Thursday, January 14, 2010

Insurance Companies do the darndest things

Insurance companies are heavily reliant on ratings. Although many insurers would have rock solid portfolio managers in place, perhaps even more so on CRE investments, others would target the highest yield available solely based on the credit rating. Obviously that was not smart.

I don't know what the right solution is, haven't thought about it much and not going to right now. However, presumably they have thought about it, and their solutions will make you scratch your head. Instead of changing the silly reliance on credit ratings, they just started rating their own bonds. They're already doing this for RMBS, and they're looking to expand it to CMBS. This is not THAT crazy - instead of trusting a biased third party with a horrible track record, they're presumably doing some credit analysis of their own (or trusting PIMCO to do it).

Now they're also adjusting the rules regarding how to value the security, at least in terms of how it affects their capital reserves. Taking the opposite approach of FASB, they're just valuing bonds at par instead of book...

Life insurers are readying for an estimated $5 billion-plus capital benefit ...

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.

Ha! So, the rating providers actually put thought and 'economic assumptions' into ratings? Could have fooled me. The most disturbing thing about the entire article is that last paragraph though. Moody's reviewed the new NAIC assumptions, and felt they were demonstrably similar - so the NAIC ratings are as weak as the public rating agencies. This tells us one of two things 1) Moody's is wrong, there are no similarities and the NAIC is simply doing a better job at monitoring their firms' credit risk, or 2) The NAIC is making stuff up as they go. I'm leaning towards the former option, but either way the rating agencies no longer serve any purpose and will quickly go out of business at this rate.

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