American life insurers, at least.
A lot of focus has gone into whether insurance companies could be sitting on big piles of troubled structured-finance bonds, like mortgage-backed CDOs. That makes sense.
Insurers, just like the banks, have indeed been big buyers of structured paper. Insurers are, after all, traditionally big fixed-income investors. Met Life, for example, has a $239bn bond portfolio.
And yet so far – AIG notwithstanding – no particularly egregious structured-finance slip-ups have come to light. Indeed, it’s only Met Life that has a tremblingly large structured finance holding – 35 per cent of the insurer’s fixed-income portfolio is in asset-backed bonds. In contrast, the average asset-backed holding among the top US insurers is around 20 per cent.
There is probably a lot more structured finance pain to be felt here, but we suppose that’s nothing most people didn’t already know or suspect anyway.
So what caught our eye, in an note from Barclays earlier this week, were these two concluding pars (emphasis ours):
While the discussion over life insurers’ holdings of structured-finance bonds – CMBS, sub-prime, alt-A, and the like – has been exhaustive (and perhaps exhausting), relatively little has been said or written as far as we know about life companies’ holdings of corporate bonds.
Yet, as the recession drags on and threatens to deepen, we suspect few investors would contest the assertion that defaults on corporate bonds could in the end pose an even greater threat to life insurers’ balance sheets than losses from the structured bonds.
Barclays also produced this table, which to our mind, speaks volumes:
The table shows the performance of a sample* of insurers’ corporate bond holdings over the particularly turbulent fourth quarter of 2008 compared with the performance of the Barcap corporate bond index. The latter is weighted to reflect the rating distribution of the former.
(* “Sample” because the insurers’ precise corporate bond holdings are unknown. Barclays analysts have performed a service by collecting all the public data from SEC filings and similar, that they could find.)
Here’s BARC:
Table I makes the main point that nearly all of the carriers in our study underperformed the index. “Beta” is the degree to which credit spreads on a sample from insurers’ corporate-bond portfolio widened more than the credit spreads on what we’re calling a “market” portfolio. The “market” portfolio is simply a portfolio consisting of all the bonds in the Barclays Capital Corporate Bond Index with the amount “invested” in each rating category being set equal to each company’s corporate bond portfolio ratings distribution. The only difference, therefore, between a company’s sample portfolio and the market portfolio is bond selection,
As can be seen from the raw numbers – and indeed the beta – the insurers, with the exception of Met Life, are very bad bond investors. Aflac‘s beta of 2.03 implies that the spread widening on Aflac’s bond portfolio was 103 per cent more than the already drastic market spread widening. (Barc’s measure for beta is simply the insurer’s portfolio spread widening divided by the index spread widening – in Aflac’s case, 303/149).
There isn’t just a nasty market risk involved here though. Presumably the greater spread widening in the insurers’ corporate bond portfolio’s vis-a-vis an accordingly weighted index implies a greater actual credit risk.
Moreover, among the insurers’ corporate bond holdings, BBB-rated bonds are extremely prevalent. Consider Principal Financial. Nearly 58 per cent of its entire corporate bond portfolio is rated BBB or below – that’s $17bn on bonds. Even Met – the good bond picker – has a scarily large amount of its portfolio invested in BBB/junk corporate bonds – 43 per cent, or $43bn worth.
Given what is being projected about the corporate default cycle, we’d say life insurers do indeed, make terrible bond investors.
Related links:
Swiss Re turns to Buffett for new funding -FT
Aviva to slash promised £1bn payout – FT