If a CLO triple B note is downgraded and loses its investment grade status, it will typically drop from a National Association of Insurance Commissioners (NAIC) category two investment to category three. Depending on the type of insurer, that could result in risk-based capital charges increasing from 1.3% to 4.6%.

Secondary CLO investors seem to have priced in pending downgrades. reported last month that triple Bs on negative watch are trading seven points below triple Bs that have the all-clear (72 cents versus 79 cents, in US and European markets).

“CLOs will be treated as corporate debt with the same rating,” says Rich Sega, global chief investment strategist at Conning in Connecticut. “If a CLO is downgraded to below investment grade it carries a more onerous capital charge and you may have to mark to market instead of being able to carry it at cost, but it’s essentially treated the same as high yield debt. Whether or not insurers will need to sell depends on how big their exposure is and how much capital is drained from them.”

A CLO tranche investor at a large insurance company agrees with this sentiment, but concedes that although forced selling is unlikely, the spate of credit downgrades means that most insurers won’t be buyers for the time being.