In recent years, there has been growing interest in rated note structures that combine rated notes and equity interests, particularly as a way to attract insurance company investment in private funds. In a commingled private fund that also includes non-insurance investors, a common approach is to establish a feeder fund that holds an interest in the commingled master fund and issues one or more classes of rated notes and equity interests to its investors. We have seen several trends regarding rated note feeder structures that we discuss below.

For certain U.S. insurance companies, investing in rated note structures can be more desirable than holding a typical equity interest because rated notes may receive more favorable risk-based capital (RBC) treatment under insurance company statutory accounting. This treatment depends on the investment being characterized as a bond under statutory accounting and on RBC rules that generally impose lower asset charges on qualifying rated bonds than on equity investments.

The U.S. National Association of Insurance Commissioners continues to adopt new initiatives to prevent so-called RBC arbitrage, including greater reporting requirements for structured securities, the ability to override the RBC designation of securities held by U.S. insurance companies and the introduction of a 45% RBC asset charge applicable to the first-loss tranche of asset-backed securities (in contrast to the 30% asset charge generally triggered by equity investments). Even with these measures, however, holding the rated notes and equity interest of a rated note structure still typically provides meaningful benefits in the RBC treatment of the overall investment.

Another increasingly popular product in the market is the “collateralized fund obligation” (CFO). CFOs typically invest in a portfolio of funds (unlike rated note feeders, which are typically private funds with a single asset pool) and can include assets with less predictable returns, like interests in equity-focused funds. These have recently gained increasing prominence due to institutional investors seeking rated, capital-efficient access to private funds as well as sponsors requiring flexible liquidity solutions. (We have covered CFOs in more detail in a separate article.)

Horizontal Rated Note Feeders

Historically, investors in rated note feeders have been required to hold tranches of debt and equity issued by the feeder fund in the same proportion—a “vertical strip”—which together indirectly holds an underlying interest in the master fund. This structure results in investors obtaining a more favorable overall RBC charge while replicating, to the extent possible, the economics of investing as typical limited partners in the master fund. Recently, vertical strip feeders have been receiving closer scrutiny from investors and rating agencies to ensure the rated notes have true debt-like features. Certain of the conventions used in earlier vertical strip feeders that permitted the sponsor to apply analogous concepts to those that apply at the master fund level are now evolving into more conventional debt features.

Due to increasing investor demand, some sponsors are offering horizontal rated note feeders, in which the tranches of debt and equity are not required to be held proportionally and may be held by different investors rather than being stapled together. In these structures, debt investors have priority of repayment on the principal and interest, whereas equity investors effectively own a levered return on a master fund, which itself may have a different leverage profile. Equity holders bear certain responsibilities, such as the requirement to return distributions to fund a partnership’s liabilities or to increase funding levels to accommodate recycling needs. Due to the different interests of debt and equity investors, documentation for horizontal rated note feeders introduces additional complexity and is more prescriptive on how funding obligations, priority of payment and liability and expenses are allocated between debt and equity. Sponsors contemplating horizontal rated note feeders will want to consider this early in the fundraising process, as it is often helpful, and sometimes necessary, to make changes in the underlying master fund agreements to accommodate features required in a horizontal rated note feeder.

While there is increased demand for rated notes, the investor base for an equity tranche of a horizontal rated note feeder is limited because of its higher risk profile. While we have seen third-party investors, such as family offices and other funds, invest in these equity interests, the equity tranche is often held by the sponsor or sponsor-related investment vehicles. Sponsors sometimes introduce incentives to aid in marketing the equity tranche to third-party investors, such as prioritizing payment of a minimum return on the equity in the payment waterfall ahead of repayment of principal on the debt (subject to meeting overcollateralization tests).

Subscription Facility Considerations

Sponsors often seek to have investor commitments to a rated note feeder included in the borrowing base for the master fund’s subscription credit facility. This can create tension with respect to debt commitments, given concerns regarding whether those commitments would be as enforceable (as equity commitments are) in bankruptcy proceedings.

To address this, subscription lenders will generally require a parallel equity commitment alongside the debt commitment, either in the limited partnership agreement or in a separate equity commitment letter. The equity commitment cannot be “springing”—that is, arising only from a default—because such a structure may present enforceability concerns in the event of a fund bankruptcy. Investors must instead acknowledge that, if a capital call is made during a default under the subscription facility, they are obligated to fund the call as an equity contribution under the limited partnership agreement rather than as an advance under the note purchase agreement, with the corresponding note commitment reduced dollar for dollar.

Reinsurance Sidecars

Reinsurance sidecar structures enable an insurance or reinsurance company to transfer a portion of its liabilities to a separately capitalized reinsurance vehicle funded by third-party investors. Investors commit capital to a holding company that owns the operating reinsurance company, which assumes liabilities from the sponsoring insurer or reinsurer. Premiums received in respect of such insurance business are deployed in a portfolio of investments according to an asset management agreement with an investment manager. As asset managers increasingly sponsor reinsurance sidecars and raise capital for them through traditional fundraising channels, rated note feeders have emerged as a means of attracting regulated investors seeking favorable RBC treatment. Reinsurance sidecars have unique features that require special consideration when establishing rated note feeders.

Given the long-dated nature of insurance liabilities underwritten by sidecars and their highly regulated nature, sidecars do not have defined terms after which they automatically wind-up and liquidate. The maturity date of the rated notes should be aligned with the sidecar’s projected terminal date—the outside date by which the sidecar is projected to meet its target return.

To give sidecar investors more certainty regarding liquidity, sponsors often allow investors to elect whether to participate in a liquidity transaction of the sidecar beginning on the date on which the sidecar is projected to meet its target return (typically around 10 years from commencement). Because rated note feeders investing in closed-ended structures do not permit partial redemptions or non-pro rata distributions to noteholders, the rated note feeder must, for any such liquidity transaction, make a single election applicable to all noteholders and specify in the rated note feeder governing documents how such election will be made.

Depending on a sidecar’s jurisdiction of organization, distributions may be restricted or require additional regulatory approvals while the sidecar is actively underwriting new reinsurance business. The possibility that interest will be fully PIK on the rated notes during the early years of the sidecar’s operations may put pressure on the sponsor’s ability to obtain a desired rating, as rating agencies will examine the potential for cash interest payments on the notes. Sponsors have successfully navigated this concern through sizing a larger equity tranche, by maintaining an overcollateralization ratio or by using other structural enhancements.

Evergreen Fund Structures

Rated note feeders are increasingly being used with private credit evergreen funds. However, there is a structural mismatch between rated note feeders and evergreen funds. Whereas individual investors in an evergreen master fund may subscribe for and redeem their interests monthly or quarterly, a rated note feeder is structured for a fixed group of investors holding notes that rank pari passu within each class and does not permit redemptions at different times.

To address this disparity, a typical rated note feeder obtains liquidity by submitting a request for redemption to the evergreen master fund in respect of the rated note feeder as a whole. If sufficient cash is available, the rated note feeder can apply this cash to repay the rated notes. The maturity date of the notes and redemption timing should be carefully coordinated to mitigate the risk of reaching the note maturity date without having been able to repay the full remaining principal on the notes.

Conclusion

Rated note feeders continue to evolve as sponsors seek to accommodate insurance company investors while adapting to regulatory changes in capital treatment. Horizontal structures, subscription facility solutions, reinsurance sidecars and evergreen funds each present distinct structuring challenges, but they also illustrate the flexibility of the rated note feeder structure. As regulatory requirements and investor demand continue to develop, sponsors are likely to keep refining these structures to expand access to insurance capital.

Private Equity Report Fall 2026, Vol 26, No 3