Will Insurance Companies Be Part of the Bailout?

The $700 billion bailout package was intended to save the American banking system. But at least three U.S. insurance companies have reportedly been working with Treasury officials over the weekend to figure out if they can tap some of that money.  Meanwhile, AEGON (AEG), the giant European insurance group, disclosed that it was in talks with the Dutch government to see if it could join the $26 billion state capitalization scheme originally launched in the wake of the crisis at ING (ING) and Fortis (FORSY). And Nordic countries are racing to implement support plans for banks and insurers within days.

Without doubt, if insurance companies in America and Europe come under pressure this week, equities and bonds worldwide could easily be hit with another wave of selling. For all material purposes, the insurance industry is even more "international" than banking, given the extensive, long-standing reinsurance agreements between domestic policy writers on one hand and specialist risk buyers in the major financial centres on the other.

Metlife (MET), Prudential Financial (PRU) and New York Life are the three insurers believed to have been meeting with Hank Paulson and Neel Kashkari. Without doubt, falling markets are pressurizing solvency ratios across the board; in certain instances, solvency ratios may already have been compromised. To make matters worse, sharp currency fluctuations are turning the assessments of such ratios into day-to-day moving targets. Furthermore, though no precise figures are available at this point, it is fair to assume that a number of insurance companies in America and Europe are exposed to hefty losses from the synthetic collateralized debt obligations (CDOs) market.

Rating agencies have placed the entire life-insurance sector on "negative" watch in anticipation of one- to two-notch downgrades triggered primarily by investment losses, the true extent of which may finally justify a dedicated bailout package altogether. But will recapitalization programmes solve the challenge of insurance premium flexibility and competitiveness, both of which have been closely linked to investment profits?

Of course, recapitalization of any kind is ultimately meaningless unless the historical, and obviously intricate, relationship between the insurers, the derivatives players and the hedge funds is understood in a comprehensive manner. If AIG's (AIG) portfolio was simply a reflection of established practice, then the amount of money required to support the insurance industry could well exceed the Treasury's budget for banks and financial institutions.

Earlier this month, upon hearing that AIG was granted another $38 billion (beyond the initial rescue amount of $85 billion), Rep. Barney Frank, chairman of the House Financial Services Committee, vowed to initiate legislation to regulate the credit default swap market when Congress reconvenes in January. By that time, however, Rep. Frank may have a much more complex problem on his hands, the problem of leverage of the very highest order: Constant-proportion debt obligations (CPDOs, leverage standard 15:1) and credit derivative product companies (CDPCs, leverage standard 80:1).

The Wall Street Journal (Oct 21, 2008), citing a Citigroup report, warned that the liquidation of CDPCs "could wreck havoc on the marketplace." CDPC names mentioned included Theta Corp., Primus Financial and Athilon Capital. Moody's slashed Theta's credit rating to Aa2 (from AAA) two weeks ago. But since the creation of 80:1 leverage is predicated on a rigid application of the mark-to-market rule, the rating agencies are obviously finding it hard to keep pace with ground events which are changing by the hour.

Stock position: None.

Comments

[Jimmy Lathrop:]

The government is, essentially, pulling a Warren Buffet on Warren Buffet. As soon as I heard about this deal I dumped my BRK,B. Three months ago I thought HIG at 51 was a bargain. If the government is going to start getting involved with insurance companies, its over. If someone wants to make a case as to why any plan will not be dilutive to common shareholder interest in these companies, I urge them to make it.

2008 Oct 26 11:41 AM

[helplessobs...:]

Today Loews(L) stock is being slammed because of troubles with its flagship holding CNA Financial Corp. If James Tisch has to inject $1B into CNA, then we had better hunker down for a long financial storm.

2008 Oct 27 12:34 PM