follow our producers Kerman Rodriguez at Kerman armand dash Ol 0:50:35.440 --> 0:50:38.880 Bennett at Dashbot, Cale Brooks at Calebrooks, and Kevin Lozano 0:50:38.960 --> 0:50:41.759 at Kevin Lloyd Lozano. And from our Oddlats content. 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