Wall Street Journal: For Insurers, a $5 Billion Benefit

The Wall Street Journal published this article on January 15, 2010.

Rule Change Will Allow Firms to Set Aside Less Capital on Written-Down Bonds

By LESLIE SCISM

Life insurers are readying for an estimated $5 billion-plus capital benefit from a new approach to sizing up risk in home-mortgage bonds. Much of the gain won’t come from a rosier view of those bonds, but from a rule change that has received scant attention, according to a new analysis.

The new rules, imposed by state regulators, will allow life insurers to change the way they calculate the capital needed to be held against each bond-using the carrying value of the bond, rather than the par value.

That will allow insurers to hold less capital against a bond if they have already written down its value.

Moody’s Investors Service calculates that the use of carrying values will account for “most of the reduction” in required capital that insurers and regulators are expecting. Consumer groups and other critics of the change had suggested that the benefit would come mainly from more-optimistic assessments of the bonds, something that could backfire if that view was wrong.

“The fact that the holder of the bond has already recognized a loss from par value lessens the potential for additional losses,” said Michael Moriarty, a deputy superintendent of the New York Insurance Department.

The new rules are part of sweeping changes made by the National Association of Insurance Commissioners, the most high-profile of which was to ditch the use of ratings as a way to determine capital requirements. Instead, regulators hired bond powerhouse Pacific Investment Management Co. to estimate losses in more than 20,000 securities held by life and other insurers.

Last week, regulators said a preliminary analysis indicated that life insurers stood to save at least $5 billion of the $14.5 billion in capital the old system would have required, based on December 2008 holdings, the latest data available.

Insurers have taken write-downs on some bonds. Moody’s said life insurers carried the bonds at about $139.2 billion at the end of 2008, compared with par value of $149.6 billion. A big chunk of that difference reflects write-downs and “will drive the big benefit to companies” under the new methodology, while Moody’s expects “sizable impairments” in 2009 that will provide additional benefit,Scott Robinson, a Moody’s senior vice president who wrote the analysis, said in an interview.

In a report, Moody’s said the method change may encourage insurers to be more aggressive in their write-downs of underperforming bonds. That would cut into earnings but enable them to set aside less capital.

The new approach “eases the pain of taking write-downs” by giving a financial incentive to do so, Mr. Robinson said. He said the required back-up capital can be “dramatically” lower in some instances, which concerns him because, “under certain stress scenarios,” the reduced amount “may be inadequate.”

Regulators said they are comfortable the changes would still protect consumers.

The deadline for insurers to file 2009 reports is March 1, and until then, “it would be premature to estimate how much of the difference is accounted for by the carrying value,” Mr. Moriarty said. He noted that the capital requirements are subject to additional adjustment, but, speaking generally, the amount backing up the mortgage bonds “will be materially less” than what would have been required under the previous approach.

The change involving carrying values has been largely off the radar screen, as consumer groups have fretted that Pimco and the NAIC would employ economic assumptions more optimistic than those used by rating providers in the past year or so in downgrading many once-triple-A-rated bonds to “junk.”

Moody’s concluded that assumptions disclosed recently by the NAIC-for things such as home prices and unemployment rates-“are quite similar to the assumptions we use in rating these securities.” Pimco declined to comment.

Write to Leslie Scism at leslie.scism@wsj.com