actions. While new delinquencies continued to decline, the rate of decline was less than the guarantors previously expected for some RMBS deals. Assured Guaranty increased its pre-putback RMBS loss estimate by $394 million in fourth-quarter 2010. MBIA also increased its RMBS reserves (see exhibit below), and established $1.1 billion in total reserves for commercial mortgage-backed securities (CMBS) as it increased the probability of higher severity scenarios. Increasing RMBS Reserves Despite Greater Expected Putback Recoveries Increase in RMBS loss estimate, pre-putback (Q4 2010) Increase in putback recovery estimate (Q4 2010) Putback recovery estimate (YE 2010)
Mortgage A Rate s1r Payment dsearchG Deals a Mortgage asearchtsearch Mortgage BsearchA Lendersmortgagepayments
$394 million $300 million
$337 million $500 million
$1.7 billion $2.5 billion
*Estimates from the operating supplement of MBIA. Source: SEC filings and operating supplements.
Mitigating the higher RMBS losses for the guarantors were increases in the benefit taken for recoveries from potential putbacks (see the exhibit). The estimates were substantial and the guarantors have realized some, but both were not enough to offset the adverse effect of the increase in RMBS losses pre-putback. Assured Guaranty has reached agreements with mortgage originators on $555 million of mortgage repurchases through 31 January 2011. MBIA¡¯s putback recoveries have been very limited, as its litigations with the originators continue. Assured Guaranty also increased loss-severity estimates on loans. Foreclosure delays and excessive servicer advancing will reduce recoveries for some senior RMBS bonds, negatively affecting the guarantors, which typically hold such senior positions in the securitizations.18 To protect their interests, the guarantors have been active in scrutinizing RMBS servicing practices, and in order to improve recoveries, sometimes they transfer servicing or establish special servicing. The guarantors continue to face substantial losses from legacy real estate exposures. Given the significant amount of putback benefits recorded, their ability to recoup losses through putting back bad loans to originators is critical as loan losses continue to rise.
18
Typically, foreclosure holdups and excessive advancing delay loss recognition of subordinated bonds (e.g., by preventing the trusts from writing down subordinated bond balances to reflect liquidated loans). As a result, subordinated bonds continue to receive interest payments at the expense of the principal payments of senior bonds.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
David Masters Assistant Vice President - Analyst +44.20.7772.1605 david.masters@moodys.com
Gender Blind EU Ruling Is Credit Negative for Insurers Last Tuesday, the European Court of Justice (ECJ) announced that as of 21 December 2012, insurers won¡¯t be allowed to price insurance contracts based on gender. This is credit negative for European insurers, as they will lose a valuable pricing tool. Furthermore, prices for some segments of the insurance market are likely to rise, potentially reducing demand for discretionary insurance products. The ruling is likely to lead to a wide-scale re-pricing of affected insurance policies ahead of the implementation date. The type of policies most likely to be affected include motor insurance (particularly for younger drivers), pensions annuities, life insurance and, to a lesser extent, private health insurance, which, with the exception of motor insurance, are largely discretionary purchases for policyholders. For example, the Association of British Insurers estimates that within the UK, average motor premiums for women under the age of 25 could increase 25%, whilst annuity rates for men could fall 8% but increase 6% for women.19 Last week¡¯s ruling by the ECJ follows a non-binding opinion of the Advocate General of the ECJ announced on 30 September 2010 that stated the use of gender to assess premium rates in the insurance industry conflicted with the European Union¡¯s principles of equality and nondiscrimination. Previously, EU member states were permitted to allow their insurers to price using gender as a factor as long as they ensure the underlying data was reliable, regularly updated, and available to the public. Historically, insurers have typically charged younger female drivers lower insurance premiums than male drivers the same age, as insurers¡¯ statistical data has shown that young female drivers are less likely to submit motor-related claims. Conversely, according to actuarial statistics, women typically have longer life expectancies than men, typically leading insurers¡¯ annuity payments to women to be lower than those for men for a given lump sum investment. The exhibit below explains the probable winners and losers of the ECJ ruling by sex. Policyholder Winners and Losers Following European Court Ruling Insurance Winner(s) Loser(s)
Motor insurance Pension annuities Life insurance Private health insurance Source: Moody¡¯s
Young men Women (and male spouses living off their wife's pension) Men Women
Young women Men (and female spouses living off their husband's pension) Women Men
Gender is widely utilised by the insurance industry as one of the key differentiators for pricing and benefit differences, although there are notable exceptions, such as Belgian and Dutch motor insurances, which do not use gender in pricing. Removing gender as a factor will likely force insurers to raise premiums across the board to reflect the loss of accuracy in their risk calculations and the incremental costs incurred as a result of the changes. As a result, overall consumer demand for discretionary insurance products is likely to decline, particularly in those segments bearing the brunt of price increases. It may also spur insurers to reduce some coverage and withdraw some products, such as parts of the motor insurance (e.g., coverage of younger drivers) and annuities markets, directly 19
Source: ABI commissioned research by Oxera, Autumn 2010.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
affecting the majority of mainstream European insurers revenues. These changes will affect not just niche players, but also the largest European insurers such as Allianz SE (financial strength Aa3 stable), Axa SA (main operating companies financial strength Aa3 stable), and Assicurazioni Generali S.p.A (financial strength Aa3 stable). Another risk is that insurers¡¯ reduced ability to adequately segregate and price risks using a proven rating factor may cause some insurers to accumulate risks that do not match their pricing assumptions. Insurers that do not control this risk through use of other appropriate rating factors will likely see a deterioration in operating revenues and profits.
29
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Kevin T. Lee Vice President - Senior Credit Officer +1.212.553.2907 kevin.lee@moodys.com
New Zealand Earthquake Weakens Earnings Outlook for Reinsurers On 2 March, Swiss Re (financial strength A1 stable) estimated it will incur $800 million of losses from the recent New Zealand earthquake (net of retrocession and before tax), a sign that global reinsurers will shoulder most of the insured losses from the disaster. Combined with estimated losses from January¡¯s Australian floods and February¡¯s Cyclone Yasi, the earthquake pushes Swiss Re over its $1 billion catastrophe and large claim budget for the year, and we expect to hear about significant erosion of catastrophe budgets from other reinsurers. These losses are credit negative for reinsurers, as they hurt already less-than-stellar expected returns. But because of an oversupply of capacity in the industry, the losses are not big enough to halt the momentum of reinsurance price declines globally. The magnitude 6.3 earthquake hit near the city of Christchurch, New Zealand, during the early afternoon of 22 February. It was the second major quake to hit Christchurch in six months. Early estimates of insurance industry losses range from $3.5-$12 billion.20 While this second quake registered a lower magnitude than the September 2010 quake¡¯s 7.1 magnitude, we think insured losses from this second event will be higher than the first event because the epicenter was shallower and closer to Christchurch¡¯s central business district, where poor soil conditions amplified physical damage. Business interruption losses will also be more prominent for last month¡¯s earthquake because the majority of losses will come from commercial rather than residential insurance policies. Lastly, the short time span between the two quakes means that buildings partially damaged by the first quake may have been more vulnerable in the second quake, and significant demand for reconstruction will likely push construction costs, and therefore insurance payouts, higher. Insured losses from the February 2011 quake will touch many insurers and reinsurers, but we think reinsurers will end up with most of the insured losses. Affected parties include:
»
The New Zealand Earthquake Commission (EQC): This government-backed entity provides residential earthquake insurance and has NZD2.5 billion ($1.8 billion) of reinsurance protection excess of NZD1 billion ($700 million) retention for the February quake Australian and New Zealand Insurers: The list of local insurers is long, and includes IAG, Suncorp, Wesfarmers Australia, Vero NZ, Ansvar NZ, AMI, and Tower. All have extensive reinsurance protection, but notably IAG has a main reinsurance program that covers losses from AUD250 million up to AUD4.1 billion per event plus other reinsurance arrangements. Suncorp has a main reinsurance program that covers losses from AUD200 million to AUD5.8 billion per event plus other reinsurance arrangements International Insurers: Chartis, Allianz, Zurich, among others, insure commercial and industrial properties in New Zealand but transfer a portion of this risk to reinsurers Reinsurers: Global reinsurers will receive claims from all the parties above. Losses will flow to reinsurers from a variety of reinsurance protections sold, including protection for accumulated losses from a single disaster, aggregate losses from multiple disasters, and protection on individual buildings. Some of these reinsurance losses will be hedged. In particular, some reinsurers bought protection from retrocessionaires, or companies that provide insurance to reinsurance companies
»
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20
AIR Worldwide, a company that develops catastrophe models, has estimated insurance industry losses of $3.5-$8 billion. Swiss Re has estimated insurance industry losses of $6-$12 billion.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS »
Credit Implications of recent worldwide news events
Retrocessionaires: Some reinsurers decided to buy more hedge protection from retrocessionaires in the past year, motivated by abundant availability and attractive prices. Notably, specialist companies that sell such protection, including some reinsurers and hedge funds, have been willing to provide ample protection for natural disasters in New Zealand and other so-called ¡°coldspot¡± regions, or areas that fall outside the hotspots of the US, Europe, and Japan, where natural disasters are more frequent. If industry losses end up at the high end of the range, we think a meaningful portion of reinsurers¡¯ losses will be passed on to the retrocession market
So far, few reinsurers have disclosed their loss estimates for last month¡¯s earthquake. In the table below, we show the handful that have disclosed their estimates. For reference, we have also included reinsurers¡¯ loss estimates for the September 2010 earthquake. Generally, we believe losses from last month¡¯s earthquake will exceed those for the September 2010 earthquake, although this will vary by reinsurer. New Zealand Earthquake and Other Recent Catastrophe Losses for Select Reinsurers ($ millions) Company Ace Limited Allied World Assurance Company Holdings Ltd. Alterra Capital Holdings Ltd. Amlin Plc Arch Capital Group Ltd. Argo Group International Holdings, Ltd. Aspen Insurance Holdings Limited Axis Capital Holdings Limited Endurance Specialty Holdings Ltd. Everest Re Group, Ltd. Flagstone Reinsurance Holdings Limited Hannover Re Lancashire Holdings Limited Montpelier Re Holding Ltd. Munich Re PartnerRe Ltd. Platinum Underwriters Holdings, Ltd. RenaissanceRe Holdings Ltd. SCOR SE Swiss Re Transatlantic Holdings, Inc. Validus Holdings, Ltd. XL Group plc Ticker ACE AWH ALTE AML ACGL AGII AHL AXS ENH RE FSR HNR LRE MRH MUV PRE PTP RNR SCR RUKN TRH VR XL Dec 2010 Common Equity * 22,974 3,076 2,918 2,699 4,188 1,626 3,241 5,125 2,648 6,284 1,135 6,083 1,287 1,629 30,700 6,687 1,895 3,386 5,792 25,342 4,284 3,505 9,611 156,115 Source: Company reports, Earnings calls * Hannover Re, SCOR SE as of Sept 30, 2010 (1 EUR = 1.3648 USD).Munich Re is a rounded figure. ** Estimates are net of retrocession and, in some cases, net of reinstatement premiums
Sept 2010 NZ Quake ** 55.0 17.0 11.0 160.0 33.0 23.5 52.8 138.0 11.6 106.0 75.5 157.0 <5 30.0 473.0 149.0 96.7 135.3 35.0 230.0 19.0 45.3 47.0 2,101
Jan 2011 Australia Floods + Feb 2011 Cyclone Yasi ** 45-60 10-20 2-12 ? 30-60 15-25 < 1% mkt (< $25-50) ? ? 45.0 60-80 56-139 (floods only) ? ? ? 80-110 15-30 < 50 ? 325.0 50-100 ? 75-95
Feb 2011 NZ Quake ** ? ? ? ? ? ? ? ? ? ? ? 209 ? ? ? ? ? ? ? 800 ? 25-50 ?
2011 Cat Budget 370 ? ? ? ? ? 170 ? ? ? ? ? ? ? ? ? ? ? ? 1,010 ? ? ?
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Gavin Foster Assistant Vice President - Analyst +1.212.553.1418 gavin.foster@moodys.com Rory Callagy Vice President - Senior Analyst +1.212.553.4374 robert.callagy@moodys.com
Proposed SEC Rule Limiting Asset Manager Incentive Compensation Is Credit Positive On 2 March, the Securities and Exchange Commission (SEC), by a 3-2 margin, approved a rule establishing parameters for incentive-based compensation at investment advisers in accordance with the Dodd-Frank Act. The rule has positive credit implications for asset management firms, as it will lead to a reduction of incentive-based cash compensation expenses. In addition, it prohibits incentive compensation arrangements that encourage disproportionate risk-taking by key decision makers. The rule, if implemented, applies to investment advisers with proprietary assets of at least $1 billion on their consolidated balance sheet. Additional requirements are proposed for investment advisers with $50 billion or more in total proprietary assets.21 Investment advisers with $1 billion in total assets would make a non-public filing of incentive-based compensation with the SEC on an annual basis to reduce ¡°excessive¡±22 incentive-based compensation arrangements that may encourage inappropriate risk-taking. Investment advisers would also be required to develop policies and procedures to improve monitoring of incentive-based compensation. For investment advisers with $50 billion or more in total consolidated balance sheet assets, the rule would require at least 50% of incentive-based compensation for executive officers to be deferred for three years. Most investment advisers do not currently report their consolidated assets to the SEC. However, the SEC¡¯s Investment Management Division (IARD) estimated that investment advisers with at least $100 billion in assets under management would have proprietary assets of $1 billion, while investment advisers with assets under management of at least $500 billion would have proprietary assets of at least $50 billion. Using these assumptions, independent US-domiciled asset managers likely to be subject to the SEC rule are listed in the exhibit below.
21 22
Segregated client assets would not count in the calculation of total assets. As defined under Section 39 of the Federal Deposit Insurance Act.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
List of Independent US Money Managers to Which the SEC Ruling Applies Under the SEC Assumptions: US Money Managers with total consolidated assets of $50 billion and above 1
BlackRock Capital Group Fidelity investments Franklin Templeton Legg Mason State Street Global Vanguard Group Wellington Management Under the SEC Assumptions: US