Home Alternative Investments Innovative Rated Note Structures Spur Insurance Investments In Private Equity – Financial...

Innovative Rated Note Structures Spur Insurance Investments In Private Equity – Financial Services


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As insurance companies look for opportunities to invest in a
diversified portfolio of funds, and funds look for ways to access
additional capital, there is increasing demand for innovative rated
note structures. Such investments are typically structured as one
or two tranches of rated debt supported by limited partnership
interests in the underlying funds that comprise the investment
portfolio and a tranche of equity commitments, which, as the
first-loss tranche, is important for the ratings analysis. The past
year has seen an increase in the use of such note structures, and
we expect their popularity to continue to increase so long as
market performance is strong and insurance regulators do not change
the investment classification of the notes issued, or the loans
incurred by, these structures.

This article reviews how these investments are typically
structured, some important parameters that need to be determined in
their structuring, the current regulatory environment and recent

Key Characteristics

  • Basic Structure: Structured notes obligations generally involve
    two entities: an issuer, which is a special purpose vehicle that
    issues debt and equity, and an asset holdco, which is a special
    purpose vehicle that is a direct subsidiary of the issuer and is
    the entity that holds the investment portfolio. The issuer then
    pledges its ownership interest in the asset holdco for the benefit
    of the noteholders.

  • Debt-Like Characteristics: Insurance companies rely on the debt
    characterization of the structured notes obligations for their
    risk-based capital (“RBC”) analysis. To support this
    analysis, the return on the debt is generally structured as regular
    interest payments and repayment of principal, subject to a priority
    of payments waterfall. The equity in the issuer gets the benefit of
    the upside once the scheduled debt payments have been made pursuant
    to the priority of payments.

  • Priority of Payments Waterfall: Structured notes structures
    typically have long tenors (for example, 10 – 15 years). Because of
    this, a structured notes obligation that relies on market
    performance and is supported by alternative investments which are
    inherently illiquid assets requires some protection from economic
    downturns. Common terms used to provide that protection

  • Payment of interest is generally required only to the extent
    cash is available; otherwise, the interest is deferred until cash
    is next available in the priority of payments.

  • The amortization schedule is usually a target amortization
    schedule that requires amortization payments only to the extent
    cash is available in the priority of payments (with cumulative
    catch-up payments in subsequent periods).

  • Full repayment of the debt can be targeted within a relatively
    short period of time (e.g, four-five years) based on modeled cash
    flows, but legal final maturity will often be set at 10-15 years to
    provide flexibility, in particular in case of an economic

  • Distributions are made to equity only once interest and target
    amortization have been paid in accordance with the target schedule.
    Distributions to equity are also generally subject to pro forma
    satisfaction of a loan-to-value ratio and, sometimes, a liquidity

  • Funding Capital Calls: There are certain structural holes that
    the investors need to be prepared to either address in the
    documentation or, more commonly, accept as deal risk:

    • The debt and equity committed to the issuer is generally (but
      not always) equal to the LP commitments made to the underlying
      funds. If the underlying funds can call capital to pay fees and
      expenses in addition to the LP capital commitment, in the absence
      of adequate reserve, there is a possibility that there will not be
      sufficient cash available to fund a capital call to pay fees or

    • Many funds permit recycling of commitments. However, if the
      issuer has received a cash distribution from the underlying funds,
      and that cash is run through the waterfall, it is no longer
      available for recycling. The portfolio needs to provide sufficient
      cash into the structure to be able to cover these additional calls
      on capital.

    In these cases, the issuer would become a defaulting LP if the
    investment portfolio does not generate sufficient cash to service
    these capital calls, thereby impairing the debtholders’
    collateral. It is therefore important to control when and how much
    cash leaves the structure.

  • Investment-Grade Rating: Insurance companies rely on the
    investment grade or quasi- investment grade rating of the debt for
    their RBC analysis. If the debt is downgraded, the debtholders
    might request an Event of Default or a draw stop on unfunded
    commitments until the investment grade rating is restored.

Critical Structuring Parameters

When structuring these investments, issuers must determine
certain key parameters. We list three of them here, and discuss
each in turn.

  • Whether the investment portfolio will be set as of the closing

  • Whether the commitments to the issuer will be funded in full on
    the closing date; and

  • Whether the issuer will be consolidated with its parent’s
    balance sheet and whether that parent has other obligations that
    subject the parent and its subsidiaries to covenants with which the
    structured notes obligations might conflict.

Setting the Investment Portfolio

The issuer needs to determine whether the asset holdco will have
set the investment portfolio as of the closing date, or whether the
asset holdco will build or adjust the portfolio after the closing
date based on agreed investment guidelines. If the investment
portfolio may change after the closing date, it is important to
ensure the investment portfolio will be sufficiently diversified to
support an appropriate rating. In addition, the issuer needs to be
prohibited from committing more than the aggregate principal amount
of debt and equity that has been committed to the issuer.
Alternatively, noteholders will have to be comfortable that
expected distributions on the underlying funds will be sufficient
to fund capital calls for which no matching source of funding is
identified at closing.

Funded or Unfunded Commitments

Another important parameter is whether the debt and equity
commitments will be fully drawn on the closing date, or if there
will be a delayed drawing schedule. Having some or all of the
commitments unfunded as of the closing date presents additional
considerations. There needs to be a comfort level regarding the
credit worthiness of the debt holders and equity holders.
Protections may be necessary to ensure the issuer receives the full
draw amount needed, including defaulting noteholder provisions and
GP or other parent support from the issuer or the underlying funds.
Finally, the investment may need to come with drawing conditions,
such as a ratings downgrade or an LTV breach, in the event the
condition of the structured notes obligation has changed since the
closing date. However, the matter of drawing conditions should be
approached cautiously, as a draw stop may cause the issuer to
become a defaulting limited partner with respect to some or all of
the underling funds, thereby exacerbating the problem.

Balance Sheet Considerations

While the issuer of a structured notes obligation is a special
purpose vehicle, the parent of the issuer may be a company that
itself has debt obligations. If the parent is required to
consolidate the issuer in its balance sheet, the covenants in the
parent’s debt agreements may extend to the parent’s
subsidiaries and must be considered to ensure that the debt
issuance by the issuer does not conflict with those covenants.

Liquidity Facility

Many structured notes structures include liquidity support, in
the form of a revolving facility provided by a third-party lender,
that can be used to bridge a funding shortfall. These liquidity
facilities are generally available to fund fees and expenses,
interest on the debt tranches and, sometimes, capital calls from
the underlying funds. While these liquidity facilities are rarely
used, including a liquidity facility in the structure provides
stability to the structured notes obligation by supporting the
ratings analysis and reducing the possibility that the structure
will fail.

Regulatory Treatment

The structure of structured notes obligations is based on the
current RBC treatment of the notes’ debt investments as debt
investments. However, the National Association of Insurance
Commissioners (“NAIC”), the standard-setting and
regulatory support organization created and governed by state
insurance regulators, has for a number of years been exploring
changes to statutory accounting principles and securities valuation
office (“SVO”) procedures that could affect the reporting
and capital treatment of structured notes obligations rated note
feeder vehicles and similar structures. Currently, the NAIC is
working on a principles-based approach to structured notes with the
goal of settling on final rules by May 2023 with a January 1, 2024
effective date. We generally see the insurance company debtholders
assume the risk of a change in law or of the structured notes
obligation not achieving the desired capital or reporting

Recent Trends

  • Decoupling of debt and equity commitments: While investors
    in some structured notes obligations are purchasing a vertical
    slice of the structure that includes both debt and equity, we are
    increasingly seeing structures that decouple the two. This strategy
    works well for insurance companies that wish to invest in rated
    debt instruments but not the equity. The equity is then purchased
    by investors such as a balance sheet fund of the firm forming the
    structured notes obligation, family offices and other third-party
    investors attracted to the combination of levered exposure to
    multiple funds and the potential for high returns. While equity
    holders may be required to make an initial funding, often no
    further funding is required (subject to certain downside events
    such as a loss of rating for a period of time) until the debt has
    been funded in full. If the portfolio produces sufficient cash
    flows to service future capital calls, it is possible that the
    equity is never drawn again but still gets the benefit of excess
    cash distributions out of the system.

  • Equity Credit Support: To the extent that equity
    commitments are not funded in full on the closing date, equity
    holders may be required to have an eligible rating or provide
    adequate credit support from a person with an eligible rating. This
    credit support frequently takes the form of a parent guaranty, a
    letter of credit or a cash collateralization, in each case for the
    full amount of the equity commitment. This credit support not only
    supports the ratings analysis, but also provides comfort to the
    debtholders that the equity holders will fund when required to do
    so under the terms of the transaction documents.


In the current market environment, we expect to see more private
equity firms and insurance companies develop and invest in these
structures to maximize their access to liquidity and as a new
investment opportunity. We also expect further innovations as
market participants react to regulatory and other developments.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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In the days leading up to the closing of a credit facility, it is not uncommon for the administrative agent to ask each lender a simple question, “do you need a note?”

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