WASHINGTON (July 23, 2019) — The NAIC's Capital Markets Bureau, a division of the Securities Valuation Office (SVO) has released a report detailing the insurance industry's exposure to collateralized loan obligations (CLOs) as of year-end 2018. The SVO monitors capital markets activities and investment trends to assess potential impacts on the investment portfolios of U.S. insurance companies for state insurance regulators.
CLOs are structured securities collateralized primarily by leveraged bank loans, which include broadly syndicated bank loans (BSLs) and middle market (MM) loans.
As of year-end 2018, U.S. insurers reported approximately $122 billion in book/adjusted carrying value (BACV) of CLOs, representing less than 2% of U.S. insurers' total cash invested assets under management as reported in the annual statement filings to the NAIC. The vast majority, or 77%, of these investments were held by life insurance companies and 20% in property/casualty (P/C) insurers.
"Most U.S. insurers' CLO investments were of a high credit quality rated single A or higher," said Eric Kolchinsky, Director of NAIC Structured Securities. "However, recently underwritten leveraged loans are adopting more aggressive EBITDA assumptions and have fewer covenants. These trends call for a closer examination of this type of investment."
"Earlier this year, state insurance regulators, through the NAIC, implemented changes in determining the reported credit risk assessment for certain instruments, which include CLOs, to more accurately capture their risk. The NAIC SVO is currently working to stress test the CLOs held by insurance companies at the individual investment level," said Eric A. Cioppa, NAIC President and Maine Insurance Superintendent. "We are fortunate to have a number of investment experts within the NAIC who have in-depth experience with CLOs, and we are looking forward to seeing the stress testing results in the early fall."
CLOs often earn a higher rate of return compared to more "traditional," similarly rated bonds, such as corporate bonds, due in part to their complex structure. As such, CLOs have the potential to be more volatile in an unstable economic environment, such as at the turn of a credit cycle. Companies with large exposure relative to their overall portfolios could, therefore, experience higher than expected credit risk. However, historically CLOs have not experienced any severe defaults or downgrades even through the recent financial crisis, and U.S. insurers' high credit quality exposure should mitigate negative impacts. Notwithstanding, the NAIC will continue to closely monitor insurers' CLO exposure.