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Insurers exposed to the credit crisis

By Hubert Roy | October 13 2008 07:56PM

Until recently, the insurance industry had managed to avoid the turbulence linked to the credit crisis that emerged in early 2008. That immunity ended on September 15 and 16, with the successive failures of Lehman Brothers and American International Group (AIG). The insurance industry, both in Canada and around the world, must now deal with that crisis and its aftermath.

AIG, the world’s largest insurer, was the first affected by the crisis. The Federal Reserve – the U.S. equivalent of the Bank of Canada – saved AIG from bankruptcy with a two-year loan of more than US$85 billion, but the U.S. Government now has a 79.9% ownership interest in the company.

The problems experienced by AIG’s parent company have now spilled over to Canada with Peter McCarthy, president and CEO of AIG Life Canada announcing that the company is up for sale (see inset text).

The domino effect

The problems of AIG and Lehman Brothers have had a domino effect on the entire industry. One after another, insurers have announced their exposure to the troubled companies. Some insurers have also reported exposure to the Washington Mutual and Wachovia banks.

In addition, the Federal Bureau of Investigation announced that it has launched an inquiry into the struggling firms and their senior executives.

The U.S. Federal Reserve and the Treasury Department also presented a US$700 billion bailout plan to prop up the ailing financial institutions. After an agreement in principle was reached on September 27, the plan was rejected by Congress on September 29. Congress finally passed the plan on October 1, and it was approved by the House two days later.

The plan calls for an immediate government injection of US$250 billion into the troubled companies. An additional sum of US$100 billion could be added later at the discretion of the White House. Congress could then approve the payout of a final instalment of US$350 billion.

To recover its investment, the government could resell the high-risk mortgage securities. The plan calls for the pay of executives at financial institutions participating in the plan to be limited to US$500,000 and includes tax breaks for the middle class and various companies. An insurance program for mortgage-backed securities will be created, with premiums paid by financial firms. Finally, the federal deposit insurance limit will be increased from $100,000 to $250,000.

In Canada, the regulatory environment has helped reduce the impact of the credit crisis. Regulators are nonetheless standing by to see if intervention is required. The Industry Regulatory Organization of Canada (IIROC) announced that it has increased its "regular monitoring of trading on equity marketplaces in Canada, including heightened surveillance of all short selling activity."

Ontario and Quebec have taken a step further, and like the Securities and Exchange Commission (U.S.) and the Financial Services Authority (U.K.), the two provinces have prohibited the short selling of securities of certain financial-sector issuers that are listed on the Toronto Stock Exchange (TSX) and are also inter-listed in the United States.

Exposure

Manulife Financial announced exposure of about $1.4 billion, including $395 million invested in Lehman Brothers and $374 million in AIG. Manulife also reported exposure of $600 million to Wachovia and $41 million to Washington Mutual. Manulife will record the costs related to these investments in the third quarter. With assets of $164 billion, Manulife says the exposure is relatively small.

Dominic D’Alessandro, CEO of Manulife, sent a letter to reassure its clients and sales force. The Insurance Journal obtained a copy of that letter, in which Mr. D’Alessandro affirms that Manulife’s exposure is minimal and that the company has always been prudent in its investment strategies.

"We also enjoy one of the highest levels of capital in the financial services industry, which affords us an ample cushion to absorb even the most calamitous events in financial markets."

Sun Life Financial reported total exposure of $919 million. It invested $334 million in Lehman Brothers, $315 million in AIG, and $270 million in Washington Mutual. Sun Life will record costs to that effect in its third quarter results. It has assets of $100 billion.

Great-West Life has total exposure of $450 million. It invested $101 million with Lehman Brothers and $347 million with AIG and its subsidiaries. Great-West also reported exposure of $2.1 million with Washington Mutual. Its portfolio of invested assets is $161 billion. It will record the costs to that effect in its third quarter results.

Two other insurers reported exposure in Canada. In the life insurance sector, Industrial Alliance had invested $15 million in AIG. In property and casualty insurance, Kingsway Financial Services had invested almost $30.25 million in various AIG subsidiaries and $17 million in Lehman Brothers.

Elsewhere, Dutch insurer AEGON reported total exposure of 390 million Euros (€). It had invested €265 million in Lehman Brothers and €125 million in Washington Mutual, but claims to have liquidities of €1.8 billion to handle the crisis.

For its part, the Dutch insurance conglomerate ING Group expects to absorb a loss of €100 million. It had invested €200 million in Lehman Brothers bonds and derivative products.

French insurer AXA Group announced that it had invested €300 million in Lehman Brothers and €150 million in AIG. Its total exposure is €450 million. It holds a proprietary equity interest of 0.05% in Lehman Brothers and of 0.02% in AIG.

British insurer Aviva reports having invested 270 million pounds (£) in Lehman Brothers. It had also invested £148 million in AIG and has minimal exposure to insurance, reinsurance, and other subsidiary companies in the AIG group. Aviva’s total exposure is £418 miilion.

Swiss insurer Zurich Financial declared exposure of US$615 million in three U.S. financial institutions. It had invested US$295 million in Lehman Brothers, $275 million in Sigma Financial, which declared bankruptcy on October 1, and US$45 million in Washington Mutual.

Reinsurers have also been affected by the crisis.

Munich Re invested about €350 million in Lehman Brothers. Swiss Re has total exposure of US$223 million: US$178 million to AIG and US$45 million to Lehman Brothers. It has also reported that it has acted as a reinsurer to AIG.

Partner Re has reported exposure of US$110 million to Lehman Brothers; Aspen Re has exposure of US$38 million to Lehman Brothers; and Hannover Re has reported exposure of €23 million to Lehman Brothers.

U.S. reinsurer RGA has total exposure of US$86.3 million, with investments of US$55.9 million in AIG and US$30.4 million in Lehman Brothers. It plans to report costs to this effect in its third quarter results.

(Editor’s note: at press time, a U.S. dollar was worth $1.10 Canadian; a Euro was worth $1.49 Canadian, and a British pound was worth $1.97 Canadian.)

Future consequences

Could there be other consequences for Canada? According to a recent report on the life insurance industry by rating agency A.M. Best, 62% of investments made by Canadian life insurers have been in bonds and debentures, compared to 17% in mortgage loans. A.M. Best affirms, moreover, that these mortgage loans are little exposed to the credit crisis.

Nevertheless, 39% of investments by Canadian life insurers in bonds and debentures are in the financial sector, in securities similar to those of Lehman Brothers and AIG. A.M. Best also notes that the three big industry players (Manulife, Sun Life, and Great-West) have "significant exposure" to the U.S. market. In addition, the exposure of Canadian life insurers to U.S. bonds increased from 23 to 27% between 2006 and 2007. In fact, this is the only sector in which life insurers increased their exposure over the past year.

A.M. Best downgraded its rating outlook for the U.S. life insurance industry from stable to negative due to uncertainty surrounding the current market situation. It nevertheless expects U.S. life insurance companies to weather the crisis, although it expects more negative than positive outlooks for U.S. life companies in the near to medium future.

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