U.S. life insurers are well on their way to exceeding their 2018 level of issuance of surplus notes, the unsecured, deeply subordinated, debt-like instruments used by some insurance companies as a source of capital.
The combined value of $1.63 billion associated with three transactions to date in 2019 represents 53.1% of S&P Global Market Intelligence's full-year 2018* issuance tally of $3.06 billion. Only $326.9 million in face amount of surplus notes had been issued by U.S. life insurers on a year-to-date basis through May 10, 2018, as much of the activity occurred subsequent to the Thanksgiving holiday.
As such, issuance on a trailing-12-months basis has approached $4.37 billion. Though that pace of activity easily exceeds the average annual issuance volume of $2.74 billion over the past decade, it is well short of the high-water mark of $7.38 billion set in calendar year 2017.
With new issues exceeding the pace of maturities and redemptions, U.S. life companies had $33.79 billion in surplus notes on their books as of Dec. 31, 2018, up from $32.27 billion a year earlier. The rate of increase slowed from 2017 when issuance volume hit at least a 10-year high of more than $7.38 billion.
Issuance slowed more dramatically in 2018 among domestic property and casualty insurers, by contrast, with the aggregate amount of activity declining to $402.8 million from $1.39 billion in 2017. Total surplus notes outstanding in the P&C industry fell for a third consecutive year to end 2018 at less than $12.10 billion.
A fast start
Interim 2019 statutory results are not currently available, but S&P Global Ratings assigned ratings to transactions by seasoned issuers New York Life Insurance Co. and National Life Insurance Co. valued at $1 billion and $127.9 million, respectively. They were joined by a $500 million issuance from Western & Southern Life Insurance Co., which according to S&P Global Market Intelligence data is a company with no history of outstanding surplus notes going back to at least 1996.
New York Life, which ended 2018 with $1.99 billion in surplus notes outstanding, issued $1 billion in 4.45% notes due 2069 on April 1. Proceeds, according to S&P Global Ratings, would be used for general corporate purposes. The surplus notes outstanding at the company as of year-end 2018 were issued in comparable amounts in 2003 and 2009 at coupons of 5.88% and 6.75%, respectively.
Advisers to National Life positioned the company's April 25 offering as a reopening of a $372.1 million issuance that closed in July 2018. National Life issued the original and new notes at initial fixed rates of 5.25%. The notes mature in 2068, and they are scheduled to begin floating at 331 basis points over the three-month London Interbank Offered Rate, or LIBOR, after the first 30 years. Proceeds are intended for general corporate purposes.
The Western & Southern Mutual Holding Co. subsidiary might have more specific plans for proceeds from its January issuance of $500 million in 5.15% surplus notes due 2049. S&P Global Ratings said the life insurer may use those funds to assist its holding company with the repayment of a credit facility used to fund the December 2018 acquisition of Gerber Life Insurance Co.
Another capital markets transaction involving a large U.S. life insurer during the first five months of 2019 also could give rise to future surplus notes issuance.
The deal involved the creation of Harborwalk Funding Trust, an entity that would be required to purchase certain of Massachusetts Mutual Life Insurance Co.'s surplus notes under specified scenarios. S&P Global Ratings said that the precapitalized trust securities to be issued by the trust are intended to create a source of contingent capital as the requirement to purchase surplus notes would apply at any time, regardless of MassMutual's financial condition or market developments.
An active, but not outstanding, year
Global Atlantic Financial Group Ltd.'s Commonwealth Annuity and Life Insurance Co. led the U.S. life sector and the insurance industry as a whole with an $820 million December 2018 issuance to an affiliate. The 6.25% note replaced a $620 million 5.75% issuance from the prior year. AXA Equitable Life Insurance Co. issued a 3.75% $572.3 million surplus note to parent AXA Equitable Holdings Inc. in December 2018.
Municipal bond insurer Build America Mutual Assurance Co. issued $481.2 million in variable-rate surplus notes due April 2042 in December 2018. The company exchanged the new surplus notes for those it issued in 2017.
S&P Global Market Intelligence calculates a weighted average interest rate of 5.69% for fixed-rate surplus notes issued in 2018, up 115 basis points from 2017.
Investment activity follows issuance
U.S. P&C and life insurers have actively invested in surplus notes issued by peers and affiliates. While 2018 was no different, the aggregate amount of new investments declined on a year-over-year basis in a matter consistent with the pattern of issuance.
Based on data reported on the relevant section of Schedule BA of annual statements, acquisitions of surplus notes totaled $1.72 billion in 2018, down from $3.17 billion in 2017, with securities issued by unaffiliated entities accounting for 68.3% of the tally.
Commonwealth Annuity & Life had the largest single new investment in a surplus note. The company assigned Jan. 1, 2018, as the acquisition date for a surplus note previously issued by its wholly owned subsidiary, Forethought Life Insurance Co. The year's largest acquisition of an unaffiliated surplus note was Protective Life Insurance Co. May 1, 2018, addition of $74.5 million of the 2003-vintage New York Life surplus note.
All told, U.S. life insurers had $12.09 billion invested in unaffiliated surplus notes as of Dec. 31, 2018. That marked an increase from $11.36 billion on the same date in 2017 and it is the highest such level of investment in that asset class in the 13 years for which data is available. And even while P&C insurers' issuance volume fell in 2018, their investments in unaffiliated surplus notes also climbed to at least a 13-year high as they increased to $937.4 million from $777.8 million year over year.
Mixed leverage ratio trends
While the ratio of surplus notes to policyholders' capital and surplus among P&C insurers fell to at least an 18-year low at 1.60%, it has been on the rise in the life industry. The ratio of 8.45% as of year-end 2018 marked an increase of 28 basis points year over year to a level that is well above the pre-financial crisis average.
With the Federal Reserve having signaled its intent to remain on the sidelines for the time being as it pertain to potential increases in the federal funds rate, conditions could remain favorable for further surplus notes issuance. The weighted average coupon on the three aforementioned 2019 transactions of 4.79% is 61 basis points below the full-year 2018 result.
But it is not reasonable to assume the life industry will keep up the torrid pace of activity through the balance of the year, which would imply a total of approximately $4.88 billion, or nearly 1.8x the average for the 10-year period ended in 2018. The New York Life issuance represents one of only four U.S. life company offerings of surplus notes with face amount of $1 billion or more since the start of 2010.