Hedging Strategy

In Search Of Yield, U.S. Insurers Boost Investments in CLOs

Though industry levels are low, lower-rated CLO holdings could contribute more noticeably to losses
from certain insurers’ investment portfolios

Excerpts from Moody’s Insurance Investments Deep-Dive report. For more information, visit moodys.com

In an effort to boost investment returns, US insurers expanded their collateralized loan obligation (CLO) holdings in 2018, albeit the investments were highly rated, Moody’s Investors Service says in a new report, the third in a series examining insurers’ investments. “Insurers started making material investments in CLOs in 2016, in securitizations of ever-increasing size. The purchases are a net addition offsetting CLOs that pay off as a result of refinancing,” Shachar Gonen, a Moody’s vice president said. “US life insurers added $45 billion of gross CLO investments in 2018 and buying continues into 2019, although at a slower pace.”

Key points:

  • CLO investments by insurers continue to increase, but credit quality remains high.
  • Life insurer CLO exposure would contribute noticeably to losses for certain insurers in a downturn.
  • Top 15 life insurers have exposure from 1% to 15% of investments in CLOs with varying subordination levels.

US insurers’ collateralized loan obligation (CLO) purchases peaked in 2018 and buying continues in 2019, as insurers seek to boost investment returns given that interest rates have remained low for a long stretch. Although industry levels of CLOs remain modest, in an economic downturn, lower-rated CLO holdings could contribute more noticeably to losses
from certain insurers’ investment portfolios. Insurers with higher exposures to more risky CLO exposures – CLO tranches with limited subordination to absorb losses, such as mezzanine investments and subordinated investments – are most susceptible to increased losses as well as capital charges from ratings migration.

 CLO investments by insurers continue to increase, but credit quality remains high

CLO investments by US life insurers increased 31% to $79.4 billion at year-end 2018 from $60.5 billion at year-end 2017. This represents about 2% of cash and invested assets (C&IA) at year-end 2018. US P&C insurers held a more modest 1% of C&IA at year-end 2018. The majority of CLOs held by life and P&C insurers are highly rated.

Life insurer CLO exposure would contribute noticeably to losses for certain

insurers in a downturn. For most insurers, CLOs represent a small exposure, but for several insurers lower-quality CLO investments could noticeably contribute to deterioration of regulatory capital ratios in an economic downturn. Our major
analytical focus is on principal losses and increased capital requirements for lower-rated investments as a result of credit rating migration.

Top 15 life insurers have exposure from 1% to 15% of investments in CLOs with varying subordination levels

We examine and stress this exposure as part of an insurer’s overall investment portfolio.

US insurers’ CLO investments continue to increase

Overall, the US life insurance industry held approximately $79.4 billion in CLOs (statutory carrying value) representing 2% of cash and invested assets at year-end 2018. Although still a modest level, there has been significant interest in the CLO asset class and it has been growing quickly.

A CLO is a special purpose vehicle (SPV) that securitizes and invests in predominantly leveraged loans – loans made to speculative grade corporate borrowers. It passes on the loans’ interest and principal payments to multiple classes of notes, each with a different priority of repayment and, hence, level of credit risk.

nsurers started making material investments in CLOs in 2016, in securitizations of ever-increasing size. The purchases are a net addition offsetting CLOs that pay off as a result of refinancing...

Insurers started making material investments in CLOs in 2016, in securitizations of ever-increasing size. The purchases are a net addition offsetting CLOs that pay off as a result of refinancing. US life insurers purchased $45 billion of gross CLO investments in 2018. Incremental CLO investments by US life insurers peaked in Q2 2018 and moderated slightly in the second half of 2018. We believe the growth rate will likely moderate in the first half of 2019 driven by lower leveraged loan issuance in late 2018 and early 2019.

Most insurers’ CLO holdings are highly rated

Most CLOs held by life insurers are highly rated, with approximately 58% rated A and above. However, approximately one third of US life insurers’ CLO investments do not contain Moody’s ratings or have had the ratings withdrawn. Among the non-Moody’s-rated CLO holdings, over 95% have National Association of Insurance Commissioners’ (NAIC) Securities Valuation Office (SVO) 1 and 2 classifications, which are considered investment grade levels. Exhibits 2 and 3 below present the ratings distribution of CLO holdings and the NAIC SVO classifications for the non-Moody’s-rated or withdrawn ratings.

 

For more information, visit moodys.com