Due to their long-term investment horizons, US insurance companies historically have been significant investors in alternative assets such as private equity and private credit funds. More recently, making investments in limited partner or similar equity interests issued by such funds can result in significant regulatory capital requirements for insurance company investors. To address this concern and still appeal to insurance company investors, fund sponsors have increasingly turned to issuing both rated debt instruments as well as traditional limited partner interests when launching private credit and other alternative asset funds. These dual-issuance structures are commonly referred to as rated feeder funds or rated note feeders.

Increasing regulatory scrutiny by insurance company regulators such as the National Association of Insurance Commissioners (NAIC) and other developments have altered market practice in key areas and led to an increasing distinction in the rights and obligations of debt holders versus equity holders. In this article, we outline below a number of these key structuring considerations for alternative fund sponsors who are interested in implementing the use of these structures to attract long-term, institutional capital from insurance companies. Many of the typical features of an equity investment in a fund need to be modified from their historical market standard to permit the debt instruments to be classified in a manner that would allow insurance company investors to achieve a capital efficient investment. By leveraging the characteristics and features of structured finance instruments, fund sponsors can develop debt instruments that will continue to attract these long-term insurance company investors.

1. DEBT INSTRUMENTS REQUIRE INTRACLASS PRO RATA TREATMENT

In designing any fund that seeks to issue both debt and equity instruments to investors, fund sponsors should take into account that debt instruments and equity interests operate differently.

It is common for an alternative asset fund (such as a...