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November 2015 | Insurance

With Rising Rates, CLOs May Float to the Top

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Insurance companies are challenged to achieve adequate returns amidst persistently low interest rates. Central banks in Europe, Japan and China have continued to increase stimulus in the face of slow global growth, keeping global bond yields lower. In contrast, the US Federal Reserve is poised to raise its benchmark interest rate for the first time in nearly a decade. In an environment where interest rates have remained persistently low, senior tranches of collateralized loan obligations (CLOs) may serve as an attractive alternative to an insurer's investments in traditional fixed interest rate securities.

In addition to providing attractive spreads, CLOs are floating-rate securities that can be beneficial for managing interest rate risk. CLOs have coupons tied to LIBOR, and therefore the valuations of these assets are less sensitive to interest rate movements relative to fixed-rate securities, which may suffer declines in value as interest rates rise.

For insurers subject to NAIC risk-based capital (RBC) requirements, senior CLO tranches are highly capital efficient with charges equivalent to those of investment grade corporate bonds.

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