Moody’s reports that further decline is likely for many U.S. P/C insurers’ investment portfolios because of credit losses resulting from exposure to troubled companies.
However, in the newly released report, Moody’s predicts the relative magnitude of these losses to be mild compared to the losses suffered by financial institutions, like life insurers, whose business models are more dependent on investment returns. At the same time, the rating agency believes that U.S. P/C insurers face potentially significant risks from underwriting exposures related to credit default swaps, directors’ and officers’ (D&O) liability policies and surety bonds written on projects and financial obligations of troubled companies.
According to Moody’s Associate Analyst James Eck, the losses that result from these collateral exposures alone should not cause rating downgrades, noting that they – along with direct investment losses – will decrease the financial benefit of a strong cyclical upturn in industry pricing.
Eck adds that of the 70 largest U.S. P/C insurance and reinsurance company groups, Moody’s determined that the largest exposure as a percent of policyholder surplus was 13.1 percent, with an average of 3.9 percent. He noted that the size of potential investment losses does not appear to be significant for most companies relative to their capitalization.
U.S. P/C companies had 87 percent of their fixed income portfolios invested in NAIC Class 1 securities (generally rated Aaa, Aa and A by Moody’s) at year-end 2001, according to Eck. The remaining 13 percent was divided between Class 2 securities (generally rated Baa) and Class 3 and below securities (speculative grade).
U.S. life companies, by contrast, had 38 percent of their fixed income portfolios invested in low investment grade and speculative grade securities at year-end 2001. These are precisely the types of securities that have performed poorly in the current high default rate environment. Underwriting Risks Potentially Significant Deteriorating credit markets represent a clear risk to investment performance, but for many P/C insurers, the risk to underwriting performance can be just as significant.
By writing surety bonds, D&O liability policies, credit default swaps, and CDOs, P/C insurers and reinsurers have added on additional risk exposure to these problem credits. Structured credit underwriting is a new business for U.S. P/C firms and they are still learning how to negotiate the risks of this line.
According to the report, while it is too early to jump to conclusions about the wisdom of entering this market, recent disclosures indicate that the performance of structured credit portfolios will be weak in the near-term because of the need to mark portfolios to market. Where surety bonds are concerned, it appears that insurers may have collectively misjudged the potential risks inherent in these policies.
In some segments, there appear to be quite sizable exposures relative to the premiums received, as evidenced by policies written on gas forward purchase contracts, leading the rating agency to question just how the surety bond product was purchased and sold.
Was this article valuable?
Here are more articles you may enjoy.