to deny a rate increase. Instead, its review process is designed to provide additional scrutiny and rigor to a state¡¯s existing review process. And, if HHS determines any rate increase to be ¡°unreasonable¡± under its prescribed review process, states would have a justification to deny a rate increase. Under HHS¡¯s proposed methodology, an ¡°unreasonable¡± rate increase is one found to be excessive, unjustified, or unfairly discriminatory. Given the volume of rate increases that may need to be reviewed under the proposed 10% limit, we are concerned that a lengthy or backed-up review process would delay rate-increase approvals, which could hurt insurer¡¯s profitability even if rates are ultimately approved. Over the past several months, we have seen examples where state regulatory agencies have denied or delayed premium rate increases, resulting in net losses on the products impacted according to the health insurers. More recently, delays by regulators in California have resulted in WellPoint (financial strength A1 stable), UnitedHealth (financial strength A2 stable), and Aetna (financial strength A1 stable) postponing requested rate increases.
16
See Moody¡¯s Industry Outlook: US Healthcare Insurers: Outlook Remains Negative, 29 December 2010.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Rokhaya Cissé Associate Analyst +1.212.553.3870 rokhaya.cisse@moodys.com Laura Bazer Vice President - Senior Credit Officer +1.212.553.7919 laura.bazer@moodys.com
Proposed FHLB Reform Will Hurt Liquidity of US Life Insurers
Last Tuesday, US Treasury Secretary Timothy Geithner told the House Financial Services Committee that the Federal Home Loan Banks (FHLBs) should be reformed to ¡°include instituting single district membership, [and] capping the level of advances for any institution.¡± If adopted, such reforms would be credit negative for some US life insurers that use the FHLBs as a readily available, and relatively cheap, source of liquidity. The FHLB system was established by the Federal Home Loan Bank Act of 1932 to provide a reserve banking system to support thrift institutions¡¯ residential mortgage lending activities. These days, it counts insurance companies with mortgage loan portfolios among its members. Membership is obtained by eligible financial institutions with the purchase of untraded FHLB capital stock. The exhibit below shows some of the public life insurance companies with FHLB membership likely to be affected by the Obama administration¡¯s proposed reforms.
EXHIBIT 1
Insurance Company Membership in FHLBs
Common Stock in FHLB Ticker Member Subsidiary FHLB Membership With Total FHLB Liabilities Capacity
$M as of December 31, 2010
MetLife Insurance Company of Connecticut (Aa3, Negative) Metropolitan Life Insurance Company (Aa3, Negative) MET MetLife Investors Insurance Company (Aa3, Negative) General American Life Insurance Company (Aa3, Negative) MetLife Bank (unrated) PRU GNW DFG LNC PL RGA PFG Prudential Insurance Company of America (A2, Stable) Prudential Retirement Insurance & Annuity Company (A2, Stable) Genworth Life Insurance Company (A2, RUR-down) Genworth Life & Annuity Insurance Company (A2, RUR-down) Reliance Standard Life Insurance Company of Texas (unrated) Lincoln National Life Insurance Company (A2, Stable) Protective Life Insurance Company (A2, Stable) RGA Reinsurance Company (A1, Stable) Principal Life Insurance Company (Aa3, Stable)
Boston New York Des Moines Des Moines New York New York Boston Pittsburgh Atlanta Dallas Indiannapolis Cincinnati Des Moines Des Moines
70 890 10 10 187 N/A N/A 24 47 N/A N/A 61 19 N/A
100 12,600 0 0 3,800 2,500 0 493 140 55 350 976 199 2,748**
N/A N/A N/A N/A N/A 6,200 1,100 N/A 798 N/A 630 1,016 997 N/A
**Represents the amount of securities posted and does not necessarily equal the company's total liability Source: 2010 10K filings and NAIC annual statements
Current eligibility rules require life insurers to have mortgage-related assets that reflect a commitment to housing finance. Members may obtain loan advances from the 12 regional banks that make up the FHLB system by posting real estate related securities as collateral. Provided that arrangements of pledged collateral are maintained, members can get same-day access to funds upon request. Insurance companies have used these advances as operating liquidity to manage expected or unexpected cashflow shortfalls, and to opportunistically buy attractively priced bonds. They have also,
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
at times, used the low-cost FHLB advances to reduce their cost of funds and increase yields on their institutional investment product (IIP) spread lending business, reducing capacity that could be used for emergency liquidity. Total FHLB liabilities of our rated US life insurers totaled approximately $33 billion as of 30 September 2010, up from very low levels in 2002. Exhibit 2 displays the rapid growth in FHLB lending activity to our-rated insurers.
EXHIBIT 2
FHLB Advances for Moody¡¯s Rated Life Insurers
45 40 35 30 82%
$Billions
25 20 15 10 5 0 2002 2003 2004 2005 2006 2007 2008 2009 3Q10
Source: Moody¡¯s
Reliance on these advances peaked during the financial crisis at year-end 2008 at $42 billion, when the heightened need for liquidity caused some IIP investors to non-extend or ¡°put¡± back certain shortterm contracts to life insurers. Because the capital markets were closed at that time, and selling investments was certain to crystallize unrealized losses in insurers¡¯ investment portfolios, insurers with FHLB membership accessed their borrowing lines for needed funds. In his report to congress, Mr. Geithner did not specify how the caps on advances would be established or measured.17 Although caps could encourage insurers to use better discipline in deciding how and when to use these emergency funds, we believe that a significant reduction in insurers¡¯ borrowing capacity would constrain their liquidity in the future. Insurance company membership in the FHLB system is very small (e.g., 3% of total FHLB membership at year-end 2009, versus 97% for banking institutions). However, life insurers¡¯ use of advances during the financial crisis proved important in sustaining their liquidity. Maintaining and even expanding the FHLB system is a vehicle that could enable the government to make an important source of liquidity available to the insurance sector during stressful periods.
17
¡°Reforming America¡¯s Housing Finance Market, A Report to Congress,¡± released 11 February 2011.
25
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Bruce Ballentine Vice President - Senior Credit Officer +1.212.553.7212 bruce.ballentine@moodys.com
Sale of MetLife Securities is Credit Positive for AIG
On 2 March, American International Group Inc. (AIG, Baa1 stable), MetLife Inc. (A3 negative), and the US Treasury announced the pricing of concurrent offerings of MetLife common stock and MetLife common equity units. These offerings will allow AIG to monetize all of the MetLife securities it received through the sale of American Life Insurance Company (ALICO) in November 2010. AIG expects to receive aggregate proceeds of approximately $9.6 billion from these transactions, the majority of which will be applied toward redemption of the Treasury¡¯s preferred interests in AIG subsidiaries. The offerings are credit positive for AIG and, to a lesser extent, for MetLife. For AIG, the transactions remove any uncertainty surrounding the realizable values of the MetLife securities, and they mark another step in the repayment of government funding. For MetLife, the positive is that the transactions provide, at a time of MetLife¡¯s choosing, for an orderly disposition of the AIG stake in MetLife, a large block of stock and other securities that was destined for sale. The original terms of the ALICO sale required AIG to hold the MetLife securities for minimum holding periods of at least nine months from the date of closing, meaning that the earliest possible date for securities sales would have been August 2011. AIG and MetLife recently reached an agreement permitting AIG to monetize the securities promptly. The concurrent offerings priced last week were:
» » »
AIG offered all of its MetLife common stock to the public for gross proceeds of $3.38 billion AIG offered all of its MetLife common equity units to the public for gross proceeds of $3.32 billion MetLife conducted a primary offering of common stock to the public for gross proceeds of $2.97 billion, which, less underwriting discounts and commissions, will be used to repurchase and cancel all of the MetLife preferred stock owned by AIG
In accordance with prior agreements, AIG will place $3 billion of the proceeds into escrow to secure obligations that may be owed to MetLife, and will use the remainder (after expenses) to redeem a like amount of the Treasury¡¯s preferred interests in AIG subsidiaries. These offerings are part of a long series of divestitures and capital markets transactions undertaken by AIG since it was rescued by the US government in 2008. The most significant event this year has been the recapitalization of 14 January. As part of that three-step process, AIG repaid its credit facility with the Federal Reserve Bank of New York, special purpose vehicles owned by AIG partially repaid the government¡¯s preferred interests in the vehicles, and the Treasury exchanged its preferred interests in AIG for AIG common stock. Additional future transactions include one or more sales by the Treasury of portions of its AIG common stock, one or more primary offerings by AIG of its common stock (perhaps concurrent with Treasury sales), and a registered exchange or similar offer by AIG for one or more series of its junior subordinated debt. To the extent that such transactions reduce the government¡¯s stake in AIG or reduce AIG¡¯s financial leverage, they would be credit positive. Government ownership and support were critical in helping AIG to withstand the credit crisis of 2008-09, but at this stage, we believe that AIG¡¯s clients and distributors would welcome a reduction in the government¡¯s role.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Helen Remeza Vice President - Senior Analyst +1.212.553.2724 helen.remeza@moodys.com
Increased RMBS Loss Reserves Are Credit Negative for Guarantors
Financial guarantors Assured Guaranty Corp. (Aa3 negative) and MBIA Insurance Corp. (Ba3 negative) on 24 February and 1 March, respectively, reported increased loss reserves for residential mortgage-backed securities (RMBS). The higher reserves are attributable to slower-than-expected improvements in mortgage performance despite higher expected recoveries following putbacks to originators because of breaches of representation and warranties. These increases are credit negative for guarantors, as losses that exceed the guarantors¡¯ expectations consume capital resources and highlight continuing uncertainty. The guarantors adjusted their RMBS reserves to reflect elevated delinquency levels, higher loss severities on loans, and reduced levels of excess spread, which is the excess cashflow available after debt service in securitization transactions. While new delinquencies continued to decline, the rate of decline was less than the guarantors previously expected for some RMBS deals. Assured Guaranty increased its pre-putback RMBS loss estimate by $394 million in fourth-quarter 2010. MBIA also increased its RMBS reserves (see exhibit below), and established $1.1 billion in total reserves for commercial mortgage-backed securities (CMBS) as it increased the probability of higher severity scenarios. Increasing RMBS Reserves Despite Greater Expected Putback Recoveries
Increase in RMBS loss estimate, pre-putback (Q4 2010) Increase in putback recovery estimate (Q4 2010) Putback recovery estimate (YE 2010)
Assured Guaranty MBIA*
$394 million $300 million
$337 million $500 million
$1.7 billion $2.5 billion
*Estimates from the operating supplement of MBIA. Source: SEC filings and operating supplements.
Mitigating the higher RMBS losses for the guarantors were increases in the benefit taken for recoveries from potential putbacks (see the exhibit). The estimates were substantial and the guarantors have realized some, but both were not enough to offset the adverse effect of the increase in RMBS losses pre-putback. Assured Guaranty has reached agreements with mortgage originators on $555 million of mortgage repurchases through 31 January 2011. MBIA¡¯s putback recoveries have been very limited, as its litigations with the originators continue. Assured Guaranty also increased loss-severity estimates on loans. Foreclosure delays and excessive servicer advancing will reduce recoveries for some senior RMBS bonds, negatively affecting the guarantors, which typically hold such senior positions in the securitizations.18 To protect their interests, the guarantors have been active in scrutinizing RMBS servicing practices, and in order to improve recoveries, sometimes they transfer servicing or establish special servicing. The guarantors continue to face substantial losses from legacy real estate exposures. Given the significant amount of putback benefits recorded, their ability to recoup losses through putting back bad loans to originators is critical as loan losses continue to rise.
18
Typically, foreclosure holdups and excessive advancing delay loss recognition of subordinated bonds (e.g., by preventing the trusts from writing down subordinated bond balances to reflect liquidated loans). As a result, subordinated bonds continue to receive interest payments at the expense of the principal payments of senior bonds.
27
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
David Masters Assistant Vice President - Analyst +44.20.7772.1605 david.masters@moodys.com
Gender Blind EU Ruling Is Credit Negative for Insurers
Last Tuesday, the European Court of Justice (ECJ) announced that as of 21 December 2012, insurers won¡¯t be allowed to price insurance contracts based on gender. This is credit negative for European insurers, as they will lose a valuable pricing tool. Furthermore, prices for some segments of the insurance market are likely to rise, potentially reducing demand for discretionary insurance products. The ruling is likely to lead to a wide-scale re-pricing of affected insurance policies ahead of the implementation date. The type of policies most likely to be affected include motor insurance (particularly for younger drivers), pensions annuities, life insurance and, to a lesser extent, private health insurance, which, with the exception of motor insurance, are largely discretionary purchases for policyholders. For example, the Association of British Insurers estimates that within the UK, average motor premiums for women under the age of 25 could increase 25%, whilst annuity rates for men could fall 8% but increase 6% for women.19 Last week¡¯s ruling by the ECJ follows a non-binding opinion of the Advocate General of the ECJ announced on 30 September 2010 that stated the use of gender to assess premium rates in the insurance industry conflicted with the European Union¡¯s principles of equality and nondiscrimination. Previously, EU member states were permitted to allow their insurers to price using gender as a factor as long as they ensure the underlying data was reliable, regularly updated, and available to the public. Historically, insurers have typically charged younger female drivers lower insurance premiums than male drivers the same age, as insurers¡¯ statistical data has shown that young female drivers are less likely to submit motor-related claims. Conversely, according to actuarial statistics, women typically have longer life expectancies than men, typically leading insurers¡¯ annuity payments to women to be low