Life Insurers Are Borrowing Against Illiquidity

Life insurance is built around duration. A policyholder pays today, an insurer invests the premium, and many of the promised cash flows arrive years or decades later. That structure has traditionally allowed life insurers to hold long-dated corporate bonds, mortgages and other assets through temporary market volatility. The liability base was supposed to be patient. The asset portfolio could therefore be patient too.

The latest data show why that simple picture is becoming less complete. The Federal Reserve's November 2026 Financial Stability Report says nontraditional liabilities at US life insurers surpassed $580 billion in the second quarter of 2026. The same report says leverage at the largest life insurers remained historically high, while illiquid assets were about 38% of life insurers' general-account assets in 2025. Those three facts belong in one frame. A long-duration institution is holding more assets that cannot be sold quickly while using more funding that can behave differently from a conventional insurance obligation.

That does not mean life insurers are banks in disguise, nor does it mean a crisis is inevitable. Most insurance liabilities are still structurally different from deposits, and regulated insurers hold capital against their risks. The more useful conclusion is that the sector's liquidity profile is changing. Funding-agreement-backed securities, Federal Home Loan Bank advances, securities-lending cash collateral and repurchase agreements can improve returns, diversify funding and support asset-liability management. They can also create fixed maturities, collateral calls, rollover decisions and cash needs that arrive sooner than the underlying assets can be sold without a discount.

Block2Learn's assessment is that the important risk is not leverage alone or illiquidity alone. It is the conversion between them. The balance sheet works when an insurer can transform long-dated asset cash flows into reliable payments on policies and wholesale obligations. It becomes fragile when several claims on cash accelerate together and the assets available to meet them are private, structured, pledged or hard to value. Life-insurer wholesale funding is therefore a test of liquidity design, not simply a debate about asset quality.

The Number That Changes the Conversation

The Federal Reserve's measure of nontraditional life-insurer liabilities includes four main components: funding-agreement-backed securities, Federal Home Loan Bank advances, cash collateral received through securities lending, and repurchase agreements. In real terms, the total fell from roughly $535 billion in 2007 to around $290 billion by 2010. It then stayed near $250 billion to $300 billion for much of the following decade before rising again. The report estimates approximately $350 billion in 2020, $420 billion in 2021, $450 billion in 2024, about $550 billion in 2025, and more than $580 billion in the second quarter of 2026.

That path matters more than any single quarterly increase. It shows that wholesale and collateralized funding has returned as an important layer of the life-insurance balance sheet. The total is still small beside the industry's assets and policy obligations, but it is no longer a footnote. It is large enough to influence liquidity management, asset selection and the transmission of market stress.

The asset side has changed at the same time. The Fed estimates that illiquid holdings across insurers rose from around $1.9 trillion in 2006 to about $2.9 trillion in 2025. For life insurers, illiquid assets represented roughly 38% of general-account assets in 2025. These holdings include commercial real-estate loans, securitized commercial-property exposure, alternative investments, illiquid corporate debt and securitized illiquid credit. Some are high-quality assets with predictable cash flows. Illiquid does not mean impaired. It means the price and timing of a sale are uncertain precisely when cash is most valuable.

This distinction is central. An insurer can be solvent in an economic sense because the present value of its assets exceeds the present value of its liabilities, yet still face a liquidity problem if cash is due before assets can be monetized. Wholesale funding increases the number of clocks on the balance sheet. Policy claims follow actuarial and contractual patterns. Funding agreements mature on specified dates. Securities-lending counterparties can return securities and request their cash collateral. Repo funding can require renewal or more collateral. FHLB advances have their own maturity and collateral terms. The risk emerges when these clocks stop being independent.

What the Four Funding Channels Actually Do

Funding-agreement-backed securities, or FABS, begin with a funding agreement issued by a life insurer. The agreement pays a fixed or floating rate and is backed by the insurer's general account. A special-purpose vehicle can use that agreement as collateral and issue securities to institutional investors. The structure gives the insurer access to debt-like funding at a potentially attractive cost. It gives investors an instrument linked to a regulated insurer's balance sheet without requiring them to buy the insurer's conventional corporate debt.

Federal Home Loan Bank advances are collateralized loans from the regional FHLB system. Insurers that qualify for membership can pledge eligible assets and obtain funding. That can be useful during normal markets and can provide a source of liquidity when other channels become expensive. The protection is not unlimited. Borrowing capacity depends on collateral eligibility, haircuts, membership rules and the value of pledged assets. An asset committed to the FHLB is not freely available for another liquidity need.

Securities lending works differently. An insurer temporarily lends a security and receives collateral, often cash, from the borrower. The insurer can invest that cash and earn an additional spread. The NAIC's securities-lending overview notes that transactions are generally overcollateralized, but the lender still has to manage the credit, duration and liquidity risk of the reinvested cash. The borrower may return the security and request its collateral on relatively short notice. If the insurer invested the cash in an asset that cannot be sold quickly, a modest income strategy can become a liquidity mismatch.

Repo is the most recognizably market-based channel. The insurer sells a security and agrees to repurchase it later, economically borrowing against the asset. Repo can be efficient and short term, but its reliability depends on counterparties, collateral values and haircuts. If volatility rises or an asset becomes less acceptable, the same position can require more collateral or less borrowing capacity.

Each channel has a legitimate purpose. The issue is that they connect an insurer's long-term portfolio to institutions and markets that reprice more quickly than policy liabilities. They also create encumbrance. The same high-quality bond cannot simultaneously support an FHLB advance, a repo transaction and an unanticipated cash call. Liquidity analysis therefore has to track not only the gross quantity of assets but also which assets are pledged, reusable, saleable and operationally available.

The Asset Side Is No Longer Just a Bond Portfolio

Life insurers have always bought private placements and mortgages because long liabilities can support long assets. What has changed is the scale and structure of the credit ecosystem around them. The NAIC's November 2026 analysis of insurer private credit estimates that the US insurance industry held $1.21 trillion under a broad definition of private credit at the end of 2025, equal to about 13% of cash and invested assets. More than half consisted of relatively familiar private-placement bonds, bank loans and middle-market collateralized-loan obligations. The NAIC identified $544 billion in more structurally complex categories such as privately rated bonds, business-development companies and private-credit funds.

Those figures should not be interpreted as a claim that every private asset is dangerous. Private credit can offer covenants, information rights and cash-flow matching that public markets do not provide. A long-dated private loan can be a better match for an annuity liability than a liquid security with a shorter maturity. The analytical challenge is that privately originated and structured assets are harder to compare, value and sell. If an insurer needs cash during stress, the asset that looked like a stable hold-to-maturity investment can become a source of uncertainty.

A Federal Reserve note on life insurers and risky corporate credit explains how insurers can gain exposure directly through high-yield bonds and leveraged loans and indirectly through CLOs, business-development companies and joint-venture loan funds. The note's representative structure shows that leverage can sit across affiliated entities rather than appearing in a single regulatory ratio. It estimates that one affiliated BDC structure could reach consolidated leverage of up to 12 to 1 when joint ventures and middle-market CLOs are included, even though the BDC's standalone regulatory leverage was below 2 to 1.

This is where the wholesale-funding question separates from the broader debate about private-credit opacity. Opacity makes it harder to see risk. Wholesale funding determines when that hidden risk must be converted into cash. A portfolio can remain stable while valuations are modelled and liabilities are patient. The test arrives when a maturity, collateral call or surrender requires a transaction rather than an estimate.

Why Annuities Change the Economics

The transformation is partly driven by competition for annuity business. Fixed and indexed annuities provide policyholders with contractual benefits while giving insurers a large pool of long-duration capital. Higher-yielding private assets can help insurers offer competitive crediting rates and still earn a spread. Affiliated asset managers may provide origination capacity and access to loans that are not available in public markets.

A Federal Reserve Bank of Chicago working paper estimates that life insurers' private placements reached $849 billion in 2024, or 14% of general-account assets, up from $386 billion and 10% in 2014. The authors find that private-equity-owned insurers drove much of the growth and that access to new forms of private credit was associated with 61% of their increase in annuity-market share. The result captures the commercial logic. The investment strategy is not separate from the product strategy. Higher asset yields can support more competitive annuity terms, which attract more premium, which creates more capital to invest.

That loop can be productive. It can also make the liability side more sensitive to customer behavior and market alternatives. Annuity contracts often include surrender charges and other protections, so policyholders cannot withdraw exactly like bank depositors. Yet surrender behavior can change when competing rates rise, confidence falls or a policy moves beyond its penalty period. The insurer then has to fund benefits while deciding whether to sell assets, borrow, reduce new business or change product pricing.

Wholesale funding adds another layer to that loop. If an insurer uses FABS or FHLB advances to expand or optimize the portfolio, it can increase earnings when spreads are stable. If asset values fall or funding becomes expensive, the institution may have to protect liquidity at the same time that annuity competition compresses margins. The business model is therefore exposed to both market prices and customer choices, even though neither operates exactly like a bank run.

Solvency Is Not the Same as Liquidity

Insurance regulation is designed around the ability to meet policyholder obligations. Risk-based capital, statutory reserves, asset valuation and stress testing are all part of that framework. These protections matter. The Federal Reserve itself describes the banking system and insurance sector without declaring an immediate crisis. Its warning is about vulnerabilities that can amplify a shock, not a forecast that losses will occur.

Still, a solvency measure can move more slowly than liquidity. Private assets are often valued with models, comparables or periodic appraisals. A public bond can fall 10% in a day; a private loan may retain its reported value until a new valuation, amendment or sale provides evidence. The slower price does not automatically make the asset safer. It can simply delay recognition.

The cash test is more immediate. Suppose an insurer has $100 of long-dated assets funded by $85 of policy liabilities, $10 of wholesale liabilities and $5 of equity. If the assets are sound and eventually pay $110, the balance sheet may be economically solvent. But if $8 of wholesale funding matures during a market disruption and only $4 of unencumbered liquid assets are available, the insurer must find the remaining $4. Selling private credit at a discount can convert a temporary liquidity gap into a permanent capital loss. Borrowing against other assets can solve the immediate problem while increasing encumbrance and future interest expense.

This conversion mechanism is why leverage at the largest life insurers matters even when policy liabilities are long. The Fed's chart places life-insurer leverage near 12 in the second quarter of 2026, historically high in its series. The exact ratio should not be read like a hedge fund's gross exposure or a bank's capital ratio; the underlying balance sheets and accounting are different. The direction is what matters. A thinner equity layer absorbs less valuation error, credit loss or forced-sale discount before confidence and capital are affected.

The Collateral Map Matters More Than the Asset List

Investors often start with an insurer's asset allocation: corporate bonds, mortgages, private credit, alternatives and cash. That is necessary but insufficient. The more revealing map shows collateral status and cash priority.

An unencumbered Treasury bond can be sold, repoed or pledged. A private loan may be valuable but ineligible for a particular funding facility. A highly rated structured security may be eligible today but face a larger haircut after a downgrade or market shock. A pledged asset may still appear on the balance sheet while being unavailable for another purpose. Cash from securities lending may have been reinvested into a longer-dated instrument. A derivative position may create a collateral call precisely when the bond portfolio is losing value.

This is the same principle visible in hedge-fund leverage beyond the Treasury basis trade: the location and trigger of financing matter as much as the headline amount. For insurers, the triggers are different, but the system logic is similar. Leverage can remain quiet until volatility, haircuts or confidence change the cash requirement.

The Bank for International Settlements' work on the transformation of life insurance highlights the sector's stronger links to private equity, derivatives, asset-intensive reinsurance and short-term funding. These connections can diversify risk and improve efficiency. They also create more pathways through which a market shock can reach an insurer and through which an insurer's response can reach markets.

The practical question is therefore not just how much liquidity an insurer reports. It is how much liquidity remains after plausible collateral calls, surrenders, maturities and operational restrictions occur together. A strong framework distinguishes cash, unencumbered high-quality securities, assets eligible for secured borrowing, assets saleable with moderate discounts, and assets that should be treated as unavailable during stress.

A Shock Can Travel Through Several Balance Sheets

Consider a rise in long-term interest rates. Public fixed-rate bonds lose value. Private-credit marks may adjust more slowly, but the economic discount rate still rises. New annuity products become more attractive, which can increase competition for customers and encourage some existing policyholders to surrender or exchange contracts. Derivative hedges may generate gains or losses depending on their design, and collateral movements can create immediate cash needs. FABS investors demand a higher yield at refinancing. FHLB borrowing capacity changes with collateral values and haircuts.

The insurer has several responses. It can hold more cash, reduce new lending, sell public bonds, borrow against eligible assets, allow wholesale funding to run off, reprice annuities or seek capital. Each action protects the institution but can transmit pressure elsewhere. Selling public bonds can deepen market weakness. Pulling back from private credit reduces financing for borrowers. Competing more aggressively for annuity premiums can compress industry margins. Increasing secured borrowing encumbers more assets.

This is why the simultaneous failure of familiar hedges matters. Block2Learn recently examined how bonds and gold can fall together when real yields rise. An insurer's portfolio is much broader than those two assets, but the lesson applies: assets with different long-run roles can still respond to the same short-run funding shock. Diversification by label is weaker than diversification by cash-flow trigger.

Interconnections also matter. Banks provide credit lines, FHLBs provide advances, money-market investors buy short-term instruments, asset managers originate private credit, and reinsurers transfer liabilities across jurisdictions. A liquidity decision by one insurer may be manageable. Similar decisions across several large insurers can affect bond spreads, private-credit issuance and secured-funding markets. The systemic question begins with common behavior, not necessarily with one failed institution.

Three Scenarios for the Next Phase

Scenario One: Managed normalization

Long-term rates stabilize, credit losses remain contained and annuity surrenders stay within expected ranges. Insurers allow some nontraditional funding to mature while maintaining access to FHLB advances and capital markets. Private assets continue to pay as expected, and enhanced NAIC reporting improves visibility. In this scenario, wholesale funding functions as a useful diversification tool. The $580 billion total stops growing faster than the sector's liquid resources, and the market treats the Fed's warning as a prompt for better management rather than evidence of instability.

The signal would be stable insurer spreads, modest FABS issuance, resilient risk-based capital and no sharp rise in surrendered policies. Illiquid allocations could remain high because their cash flows match long liabilities. The key confirmation would be that insurers preserve unencumbered liquidity instead of using every available funding channel to maximize carry.

Scenario Two: A higher-rate squeeze

Long-term yields stay elevated or rise further while credit remains broadly sound. Public bond values fall, new-money yields improve and customers compare older annuity crediting rates with newer products. Wholesale funding rolls at a higher cost. Insurers are not facing a wave of defaults, but the spread between asset income and liability cost narrows.

This would be an earnings and capital-allocation problem before it became a solvency problem. Insurers could slow asset growth, reduce buybacks or dividends, issue capital, reprice products and shift toward more liquid securities. The market impact would appear in weaker demand for private credit and structured products rather than in disorderly selling. Equity valuations of insurers with complex affiliated structures or aggressive funding growth would likely diverge from simpler peers.

Scenario Three: A liquidity conversion event

A recession or market shock produces credit downgrades, collateral calls and a rise in policy surrenders at the same time. Private assets remain difficult to sell, while public assets fall in price and secured lenders increase haircuts. Several wholesale maturities cluster within the stress window. An insurer can still be solvent on a long-horizon basis but has to raise cash quickly.

The first line of defense is cash and unencumbered high-quality securities. The second is reliable secured borrowing. The dangerous step is forced selling of private or structured assets into a market with few buyers. Discounts then become realized losses, losses reduce capital, and weaker capital raises funding costs. Other insurers may mark similar assets lower or sell liquid securities preemptively. What began as a timing problem becomes a valuation and confidence problem.

This scenario does not require every policyholder to run or every lender to withdraw. It requires enough correlated cash demands to exceed the liquid buffer. That is why the composition, maturity ladder and collateral status of the $580 billion matter more than the total alone.

What the Market Is Pricing and What It May Be Missing

The market is already aware that life insurers own long-duration assets and private credit. It generally prices higher rates as a mixed effect: they improve reinvestment yields and can support new-product economics, but they also reduce the value of existing fixed-rate assets and intensify competition for policyholder money. It also recognizes that private-equity ownership and affiliated asset management can increase complexity.

What may still be underpriced is the interaction between asset illiquidity and liability optionality. Policyholders have options. Wholesale investors have maturity dates. Secured lenders have collateral rights. Derivative counterparties have margin rights. The insurer owns assets whose cash flows may be predictable but whose sale prices are not. A balance sheet can look diversified while several liabilities share the same claim on the same pool of liquid collateral.

The market may also overgeneralize. Not every insurer has the same surrender profile, funding mix, asset quality or reinsurance structure. Firms with large legacy blocks, high wholesale funding, substantial private assets and limited unencumbered liquidity should not be valued like firms with simpler portfolios and lower leverage. The next phase is likely to reward disclosure that makes those differences visible.

What to Monitor

The first indicator is the level and growth rate of nontraditional liabilities. A rising total is not automatically negative, but growth that materially outpaces liquid assets or capital deserves scrutiny. The mix matters: FABS, FHLB advances, repo and securities-lending collateral have different maturities and triggers.

Second, watch the share of assets that are illiquid, privately rated or held through affiliated structures. The NAIC expects enhanced year-end 2026 reporting to improve classification. Better data may reveal that some exposures are simpler than feared. It may also identify concentrations that broad industry totals conceal.

Third, track surrender activity and the gap between rates credited on existing annuities and yields available on new products. Rising surrenders are not equivalent to deposit flight, but they can turn a slow liability into a faster one. Product-level disclosures and statutory filings are more useful than broad premium growth alone.

Fourth, examine collateral and encumbrance. Investors should ask how much high-quality collateral is already pledged, how borrowing capacity changes under lower market values, and how much cash would be required under derivative and securities-lending stress. The goal is not a single liquidity ratio but a ladder of cash sources under progressively worse conditions.

Fifth, compare public and private credit signals. If public high-yield spreads widen while private marks remain stable, the gap may reflect genuine underwriting strength or merely delayed valuation. Amendments, payment-in-kind interest, nonaccruals and rating migration provide additional evidence.

Finally, monitor regulation and structure. The NAIC's recalibration of risk-based capital for CLOs in June 2026 coincided with a halt in growth of life insurers' broadly syndicated-loan CLO holdings, according to the Fed. That is evidence that capital rules can change portfolio incentives. Reinsurance, affiliate transactions and offshore risk transfer deserve the same attention. Italy's effort to define the boundary between a distribution network and a financial holding company offers a related lesson: control depends on structure, not only ownership labels.

Block2Learn Assessment

Life insurers are not becoming banks, but parts of their balance sheets are becoming more market-funded. That is the central change. Funding agreements, FHLB advances, securities lending and repo can make a patient institution more efficient. They can also make part of its liability structure move at market speed.

The sector's resilience will depend on whether liquidity is treated as a strategic asset or as idle capacity waiting to be monetized. A firm that keeps unencumbered collateral, staggers maturities, limits reliance on runnable funding and stress-tests correlated cash demands can use private and illiquid assets responsibly. A firm that assumes every funding channel will remain open may discover that nominal diversification disappears when markets are stressed.

The Fed's $580 billion figure is therefore not a crisis alarm. It is a boundary marker. It says the life-insurance model must now be understood through both actuarial duration and market liquidity. The assets can remain long. The liabilities are becoming more varied. The institutions that manage the conversion between those two clocks will retain the advantages of patient capital. Those that ignore the conversion risk may be forced to sell patience at the worst possible price.

Continue Through the Block2Learn Learning Path

The Block2Learn Learning Path develops the concepts behind duration, credit risk, liquidity, leverage, collateral and financial-system transmission in a progressive sequence. Use it to connect the mechanics of insurer balance sheets with the wider structure of bond markets, private credit and secured funding.

Information is abundant. Structure is rare.