Print this article

NEW YORK February 04 (BestWire) — A new study by Lehman Bros. says it shows "significant differences" in the exposure of different U.S. life insurers to possible future upheaval in the subprime mortgage market. Among the study's major findings are that two companies seem to have "sensed" the problems in subprime before the turmoil hit in July 2007.

Lincoln National and Ameriprise “were clearly better than others” at seeing the problems ahead of the collapse of the subprime market, which hit last July, Eric Berg, an equity analyst with Lehman, wrote in a research note. The study looked at six major U.S. life insurers: Ameriprise, Genworth, Hartford, Lincoln National, MetLife and Prudential.

By using state filings to put together information on a large sample of individual subprime bonds held by these companies at Sept. 30, 2007, and by inputting this information into Lehman’s portfolio valuation system, Lehman was able to value this sample of bonds providing an estimate of future “marks” in insurers' portfolios. It also estimated how different life insurers' subprime portfolios would be affected in price if the sharp widening of credit spreads that has already occurred on AA, A and BBB-rated subprime securities became even worse, he wrote in the Jan. 4 note.

In an interview with BestWeek U.S./Canada, Berg said to the extent Lincoln and Ameriprise did any selling in their subprime portfolios, they concentrated that selling in the first half of 2007. "No one appears to have called this crisis, meaning that no one was so visionary that they saw everything that was coming and sold their portfolios en masse,” he said. But if selling did occur, Lincoln and Ameriprise seemed to do more of it earlier in 2007 than the others, he said.

“I don't know whether it was luck or smarts,” Berg said. However, Lincoln historically is conservative or "cautious” in the way it runs its business, he added. Lincoln declined to comment, while attempts to reach Ameriprise for comment were unsuccessful.

In the note, Berg wrote that state filings show that of all the subprime holdings in Lehman’s sample of bonds sold in the first nine months of 2007, Lincoln disposed of 79% in the March quarter – months before the upheaval started in July. As for Ameriprise, the state filings show that of all of the subprime bonds in Lehman’s sample, Ameriprise sold 30% from its portfolio in the January to March period and another 30% came out in the June quarter.

The study also showed a surprising finding, Berg wrote. "Although the recent sharp drop in interest rates has increased the price of some fixed-interest ABS securities, and that should help the life companies to post only modest unrealized losses on their subprime portfolios when they report their December quarter results...the outcome would have been entirely different if rates hadn’t fallen."

In that case, the widening of credit spreads on subprime securities would have determined the outcome. The life companies appear to have sharply different exposure to a further widening of credit spreads, he wrote.

When an investor buys a U.S. government bond, the government pays the investor interest because the bond is risk free, Berg told BestWeek U.S./Canada. But when an investor buys a corporate or mortgage-backed bond, they enjoy a higher interest rate because there's risk a company can go bankrupt and not repay the investor.

That higher interest — the additional interest that the investor earns for taking that risk— is the credit spread, Berg said.

Jeremy Alexander, president and CEO of Beacon Research, an independent research firm that supplies annuity data to the industry, elaborated. "Let's say the average bond a life insurer buys is AA and then those bonds go down to A," he said. The credit spread widens, meaning the cost increased because the credit quality of the bond went down and when that happens, the value of the bond also goes down, Alexander said. If life insurers currently have subprime holdings, they don't want widening credit spreads, he said.

Berg said that if investors became concerned, once again, about the riskiness of certain bonds, and interest rates on these bonds rose sharply, by how much would the price of the bonds held by these insurance companies fall? It turns out that just how sensitive the insurance companies' investments would be in terms of the price of those securities in the marketplace to renewed concerns about credit and the ability of homeowners to pay their mortgages, is not the same, he said.

MetLife came out "as most exposed to a further spread widening," Berg wrote. A MetLife spokesman declined to comment. Ameriprise, Genworth and Lincoln emerged as the least exposed of the six companies in the study to widening credit spreads, while Prudential and Hartford were in the middle.

If a company, such as Ameriprise or Genworth, did well in Lehman's study, it was either because the sensitivity of its bonds to changes in credit spreads was low or it owned subprime bonds for which the increase in credit spreads has been modest, or both statements were true, Berg wrote. If a company ranked poorly it was because the spread duration of its bonds Lehman studied was high or it owned bonds for which the increase in credit spreads has been substantial, or both statements were true, he wrote.
(By Fran Matso Lysiak, senior associate editor, BestWeek: fran.lysiak@ambest.com) BN-NJ-02-04-2008 0459 ET #

Click here for a list of companies related to this BestWire News Story