Insurer Assets Under Review

Source: Source: Dow Jones | Published on August 27, 2012

Insurers and Toxic SecuritiesState insurance regulators are considering changes that would require U.S. insurers to hold more capital against some of the riskier mortgage bonds they have been scooping up lately as high-yielding investments.

The moves under discussion could increase by billions of dollars the total amount industrywide that insurers including American International Group Inc., MetLife Inc. and others must hold to protect policyholders, estimate some analysts.

The changes could be implemented later this year by the National Association of Insurance Commissioners, an organization of state officials that sets solvency standards. The shift, currently under study by an NAIC task force, would make it costlier for insurers to hold certain bonds backed by subprime mortgages and other risky home loans.

Such a change could cool demand from insurers for the once-toxic securities that lost value when the housing bubble burst, but that lately have become some of the hottest assets in the credit markets. Strong investor demand for those securities recently helped the Federal Reserve Bank of New York to profitably sell two large portfolios of subprime and other mortgage bonds it acquired in the 2008 bailout of AIG.

Many insurers "are looking for ways to enhance yield" and mortgage-bond yields are very attractive relative to other assets, says John Melvin, global head of insurance fixed income portfolio management at Goldman Sachs Asset Management.

In 2011, insurers invested over $26 billion in residential mortgage-backed securities that aren't guaranteed by government agencies like Fannie Mae and Freddie Mac, according to data provider SNL Financial. AIG has spent at least $7 billion this year buying more beaten-down mortgage securities. Such bonds made up roughly 3% of insurers' total investments as of Dec. 31, according to NAIC data.

That is down from 7% in 2008, because many bonds have paid off or defaulted since the downturn.

Insurance-company executives say they make purchases selectively, and the appeal of the mortgage bonds is their high yield in today's low interest-rate environment, discounted prices and potential for gains in a housing recovery.

The changes under consideration would involve modifications to an approach adopted by regulators in late 2009. Back then, state insurance departments stopped using credit ratings from the likes of Moody's Investors Service and Standard & Poor's as the basis for determining how much capital insurers should hold against non-agency mortgage bonds, after scores of ratings were downgraded and proved inaccurate.

Instead, regulators hired a unit of money-management giant Pacific Investment Management Co., or Pimco, to size up the risk of thousands of residential mortgage bonds. Regulators also adopted a methodology that rewards insurers that value their mortgage-bond holdings at prices well below face value. The approach has resulted in significantly lower capital requirements for many securities.

Regulators maintain that the current capital system has worked well for the bulk of mortgage securities held by insurers. "While there are bonds that don't do so well, the industrywide profile is pretty good," said Therese Vaughan, chief executive of the NAIC.

They also say they have no intention of reverting to the old ratings model for mortgage securities. Instead, the task force is planning to propose to regulators that Pimco use a "conservative bias" in its risk analysis, meaning the firm would factor in a higher likelihood of a severe economic downturn when it estimates potential losses for bonds held by insurers, Kevin Fry, an Illinois regulator, said on a June 26 call with other members of a NAIC task force that handles securities-valuation issues.

The shift likely would increase the amount of capital for bonds that are more exposed to losses. The task force plans to put its proposal out for industry and public comment this fall. After those are considered, regulators will vote on the plan.

Insurers paid an average of 77 cents on the dollar for residential mortgage bonds last year, according to data from the NAIC. Buyers are hoping a bond bought at that price will return 80 cents, though in a bearish scenario it might deliver 50 cents, Mr. Fry said on the June call.

At the end of 2011, the insurance industry held $3.2 billion in capital to back a total of $123.2 billion in residential mortgage bonds, according to NAIC data. If the old credit ratings-based system were in place, insurers would have needed $18.3 billion in capital for those same bonds.

A Pimco spokesman says the firm's sole role is "to provide valuations for the NAIC" and that it wasn't involved in creating the methodology that regulators use for determining capital requirements. Insurance regulators set the economic-scenario assumptions that Pimco uses for its analysis.