A piechart superimposed over a dollar bill (Image: Allison Bell/ALM)

U.S. life insurers may be more important to the companies that issue a controversial class of investments — collateralized loan obligations (CLOs) — than CLOs are to most U.S. life insurers.

An analyst at the Capital Markets Bureau, an arm of the National Association of Insurance Commissioners (NAIC), has included data raising that possibility in a new report on U.S. insurers’ exposure to CLO investments.

(Related: Here’s How CLOs Are Really Surprising Investors: KBRA)

The analyst, Jennifer Johnson, found that U.S. life insurers ended 2018 with $94 billion in CLO exposure.

The borrowers with the loans in the U.S. CLOs ended 2018 owing $616 billion on those loans, according to Securities and Financial Markets Association (SIFMA) data cited by Johnson.

The Federal Reserve Board reported earlier this month that life insurers ended 2018 with $7.6 trillion in financial assets.

U.S. life insurers held 15% of the outstanding U.S. CLO debt balances at the end of 2018, but CLO holdings accounted for just 1.2% of U.S. life insurers’ financial assets, according to ThinkAdvisor calculations based on the NAIC, SIFMA and Federal Reserve data.

The Context

The NAIC’s Capital Markets Bureau has changed the way it counts CLO assets, to account for misreported securities. The bureau does not currently have comparable CLO asset figures for 2017 or for earlier years, Johnson writes.

Although U.S. life insurers are major players in the U.S. CLO market, they are less dominant in the CLO market than in the market for ordinary investment-grade corporate bonds. U.S. life insurers hold $2.8 trillion in U.S. and foreign corporate bonds, according to the Fed. FTSE Russell’s FTSE World Broad Investment-Grade Bond Index fact sheet shows that the world has about $7.9 trillion in investment-grade corporate debt. U.S. life insurers’ bond portfolios may hold about 35% of that debt.

Life insurers depend more on income from long-term investments than health insurers or property and casualty insurers do, but health insurers and P&C also have some CLO holdings.

Health insurers ended 2018 with $3.6 billion in CLO assets, and P&C insurers ended the year with $24 billion in CLO assets, according to the new CLO report.

CLOs

Investment banks create CLOs to match borrowers with investors. An investor can use a CLO to invest in loans without having to go out and make loans.

To create a CLO, an investment bank sets up a pool of loans. The loans could large bank loans that are “broadly syndicated,” or broken up into many parts. Or, the loans could be loans made to midsize companies.

The bank then creates “tranches,” or slices of the pool that offer investors exposure to different types of loan risk. One tranche might pay holders a low rate of return in exchange for offering exposure only to the highest-rated debt in the loan pool. Other tranches might offer higher returns in exchange for exposure to riskier debt.

CLOs have some similarities with other types of securities, such as collateralized bond obligations and collateralized debt obligations, that were popular before the 2007-2009 Great Recession.

The amount of CLO debt outstanding has doubled since 2010, according to SIFMA.

Some bond market analysts suggested that CLOs could turn out to be shakier than investors expect, especially during a severe recession. Regulators and credit rating analysts have watched life insurers’ CLO holdings closely.

(Related: U.S. Life Insurers Could Handle Another 2009: Fitch)

The NAIC’s Capital Markets Bureau has responded to that interest by publishing special reports on insurers’ CLO holdings in 2014 and 2018. as well as the new CLO holdings report.

Resources

The NAIC’s CLO reports are available here.

— Read A New Way to Hedge CLO Risk Is Here. It’s More CLOs., on ThinkAdvisor.

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