U.S. life/annuity and property/casualty insurance companies have ramped up their investments in collateralized loan obligations (CLO) in recent years, to $132.7 billion in 2019 from $75.1 billion in 2016, according to a new AM Best report.
The Best’s Special Report, “Collateralized Loan Obligations Holdings Continue to Grow, But Exposures Are Manageable,” states that CLOs have become a popular alternative asset class that insurers have been increasing allocations to as they shift away from traditional investment-grade corporate holdings to mitigate the decline in portfolio yields from maturities and newer low-yielding high-grade corporate assets. Rated life/annuity insurers drove growth of more than 40%, to more than $114 billion in 2019 from $65 billion in 2016. The rated property/casualty insurers also have also increased their CLO holdings during the same period, by about 45% to $18.5 billion. The steady rise has pushed the share of CLOs in the fixed-income portfolios of life/annuity companies to 4.0% in 2019 from 2.7% in 2016. Property/casualty companies’ exposure is lower—still below 3%—but is also growing.
According to the report, the investor-friendly structural features and protections of CLOs have attracted insurers. For example, CLOs cannot short securities or use derivatives, as well as over-concentrate, over-lever or stray from tight indenture requirements. Historically favorable performance, attractive yield and credit quality have further made CLOs appealing to insurers. As a result, not only have insurers been expanding their positions, but there also has been steady growth of companies newly investing in this asset class.
The credit quality of the U.S. insurers’ CLO exposures has declined slightly from 2018. The underlying fundamentals of the leveraged loan market and a possible mismatch between risk and rating emanating from the COVID-19 pandemic could exacerbate fears of a decline in CLO performance and foreshadow downgrades and write-downs. However, AM Best notes that the majority of the insurance companies’ exposure has been in senior and higher-quality tranches that are less likely to default.
“In the event of credit rating downgrades to CLO securities, insurers with larger exposures may be hit with higher capital charges,” said Jason Hopper, associate director, industry research and analytics. “Worsening performance and potential write-downs also would further pressure risk-adjusted capital levels for some, although the far majority of insurers’ CLO exposure is held by carriers at the high end of AM Best’s credit rating scale.”
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=305389.
AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in New York, London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.
Copyright © 2021 by A.M. Best Rating Services, Inc. and/or its affiliates. ALL RIGHTS RESERVED.
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Contacts:
Associate Director,
Industry Research and Analytics
+1 908 439 2200, ext. 5016
jason.hopper@ambest.com
