By the Numbers
New capital rules could lift insurer demand for mortgage loans
This material is a Marketing Communication and does not constitute Independent Investment Research.
Insurance company demand for residential whole loans, particularly non-QM loans, has been on the rise in recent years. Now, new updates to insurers’ capital framework for residential mortgages may spur even more demand, particularly from small and mid-sized life companies. Potentially more meaningfully, the changes could broadly increase life companies’ appetite to finance residential whole loans, providing a potentially robust alternative to securitization term financing for aggregators and a meaningful source of competition to securitization conduits.
Enter NAIC Item #2026-02-L
On April 30, the National Association of Insurance Commissioners Life RBC Working Group adopted Item #2026-02-L, which could create both additional capacity for smaller life companies to begin adding whole loans and broad-based increased demand to finance the asset class. Before adopting this item, which goes into effect at the end of this year, indirect investments in residential mortgage loans through an unaffiliated joint venture (JV), partnership or limited liability company (LLC) required 1.75% capital instead of the 0.68% capital for direct investments in residential mortgage loans. The revised framework would look to align Risk Based Capital (RBC) requirements with direct investments in loans at 0.68%. The nuanced point here is that it would allow smaller insurers to report whole both whole loan investments or financings that employ an unaffiliated trust as a single investment rather than having to schedule out individual loans as they would under a Schedule B direct investment or loan-on-loan financing.
The recent changes look to be part of a broader NAIC initiative to normalize RBC across residential whole loan exposures. In 2024, the NAIC adjusted the RBC framework for residential whole loans, aligning capital on both loans held in an affiliated JV and collateralized lending against performing residential whole loans with direct investments (Exhibit 1). Prior to the 2024 changes, RBC on loans held in an affiliated JV or LLC carried a 1.75% RBC factor, while ‘loan-on-loan’s structures saw their RBC factors reduced by 90%, from 6.8% to 68 bp.
Exhibit 1: The NAIC residential whole loan capital framework at a glance
Source: Santander US Capital Markets, NAIC, Mayer Brown
Note: Capital ratios are exclusive to first lien residential mortgage loans that are less than 90 days past due.
Annuity sales drive heightened asset demand from life insurers
Heightened demand from life insurers for residential loans has been driven by growth on the liability side of the balance sheet, as sales of fixed annuities have risen dramatically in recent years. For the better part of the past 15 years, quarterly sales of fixed annuity sales ranged from $20 to $30 billion. Over the past three years, sales of fixed annuities have more than doubled, peaking at $90 billion in the fourth quarter of 2023 (Exhibit 2).
Exhibit 2: Heightened annuity sales spur asset demand from life insurers
Source: Santander US Capital Markets, Bloomberg LP
Marked growth in annuity sales has been fueled by two factors. First, private equity companies have established captive life insurance companies as vehicles for generating sticky, stable funding through the combination of annuity sales and access to the Federal Home Loan Bank funding complex. This, in turn, allows them to fund illiquid or more complex assets more efficiently than they could through traditional warehouse financing agreements. Additionally, the Fed’s aggressive hiking cycle pushed benchmark rates up rapidly through 2022, and those elevated rates fueled heightened demand from retail investors for fixed annuities.
Life company demand competes with securitization conduits
The early stages of the non-QM market were marked by an ‘originate-to-securitize’ model as balance sheet demand for these loans from both depositories and insurance companies was negligible at best. And while depository balance sheet demand for these loans remains moribund, life insurance company balance sheet demand for the product has grown exponentially, vacuuming up nearly half of all originations in some recent quarters (Exhibit 3). While disproportionate insurance demand could initially be explained away by the funding advantage life companies maintained over securitization conduits when the yield curve was inverted, allowing them to price longer-dated annuities at lower yields than a securitization cost of funds, the normalization of the yield curve to some degree has done little to stymie insurance company demand for loans.
Exhibit 3: Insurance balance sheets compete with securitization conduits for non-QM loans
Source: Santander US Capital Markets, Inside Mortgage Finance
Likely implications
The updated capital framework may make it easier for smaller and mid-size insurance companies to invest in whole loans, but the more meaningful impact may be in companies’ ability to finance these assets. Typically, for insurance companies to achieve the RBC ‘floor’ of 68 bp for residential mortgage loans, they are reported under Schedule B on a loan-by-loan basis. Investments in unaffiliated JVs or LLCs would allow an insurance company to record these investments on Schedule BA as a single line item that would garner the same capital treatment, assuming all the loans are performing. Similarly, it would allow insurance companies to classify ‘loan-on-loan’ structures in a similar fashion, potentially providing both greater liquidity to the asset class and competition for securitization conduits if more insurance companies are willing to finance whole loans and classify that lending arrangement under a single line item under Schedule BA.
Ultimately, the applicability of this change will be limited to some degree based on a handful of factors. And those factors may ultimately skew the value proposition towards lending against these assets rather than owning them outright. First, while the regulators may look through these LLCs to the underlying assets, the Federal Home Loan Banks would not, thereby making these trusts ineligible investments for Federal Home Loan Bank financing. Secondly, investments classified under Schedule BA are subject to mark-to-market accounting treatment. As a result, insurance companies are more likely to add exposure through floating-rate, term loan financing structures rather than direct investments.
Another potential headwind to growth in loan investments is the fact that there is already a well-worn path for insurance companies to invest in loans through asset managers via Separately Managed Accounts (SMAs) which are generally accounted for as individual line-item direct investments under Schedule B. And away from mark-to-market considerations, insurance companies cannot classify a significant amount of their investments under schedule BA. Ultimately, these changes to the capital framework should translate to increased exposure to the asset class and greater competition for securitization conduits, but it appears more likely that competition will come in the form of term financing rather than an outright bid for the assets.
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