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Some think the subprime mortgage meltdown will have limited impact. The thing is, that is just not so. The big danger was always that the bond insurers, companies such as Ambac and MBIA, would be downgraded from AAA ratings. Now, why is this important? Because what Ambac and MBIA do, in effect, is sell their AAA rating for the use of borrowers who need to fortify their credit ratings for various projects.

But the subprime situation threw everyone a curve.

It even effects as stodgy an industry as life insurance.

We'll be looking at life insurers' exposure to subprime today, to point out just how far-reaching this debacle in truth is.

Because if financial instruments so poorly correlated to the other markets are impaired by subprime, then imagine all the things in between that are, only more so.

Back in the fall, one inquirer asked the executive team of Genworth about its subprime exposure, and what would happen should the bond insurers be downgraded.  From the Fall 2007 Strategic Update Meeting:

SUNEET KAMATH: Related to the first response, if Ambac [and] MBIA do get downgraded, would that further increase your interest cost? Is there a component related to the interest expense that is tied to the ratings of those companies?

DENNIS VIGNEAU: There is. We will have a small uptick in the cost there, about 25 basis points, which on a full-year basis, would amount to about $3 million after-tax.

SUNEET KAMATH: Okay, thanks.

Doesn't sound so bad and Mr. Vigneau did not sound too worried back in the fall.

He's probably worried today. His company's stock is down a fair bit.

Major U.S. bond insurers are in the ratings agency spotlight, and not liking it

Ambac and MBIA are now quite likely to be downgraded

BOSTON (MarketWatch) -- Shares of bond insurers traded sharply lower, retreating Thursday as a ratings agency [Moody's] warned it may downgrade Ambac Financial Group Inc. -- a move that could force the troubled company into bankruptcy.

Shares of Ambac and rival MBIA were down by 60% and 30%, respectively, in early trading. The news also roiled financials stocks since bond insurers guarantee debt held by some of the nation's largest banks.

Earlier this week, Ambac said it will seek to raise at least $1 billion in new capital by selling equity and equity-linked securities. The company also slashed its dividend by two-thirds and announced Robert Genader, was leaving as chief executive.

In addition, the company may raise more capital by selling new debt securities and buying more reinsurance.  

Ambac's bailout plan is to issue more debt.

The thing is, rival MBIA tried that last week, offering 14% yield. The notes are selling at a steep discount a week later.

"Rival MBIA raised $1 billion in new capital by selling surplus notes last week. The securities paid an initial interest rate of 14% to attract investors.

But despite that high yield, the notes have slumped this week, according to David Havens, head of investment grade corporate bond research at UBS.

The securities traded below 90 cents on the dollar earlier on Wednesday, weighed down by Ambac's announcement, recession fears and Standard & Poor's decision on Tuesday to increase its mortgage-loss assumptions, Havens explained.

Such weakness could make it more difficult for Ambac to raise money, especially by selling new debt, he added.

Point being, the market is assigning a very heavy risk premium for debt issues for the bond issuers. The other shoe - They may require an "insurer" of their own. The American taxpayer. And we are talking an immense sum of money if that occurs.

In the meantime, both Ambac and MBIA have incurred severe punishment in stock value

to put it mildly

MBIA, the biggest bond insurer, declined 75 percent on concern it may not have enough capital to cover losses on securities it guarantees, including those linked to mortgages. The Armonk, New York-based company dropped 16 percent Dec. 28 after Warren Buffett's Berkshire Hathaway Inc. won a New York state license to start a rival bond insurer.


``This could potentially hurt MBIA and Ambac,'' said Rob Haines, an analyst at CreditSights Inc. in New York. Berkshire will ``be a formidable competitor.'' Ambac Financial Group Inc., the second-largest bond insurer, dropped 71 percent in 2007.

Regardless, MBIA is putting out optimistic press. S&P, however, has another opinion per this Forbes article:

NEW YORK - MBIA Inc. said Thursday even after assuming more losses on bad mortgage loans, the bond insurer will still have a strong enough capital cushion to comply with Standard & Poor's Ratings Services' standards for financial strength.

S&P earlier this week said it now expects the loss rate on 2006 "subprime" mortgages - or home loans issued to people with checkered credit histories - will reach 19 percent, versus the ratings agency's previous forecast for losses of 14 percent.


MBIA, which insures $673 billion in debt, writes policies promising to cover missed payments by bond issuers.

S&P in December told the company its capital was deficient by $1.4 billion to maintain its top-notch financial-strength rating. A downgrade of MBIA's "AAA" financial-strength rating would harm the company's prospects of winning new business.

Did I mention "immense sums" earlier?

So, How are Ambac's MBIA's stocks doing today?

Not optimally. Ambac is down 52.12% ON THE DAY as of this writing this link

and here's the six-month chart

MBIA not doing so hot either; down 31.94% at time of writing.

another six month chart

Now for why I am interested in the life insurance angle

Life insurance has been opening up as an emerging secondary (freely-traded, more or less) securities market, just as mortgage backed securities began to be in the 1980s. The attractiveness is that the largest risk component is mortality, which is not correlated closely with changes in the capital markets. The thing is, the biggest expense other than paying claims on policies is financing the reserves that a library full of regulations requires insurers to keep. Thus there has been considerable incentive for life insurers to go more and more to the capital markets for funding. In the 1990s, many insurers went public. Now, many are acquiring debt financing to cover business expansion and maintainance of required reserves.

In this fashion, some life insurers have acquired exposure to the subprime mortgage credit debacle. ALL are affected by any impairment to the bond issuers. A variety of en vogue transactions, surplus note deals and policy block securitizations in particular, are particularly affected by any change in the credit markets, be it a downturn in market appetite for risk, steepness and volatility of the yield curve, and (this especially) rapidly widening credit spreads ( the risk premium investors command to pass over their money).

Keep in mind we are talking about the least correlated, least risky sector of the financial community and it is significantly affected by the subprime mess. Now, at the end of the day, life insurance policy values are determined mostly by the mortality of the insured population. The longer people live, the more valuable the cash flows are.

The exposure to subprime of life insurers has been on radar since August

NEW YORK, Aug 13 (Reuters) - Prudential Financial Inc. has the riskiest investment portfolio, including subprime exposure, among life insurers, while MetLife Inc. and Genworth Financial Inc. should be closely monitored, Citigroup analyst Colin Devine said in a report on Monday.

Devine said Prudential's (PRU.N: Quote, Profile, Research) portfolio had the greatest exposure to high-risk assets at 13.8 percent, with MetLife (MET.N: Quote, Profile, Research) close behind at 13.6 percent. Genworth (GNW.N: Quote, Profile, Research) followed with 9 percent, he said.

The average level of high-risk assets for life insurers as a percentage of total investments was 7.8 percent for 15 publicly traded life insurers, Devine said.

And via the troubles of the bond insurers, that risk exposure is coming home today. How much so? Let's see how the stock prices of some of the largest life insurers are doing:

Genworth is down 8.81% as of right now.

Oh, sidebar: Genworth's suprime exposure was not considered by Morningstar to be much of an issue

In the third quarter, Genworth recorded a loss of $17 million on its asset-backed securities backed by subprime and Alt-A mortgages. This write-down and the firm's $3.4 billion exposure to subprime and Alt-A loans does not concern us.

Lincoln National down 8.03%

AIG is down 5.85% as of this writing.

Get Met. It's down 4.01%

ING is down 3.84%

Prudential PLC (UK) down 3.43%

Prudential Financial down 3.40%

AXA down 3.29%

Sun Life down 3.07%

Manulife down 2.58%

Benchmarks: Dow down 2.47%, Nasdaq down 1.99% and S&P500 down 2.91% as of this writing.

Before you guys run off and think I'm smart

Seems the Germans figured this one out the day before

FRANKFURT, Jan 16 (Reuters) - The president of Germany's financial watchdog BaFin broke his silence on Wednesday, speaking for the first time publicly since the subprime crisis rattled Germany and warned that it could also suck in insurers.

"Insurers don't invest in a vacuum and so they have also been landed with structured products," said Jochen Sanio, president of the German Federal Financial Supervisory Authority (BaFin).

"Insurers could also be part of a bigger international group or financial conglomerate, which makes them vulnerable to what is happening; for example, when they are connected to a bank that manages a SIV (Structured Investment Vehicle) or Conduit."

"The issue is mainly reputational risk, but this should not be underestimated."

Originally posted to cskendrick on Thu Jan 17, 2008 at 11:00 AM PST.

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Comment Preferences

  •  This is not your usual subprime piece (25+ / 0-)

    But the effects of those practices multiply across industries. The housing and home mortgage markets are clearly affected. That the effects spill over to ostensibly noncorrelated industries such as life insurance points one message out - it's gonna hurt everybody, at least a little.

  •  So there is no misunderstanding (11+ / 0-)

    I am not equating the pain felt in the abstract by life insurance corporations and shareholders with actual, real pain such as a living person may feel.

  •  Thanks for this, csk. (4+ / 0-)
    Recommended by:
    vicki, theran, cskendrick, ek hornbeck

    I'm a life insurance agent, and this is good to know.

    I dig the Wig! It's a Wiggumarole!

    by PerfectStormer on Thu Jan 17, 2008 at 11:11:09 AM PST

  •  Not sure I understand (1+ / 0-)
    Recommended by:
    ek hornbeck

    There seem to be two types of exposure life insurance companies have, if I understand the diary:

    1. They may have invested in mortgage-backed bonds.
    1. It will cost them more money to issue their own paper if the monoline guys lose their AAA rating.

    As for 2, I have always been too stupid to understand how monoline bond insurance is not a totally BS business model.  (At the only time a bond insurer needs to raise huge amounts of money, their credit will be at its worst.  The alternative would be to be so deeply bankrolled as to be unprofitable...)

    Ortiz/Ramírez '08

    by theran on Thu Jan 17, 2008 at 11:14:58 AM PST

    •  As I (mostly likely very imperfectly) (3+ / 0-)
      Recommended by:
      theran, soonergrunt, ek hornbeck

      understand it, bond insurers "sell" the use of their balance sheet and and it don't come cheap to people who really need to have it in a fixed timeframe yet lack the alternative funding sources, expertise or scale to first get it, then keep it, on their own. As for the profitability? One would hope that bond insurers would be the most conversant in the art of managing credit risk. Which says a fair bit if two of the majors in this country are rather close to losing their street cred with the ratings agencies...

      •  So approximately it is like this? (4+ / 0-)
        Recommended by:
        wu ming, cskendrick, ek hornbeck, tjlord

        I have some interest cost to issue bonds at A and some (lower one) at AAA.  The bond insurer (who has excellent credit), charges me something in between the difference, and with the insurance I can issue my bonds at AAA, saving some money.  Also, now pension funds, Florida school districts, and small towns in Norway can buy whatever product I was issuing, since it is supposedly very safe.

        My insurer, in normal times, doesn't need to sit on a lot of cash either, since in normal times even A isn't that likely to default.  Plus, their credit rating means that they have (theoretically) very easy access to the capital markets if they need cash in a hurry.

        But insurance isn't something you buy for normal times.  In a market crisis---e.g., because all the risk models turned out to be BS---my insurer is suddenly on the hook for HUGE losses (from me and everybody else).  Since the market knows it too, this is precisely the time they can't easily cover all the losses by borrowing cheaply, so they get downgraded as their bankroll deteriorates.

        My naive mind takes away that: Credit-wraps are fundamentally unsound, since the reduction in risk didn't materialize.  Once the monoliners get downgraded, we have to stop pretending, and then it will get really unfun.  

        Ortiz/Ramírez '08

        by theran on Thu Jan 17, 2008 at 11:55:06 AM PST

        [ Parent ]

  •  What do you think? (3+ / 0-)
    Recommended by:
    theran, cskendrick, ek hornbeck

    I have holdings in Prudential and Allstate. What do you think? Get rid of them?

    "What a peaceful world it would be if Barbara had aborted!"

    by DevonTexas on Thu Jan 17, 2008 at 11:30:04 AM PST

  •  Subprime Pain Now Hurting Life Insurers (5+ / 0-)

    As a life reinsurance professional I have been waiting for this shoe to drop.  Life insurance companies follow the herd.  In the 80's they invested in junk bonds.  Because of this insurance oversight regulations now require life insurance companies to diversify and limit their investments not just by type but also by quality.

    The rating agencies (Moody's, etc.) are at fault here for assigning Triple A ratings to mortgage portfolios which enabled the life insurance companies to make these investments.  Had they been rated like junk bonds they would have been limited in making these types of investments.


    •  Ratings agencies should be investigated (2+ / 0-)
      Recommended by:
      vicki, ek hornbeck

      Everything they said about these subprime bonds was total BS.  The initial estimates of risk, the bullshit credit wraps, the health of the monoliners, etc.  Somebody should just be sent to jail for a long time over this.

      Ortiz/Ramírez '08

      by theran on Thu Jan 17, 2008 at 11:57:33 AM PST

      [ Parent ]

      •  I would not fault the ratings agencies in this (0+ / 0-)

        They know their business...they just do not always know all the details of everyone else's.

        True to tell, though, they have a hold on participants in the capital economy. They can end careers and companies with a switch of a rating.

        Consider what just threatening the AAA status of the monolines has done today.

        •  Somebody needs to take a look (0+ / 0-)

          Their business is to accurately estimate risk for the buying public.  When they are this far wrong, you can't just say it is bad luck before you take a serious look.

          Remember, they were the ones who told us that credit-wraps weren't a BS concept.  There is nothing fundamentally different about the monolines now than before.  All that is different is the market.  So either the previous ratings of credit-wraps were total BS (because the concept is not sound),  the monolines were completely misjudged for whatever reasons (because they were thought to be able to withstand substantial turmoil), or there was bad faith/sloppiness at the ratings agencies.

          Ortiz/Ramírez '08

          by theran on Thu Jan 17, 2008 at 01:27:57 PM PST

          [ Parent ]

          •  Sometimes it is just complexity (1+ / 0-)
            Recommended by:

            creating informational blind spots at places where fraud and abuse can occur...then that fraud and abuse occurs.

            Sometimes, it's relatively little uncoordinated criminals who are causing the harm.

            Sometimes it is not.

    •  Due to regulations, life insurers (0+ / 0-)

      Aren't going to get killed off by this. I would say most of their reserve folios are of good quality.

      Adverse policy selection and lack of appropriate risk management systems and data quality issues are more of an issue to my thinking. Or going whole hog into an en vogue product (think: ROP) without appropriate concern for the risks.

      And don't even get me started on STOLI.

  •  I never took possession of the life (3+ / 0-)
    Recommended by:
    theran, cskendrick, PerfectStormer

    insurance my dad left me, because Nationwide offered better interest than my bank. It's my rainy-day fund. Should I take the money out before it disappears? It's already earned $10,000 in interest. I hope I won't lose it.

    •  Life insurance policy solvency is a holy relic (3+ / 0-)
      Recommended by:
      theran, PerfectStormer, Halcyon

      of regulation in the United States and other countries where private insurance is competitive (Canada, UK, there are others).

      If your policy is insolvent that means a whole, whole lot of other bad financial things have to happen first.

      The not so subtle point of my diary is those bad financial things are coming.

    •  Two questions... (3+ / 0-)
      Recommended by:
      theran, cskendrick, Halcyon

      Is it a participating policy? That is, does it build dividends or cash value? If it's non-participating and builds cash value, leave it--the CV is guaranteed. If it's participating, the company should at least guarantee a minimum dividend. If you can live with the minimum dividend and wait out an economic turnaround, go for it.

      The company won't go anywhere. Life insurance companies are regulated out the wazoo for solvency. Nationwide's AM Best rating is A+ (better than the company I work for), so I'd say you're okay. If the unthinkable happened, the state guarantee association would still kick in and you'd still have your policy.


      I dig the Wig! It's a Wiggumarole!

      by PerfectStormer on Thu Jan 17, 2008 at 03:37:48 PM PST

      [ Parent ]

      •  Thanks for your reply. (2+ / 0-)
        Recommended by:
        cskendrick, PerfectStormer

        I don't understand why you refer to it as a policy, though. My dad died. Instead of taking a check for the insurance, I let Nationwide open an account with the money, because they offered a higher interest rate than my local bank. They sent me checks, so it's like a checking account. I can simply withdraw the money at any time by writing a check. I'm just concerned that since it's not a bank (or maybe it is with Nationwide bank?) that the account was not FDIC insured, and after reading this diary I was worried that if Nationwide had the same problems that other life insurance companies are having, from, apparently, investing in subprime, that my account might disappear into the black hole of subprime.

  •  Wow. Thanks. (2+ / 0-)
    Recommended by:
    theran, cskendrick

    I'm a life insurance agent, and this diary is extraordinarily informative.

    Wish I had more analysis to offer the discussion, but I'm new and in the middle of studying for the 6 & 63.

    Can't help but feel like the subprime market meltdown is going to be a slow-rolling process over a long period of time.  I'm seeing alot of companies are trying to delay and/or disguise their losses.  Secondarily, financial markets have become so fluid that the ripple effects of the meltdown will ricochet rather strongly from sector to sector.

    It's astonishing that so many life insurance companies have left themselves open to such losses and bad press.

    On a brighter note, "Get Met. It's down." elicited a rather loud and sadistic chuckle over here.

    Look Out! Homosexuals are gonna force your guns to have abortions!

    by Predator Saint on Thu Jan 17, 2008 at 12:24:55 PM PST

  •  I think the whole thing is a farce (1+ / 0-)
    Recommended by:

    How many people took out loans that couldn't afford them?  It could not have been that many.  

    We should have made the originating bank give the buyers interest free. I quarantee you the originators would know who bought from them.  If the buyer paid too much, we should let them walk out without paying anything.

    I wondered how my husband's life insurance would beat us out of his life insurance. They have figured out a way.

    Just in time for the boomers to start going under.

    The rich were out of the market several months ago.  Those who are still in will probably ride it to the bottom.  

    I wish they would let it fall.  Savers need higher interest rates, not reduced rates.  The rates will be so low that we will lose money because of inflation.

    I wish Hillary would quit helping the Republicans.  She is going to make them look better than what they are. When they send the checks to the average person, the republicans will get the credit.

    Why are investors paying for the mistakes of the those who made money off of subprime loans?  These loans were even sent overseas.  It is BS.  Why aren't they in jail instead of getting 110 million dollar bonuses?

    This works in so many ways.  It takes back what people made in the market.  Now they can start all over again.

    Excuse the rant.  I just find this all unbelievable and stupid.

    •  Was discussing this issue just now in a meeting (1+ / 0-)
      Recommended by:

      In insurance, there is a practice called simplified underwriting. Fewer questions are asked, assumptions made on the veracity of the answers (ie, percentage falsehoods), with checks made against medical and prescription drug records as allowed.

      The policies tend to be small in face value and expensive per unit of coverage, and simple term life.

      There is some abuse of the system but it is priced to take this into account. That price assumes the cross-checks and other prudent controls are (1) in place and (2) get lots of exercise.

      A comparable practice was in place for subprime. And it was abused. One of the questions was if the home up for a loan was to be the primary residence.

      That was not always so.

      Anecdotally I hear of flippies - homes bought for quick resale (flipping) -- being bought on subprime as no bank would issue prime rates for such purchases.

      Yet had the simple rules of the subprime business been adhered to, if the prudent controls had in fact gotten lots of exercise, this would not have been quite the disaster it is shaping up to be.

  •  Good God, what a mess (1+ / 0-)
    Recommended by:

    I got out of the stock market completely about six months ago.  My retirement is all in tax-free municipal bonds and treasury bonds, and there it will stay for quite a while.  I just started to get spooked by what I was hearing, and decided to get out wholesale.  I'm not a stock analyst by any stretch of the imagination, but it looked like trouble was looming, so I jumped.  I also have a six-month CD that I keep rolling over.

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