AM Best Flags Two-Notch Credit Slide in Annuity Reserve Backing

When individual annuity reserves exceed 36% of total U.S. life/annuity segment reserves and private equity-backed insurers control roughly 25% of those liabilities, the credit quality of the companies backing policyholder obligations becomes a first-order pricing variable. AM Best's April 2026 report documents a nearly two-notch weighted decline in issuer credit ratings across the annuity block since 2007. For pricing actuaries setting credited rates on MYGAs, fixed indexed annuities, and structured settlements, this shift directly alters the spread decomposition that determines how much yield is available for policyholder crediting after expected defaults, capital charges, and reinsurance costs.

What the AM Best Data Shows

AM Best's analysis, "Credit Quality of Annuity Reserves Declined from 2007 to 2025 on the Credit Ratings Scale," covers individual annuity reserves across the entire U.S. life/annuity segment. The core findings carry direct pricing implications:

Individual annuity reserves now represent over 36% of total L/A segment reserves, up from 32% before the 2008 financial crisis.
Approximately one-third of those reserves are held by 95 companies whose long-term issuer credit ratings have declined since 2007.
On a reserve-weighted basis, the average issuer credit rating across the annuity block has fallen nearly two notches.
Privately owned companies experienced the most pronounced downgrades, while publicly listed firms (accounting for nearly half of affected reserves) showed somewhat less deterioration.

From tracking AM Best rating actions over successive credit cycles, the magnitude here matters more than the direction. A one-notch downgrade within the investment-grade band (say, from "a+" to "a") has modest capital implications. A two-notch shift, particularly when it moves a meaningful share of reserves from the A range into the BBB range or below, triggers a step-function increase in risk-based capital requirements and expected default assumptions that flows directly into the credited-rate pricing equation.

The public-versus-private bifurcation is worth noting for competitive pricing analysis. Publicly listed carriers face equity market discipline on portfolio risk-taking, while privately held companies (which include most PE-backed platforms) face less external scrutiny of asset allocation decisions. For regulators evaluating rate filings from different ownership structures, this distinction informs the credibility weight assigned to each carrier's reported investment income assumptions.

PE-Backed Insurers and the Asset Strategy Shift

The structural driver behind the credit quality decline is the rise of PE-backed life insurers. Harvard Business School research cited by AM Best found that PE-backed insurers controlled approximately 25% of all U.S. individual annuity liabilities by 2024 and accounted for 35% of new fixed and fixed indexed annuity sales, up from just 7% in 2011. Apollo's Athene and KKR's Global Atlantic each held approximately one-fifth of their portfolios in loans to affiliated funds as of year-end 2024.

Affiliated investments among L/A insurers surged more than 17% in 2024 alone to exceed $373 billion, part of a trend averaging 13% annual growth over six years. This concentration reflects the PE-backed insurer model: the asset management affiliate originates higher-yielding private credit, CLOs, and structured products, and the insurance subsidiary purchases them to back policyholder liabilities. The gross yield is higher, but so is the embedded credit risk, illiquidity, and correlation exposure.

With U.S. retail annuity sales hitting $464.1 billion in 2025 (the fourth consecutive record year per LIMRA) and growth now projected to taper, AM Best warns that competition may force "more aggressive pricing strategies" to maintain market share. The MYGA market is the primary competitive battleground, where pricing spreads between investment yield and credited rates are already thin.

Credited-Rate Spread Decomposition

The pricing actuary's central equation for credited-rate products (MYGAs, fixed annuities, fixed indexed annuities) is:

Credited Rate = Gross Portfolio Yield − Expected Default Cost − Investment Expense − Capital Charge (C-1 and C-3) − Target Profit Margin

Each component responds differently to the portfolio quality shift that AM Best documents:

Gross Portfolio Yield. The book yield on assets backing annuity reserves. For a traditional investment-grade portfolio, this reflects the credit spread on IG corporate bonds, agency MBS, and structured products. For PE-style portfolios tilted toward private credit and affiliated loans, the gross yield is typically 40 to 80 basis points higher, reflecting both credit risk premium and illiquidity premium.

Expected Default Cost. The actuarial estimate of annual credit losses in the portfolio. For NAIC 1 assets (roughly equivalent to A-rated and above), historical annual default rates run 0.05% to 0.15%. For NAIC 2 assets (BBB), defaults run 0.20% to 0.40%. A portfolio that has shifted two notches lower on average will carry materially higher expected default costs. The appropriate assumption should reflect the actual credit quality of the backing assets, not just their statutory book values or NAIC designations obtained through the filing-exempt process.

Investment Expense. Management fees, custody costs, and transaction expenses. Private credit and affiliated loans carry higher management costs than publicly traded corporate bonds due to origination, monitoring, and workout requirements. A 5 to 10 basis point differential is common.

Capital Charge. The cost of holding risk-based capital against the asset portfolio, driven primarily by C-1 (asset default risk) factors assigned by NAIC designation category. This is where the two-notch shift hits hardest.

Target Profit Margin. The insurer's required return on the product. Competitive pressure in the MYGA market has compressed this to 15 to 30 basis points for most carriers, leaving little room to absorb higher costs from the other components.

C-1 Capital Factors and the Two-Notch Cost

The NAIC assigns C-1 risk-based capital factors by designation category, creating a step-function relationship between portfolio quality and required capital:

NAIC Designation	Approximate Rating	C-1 Base Factor
NAIC 1	AAA to A-	0.4%
NAIC 2	BBB+ to BBB-	1.3%
NAIC 3	BB+ to BB-	4.6%
NAIC 4	B+ to B-	10.0%
NAIC 5	CCC	23.0%
NAIC 6	CC and below	30.0%

A two-notch decline in the average portfolio rating, from mid-A (solidly NAIC 1) toward BBB (NAIC 2), roughly triples the blended C-1 factor from approximately 0.4% to 1.3%. The cost of this additional capital, calculated as the incremental C-1 factor multiplied by the insurer's cost of equity (typically 10% to 14%), flows directly into the pricing spread. An extra 0.9 percentage points of required capital at a 12% cost of equity adds approximately 11 basis points to the capital charge, which must be deducted from the credited rate or absorbed by thinning the profit margin.

For carriers with significant allocations to NAIC 3 assets (private credit that is genuinely BB-rated, not just NAIC-designated based on expected loss analysis), the capital cost escalates sharply. The jump from NAIC 2 to NAIC 3 adds 3.3 percentage points of required capital per dollar of assets, costing roughly 40 basis points at a 12% hurdle rate. Patterns we have seen in recent NAIC discussions on CLO capital treatment suggest that the regulatory capital regime may not remain static, adding forward-looking uncertainty to the capital charge assumption.

Asset Adequacy Testing with Private Credit Portfolios

Asset adequacy testing (AAT) under the Standard Valuation Law requires the appointed actuary to demonstrate that reserves are sufficient to cover future policyholder obligations. Under VM-20, the actuary projects cash flows under deterministic and stochastic scenarios, verifying that the present value of future benefits plus expenses does not exceed the present value of future premiums plus reserves.

When affiliated assets compose a significant share of the portfolio, three challenges emerge for the pricing actuary:

Correlated default risk. Standard default assumption tables (such as those derived from Moody's corporate default studies) assume diversified portfolios. If the parent PE firm experiences financial stress, defaults across affiliated loans could be correlated rather than independent, violating the diversification assumptions embedded in standard C-1 factor tables. Scenario-based stress testing, rather than relying solely on expected-value default loads, is necessary to capture this tail risk.

Valuation uncertainty. Private credit assets often lack observable market prices, making it difficult to calibrate realistic stress scenarios. The actuary must select default and recovery assumptions that reflect the actual credit quality of backing assets, which may differ from the NAIC designation if the designation was obtained through the filing-exempt process or private letter rating pathway. The NAIC's ongoing review of private credit regulation and the SVO's increased scrutiny of private letter ratings add a layer of regulatory uncertainty.

Asset-liability feedback loops. A credit event at the PE parent could trigger a ratings downgrade of the insurance subsidiary, which could in turn cause mass surrenders as distribution partners move business to higher-rated competitors. This surrender wave would force asset liquidation at distressed prices, crystallizing losses that static default tables assumed would amortize over time. For pricing purposes, this second-order risk should be reflected either as an explicit load in the expected default cost assumption or as an adverse scenario adjustment in the profit-testing model.

AM Best also flags offshore affiliated reinsurance as a contributor to weakened balance sheet quality. For pricing, the cost of reinsurance (including the spread on funds withheld and the counterparty risk of the affiliated reinsurer) must be reflected in the product-level profit margin, not treated as a free reserve management tool that reduces visible capital strain without transferring economic risk.

Worked Example: Traditional IG vs. PE-Style Private Credit

Consider two hypothetical insurers, both offering a five-year MYGA with $500 million in backing assets and the same 5.50% gross portfolio yield:

Insurer A: Traditional IG Portfolio

Portfolio composition: 75% NAIC 1 (mid-A corporates), 20% NAIC 2 (BBB structured credit), 5% NAIC 3 (BB high-yield allocation).

Blended C-1 factor: (0.75 × 0.4%) + (0.20 × 1.3%) + (0.05 × 4.6%) = 0.30% + 0.26% + 0.23% = 0.79%
Expected default cost: 0.10%
Investment expense: 0.10%
Capital charge (0.79% × 12% cost of equity): 0.09%
Target profit margin: 0.25%
Available credited rate: 5.50% − 0.10% − 0.10% − 0.09% − 0.25% = 4.96%

Insurer B: PE-Style Private Credit Portfolio

Portfolio composition: 35% NAIC 1 (mix of IG and private credit with NAIC 1 designation), 40% NAIC 2 (private credit, CLO tranches), 20% NAIC 3 (affiliated loans, lower-rated private credit), 5% NAIC 4 (distressed and workout positions).

Blended C-1 factor: (0.35 × 0.4%) + (0.40 × 1.3%) + (0.20 × 4.6%) + (0.05 × 10.0%) = 0.14% + 0.52% + 0.92% + 0.50% = 2.08%
Expected default cost: 0.40%
Investment expense: 0.18%
Capital charge (2.08% × 12%): 0.25%
Target profit margin: 0.25%
Available credited rate: 5.50% − 0.40% − 0.18% − 0.25% − 0.25% = 4.42%

At identical gross yields, Insurer B's risk-adjusted credited rate ceiling is 54 basis points lower than Insurer A's. Insurer B faces a clear choice: offer a 4.42% credited rate that is uncompetitive against Insurer A's 4.96%, compress the target profit margin to close the gap, or rely on actually generating a higher gross yield (the PE model's core premise) to offset the higher risk charges. If Insurer B's portfolio actually yields 6.10% instead of 5.50%, the risk-adjusted credited rate rises to 5.02%, making it competitive while carrying materially more portfolio risk.

This is the central tension AM Best identifies. PE-backed insurers can compete on credited rates only if the gross yield premium on their private credit portfolios exceeds the sum of the incremental default cost, investment expense, and capital charge. When the yield premium is insufficient, the insurer is effectively subsidizing competitive credited rates by accepting thinner margins, which is precisely the credit quality deterioration AM Best's data captures over the 2007-to-2025 period.

Why This Matters for Pricing Actuaries

The AM Best report quantifies a structural shift that pricing actuaries cannot treat as background noise. Four implications stand out:

Competitive analysis must now incorporate asset portfolio quality alongside credited rates. Two carriers offering identical MYGA rates may be running fundamentally different risk profiles. The one with lower-quality backing assets is either earning less economic profit or taking more investment risk per dollar of liability. Rate filings that present credited rates without disclosing the risk profile of the supporting asset portfolio are incomplete.

MYGA pricing dynamics will intensify as growth decelerates. With LIMRA projecting a tapering from 2025's record pace, carriers will face pressure to maintain credited rates despite a less favorable rate environment. The temptation to reach for yield through lower-quality assets, rather than accepting lower credited rates, creates the conditions for the next credit cycle. This continues a trend we have tracked across multiple rate environment inflection points and their impact on annuity pricing.

Regulatory capital assumptions should be stress-tested forward, not anchored to current factors. The NAIC's review of CLO capital factors, the SVO's tightening of private letter rating acceptance, and the Treasury Department's $1 trillion private credit inquiry all signal that regulatory capital requirements may increase. Pricing actuaries should model product profitability under tighter C-1 factor tables, not just the current schedule.

Reinsurance cost allocation matters. Offshore affiliated reinsurance structures that move reserves to jurisdictions with lighter capital requirements reduce the visible capital charge but do not eliminate the underlying credit risk. For pricing, the economic cost of the reinsurance arrangement, including the spread on funds withheld and the counterparty risk of the affiliated reinsurer, should be reflected in the product-level profit margin.

AM Best Flags Two-Notch Credit Slide in Annuity Reserve Backing

What the AM Best Data Shows

PE-Backed Insurers and the Asset Strategy Shift

Credited-Rate Spread Decomposition

C-1 Capital Factors and the Two-Notch Cost

Asset Adequacy Testing with Private Credit Portfolios

Worked Example: Traditional IG vs. PE-Style Private Credit

Insurer A: Traditional IG Portfolio

Insurer B: PE-Style Private Credit Portfolio

Why This Matters for Pricing Actuaries

Sources

Further Reading