As a mutual insurance company, you may be aware of a new initiative by the Commissioner’s office to provide guidelines regarding the purchase and retention of variable coupon bonds. In a nutshell, these rules require variable coupon instruments to adjust their interest rates based on a simple mathematical formula relating to LIBOR. In certain situations the OCI has indicated they may accept CPI or Constant Maturity Treasuries as acceptable benchmarks as well, but those are typically the exception rather than the rule.
The other, and perhaps more significant rule, as it relates to the utility of variable coupon instruments in town mutual portfolios, is the bond requirement for a minimum issue size of $250 million. While the exact details regarding the percentage of the total bond market meeting the $250 million minimum issue size requirement is hard to come by, it is our opinion that a very small percentage of all bonds in circulation (certainly less than 5% and probably much less than 5%) actually meet this criteria.
As a result, it is our recommendation for town mutuals to adopt the policy of not purchasing variable coupon bonds for their portfolio. The investment opportunity they present is not significantly better than the opportunities presented by standard bonds and does not justify the extra work and due diligence required to invest in these types of instruments under the rules the OCI has decided to impose.