Insight Why insurers are taking a fresh look at structured credit

Insurers face a difficult balancing act: Enhance portfolio income while preserving capital, managing volatility and liquidity, and meeting regulatory and accounting requirements. That challenge is bringing senior collateralised loan obligations (CLOs) back into the conversation.

At a recent Invesco roundtable, insurers, Lloyd’s market participants, consultants and industry representatives explored how the AAA CLO market has evolved, how regulation is changing and where senior CLOs may fit in insurance portfolios. The central question was whether senior CLO exposure could contribute to portfolio efficiency while remaining consistent with an insurer’s liabilities, governance framework, accounting basis, and tolerance for mark-to-market volatility.

Different portfolios, common constraints

Across life and non-life markets, participants described similar objectives: Increasing income without materially increasing credit risk, improving capital efficiency, limiting interest-rate sensitivity, maintaining liquidity through stressed markets, and meeting fixed income return targets.

Floating-rate income and short spread duration may suit non-life and surplus portfolios; life insurers may be more selective because of matching adjustment and operational requirements. Senior AAA and AA tranches may provide a defensive starting point; lower-rated tranches carry different credit, liquidity, and capital risks.

How the senior CLO structure works

A CLO typically holds diversified senior secured, floating-rate corporate loans. Senior tranches are paid before mezzanine debt and equity, while over-collateralisation and interest-coverage tests help protect AAA investors.

During the reinvestment period, the collateral manager can manage the loan portfolio within the transaction’s limits and tests. If a coverage test is breached, cash otherwise flowing to junior tranches can be redirected to repay senior debt or strengthen collateral—an important “self-healing” feature.

Four considerations for evaluating AAA CLOs

1. Relative income. Senior CLOs may offer a spread premium over similarly rated conventional fixed income, supported by structural subordination.

2. Floating-rate exposure. CLO debt is predominantly floating rate, which limits interest-rate duration. That can complement portfolios dominated by fixed-rate corporate or government bonds. The core exposure is more closely linked to credit conditions and spread movements.

3. Structural resilience. Diversification across borrowers, payment seniority, collateral coverage, and cash-flow diversion tests can provide protection beneath senior tranches.  AAA tranches can still be downgraded, experience mark-to-market volatility, or suffer losses in extreme scenarios.

4. Portfolio diversification. Because AAA CLOs are floating rate and exposed to credit spread risk, they may behave differently from duration-heavy fixed income. A measured reallocation from cash, Treasury bills or short-dated investment-grade credit may enhance portfolio income and, depending on portfolio characteristics and market conditions, support overall portfolio objectives.

Regulation may be reaching a turning point

Regulation has constrained European demand. The roundtable cited a reduction in the illustrative EU standard-formula capital charge for senior AAA securitisations from 12.5% to 2.7% per unit of spread duration¹ , benefitting senior tranches, while mezzanine exposures remain more heavily penalised.

The UK hasn’t replicated the same calibration, although Solvency UK may ease some implementation, including the potential use of structured assets in matching adjustment portfolios. Outcomes depend on each insurer’s regulatory status, liabilities, internal model, and governance.

Choosing an implementation route

Larger insurers may prefer segregated mandates with customised constraints, dedicated reporting, tailored currency management, and greater control. AAA CLO exchange-traded funds (ETFs) offer another entry point, providing immediate diversification, operational simplicity, intraday tradability, and efficient access. They may also be used tactically while a longer-term mandate is developed.

Diversification across managers, transactions, and vintages can reduce concentration risk. Underwriting capability is essential because investors need expertise in CLO structures and the underlying leveraged-loan market.

Improved liquidity, but CLOs aren’t cash

AAA CLO liquidity has improved through broader dealer participation, portfolio auctions and ETFs, although liquidity can still deteriorate during periods of market stress. However, AAA CLOs are not a direct substitute for cash.. In a risk-off environment, prices may fall as spreads widen even when credit impairment remains remote. Investors should distinguish mark-to-market volatility from permanent loss, size allocations for the asset’s liquidity profile, and recognise that execution conditions can deteriorate during stressed markets.

Governance can be the deciding factor

Perceived complexity remains a barrier. Investment committees and boards need a clear explanation of the role an allocation is intended to play, the risks being introduced, how liquidity will be managed and why the chosen implementation route is appropriate. Specialist manager selection and transparent reporting are central to maintaining that confidence.

More established portfolio construction tool

Regulatory reform, deeper markets, and broader access have contributed to greater investor interest in AAA CLOs, supporting their use as a portfolio construction tool for insurers seeking high-quality floating-rate income and diversification.

Adoption will likely remain gradual and insurer-specific, but firms able to meet governance, accounting, regulatory, and operational requirements may increasingly consider senior CLOs within strategic fixed income allocations.

Read the complete AAA CLOs and the search for efficient income paper.