‘Unprecedented stress’ for US life insurers
Causing some consternation among US Life Insurance investors on Thursday should be a report released by rating agency Standard & Poor’s yesterday. No punches are pulled:
The dramatic rise in the expected level of corporate defaults reflects our opinion of the weak credit profiles of many corporations going into this period of economic contraction. Given these difficult economic conditions, we believe that life insurers’ bond holdings, commercial mortgages, and commercial mortgage-backed securities (CMBS) could experience unprecedented stress in the next 12-18 months. Based on the combination of these factors, we are maintaining our negative outlook on the sector.
That assessment comes on top of S&P’s February slew of Life Insurer downgrades.
The story is much the same as that we have written about previously at FT Alphaville: fears over credit losses in insurers’ massive portfolio’s brought about by a rapidly deteriorating corporate default outlook.
As S&P notes though (emphasis ours):
We believe that strong liquidity and an insurer’s willingness and ability to hold portfolio investments to maturity should provide the necessary bridge for insurers to get beyond the current distressed fixed-income markets. Nonetheless, our capital adequacy analysis now quantitatively considers the projected economic losses on certain assets.
And in spite of apparent optimism about most insurers’ liquidity positions, S&P does seem to be aware of… issues:
Given the disarray in the credit and capital markets, most insurers’ financial flexibility has decreased in the past six months. The ability to access the markets varies by company and from day to day. The market dislocations are hampering two areas that are particularly important to financial flexibility: liquidity and access to the capital markets. The systemic concern regarding counterparty risk is generally heightened for financial firms. In addition, a lack of liquid markets for many securities has depressed overall access to liquidity for any corporations and financial institutions.
At which point it’s probably worth joining some dots with another S&P report, also out yesterday:
Funding-Agreement-Backed Note Issuance Stalls In First-Quarter
Standard & Poor’s Ratings Services did not rate any funding-agreement-backed notes in the first quarter of 2009.
Funding-Agreement backed notes are structured securities peculiar to the insurance industry. In a nutshell, they are investable, tradable securities, backed by payment obligations - funding-agreements - issued by insurance companies. Even though they are pretty vanilla, and even though the funding-agreements backing the notes typically sit above regular senior debt in an insurer’s capital structure, investors, it seems, are staying away. S&P continues:
As for the rest of 2009, so far, one deal closed this month, but we are not aware of any additional issuances. What is unique about this issuance was that this was the first note with a short-term put option that noteholders could exercise. Unlike extendible notes that typically did not redeem until one year after the option not to extend the notes was exercised, this issuance has a minimum redemption period (from notification to repayment) of 15 days. Although we don’t expect that one issuance by itself will raise liquidity or other concerns, given the problems the life insurance industry has had with guaranteed investment contracts with short-term puts, we will be watching to see if more notes like this are issued.
In 2009, US insurers will have $31.7bn of funding-agreement backed notes maturing. Given issuance so far has been so thin, it doesn’t seem wholly unreasonable to assume there’s going to be something of a liquidity squeeze then. In which case, just how strong, will the Life Insurers’ “necessary bridge” over troubled markets be?