Insurers investing in structured credit have been a particular concern. Both the Financial Services Authority in the UK and the Federal Reserve in the US have drawn attention to this. In 2002, FSA chairman Howard Davies suggested that insurers didn’t have the resources to assess credit risk transfer in synthetic CDOs.
It wasn’t a tough call: European insurance companies in particular were big buyers of equity tranches of cash CDOs in the 1990s that disintegrated in the 2001-02 credit crunch. But that’s not their only issue.
?You could have both sides of your balance sheet exposed to credit without this being clear,? says Claude Brown, a derivatives and structured products partner at Clifford Chance. ?On the asset side, you could have great-looking coupons which are really structured credit notes. On the liabilities side, you have exposures through selling protection to generate revenue. Insurance companies have to be careful.?
IAS 39 could stop insurance companies taking additional spread on a CDO and locking it away for five years.
Instead, insurers could become suppliers of new underlying assets by applying CDO and securitization techniques to the cash or assets sitting on their balance sheets. ?That will be the big talking point for 2005,? says one banker. ?The natural buyers of structured credit could become the natural issuers.?
Securities issued by closed life funds, for example, could become a new asset class. ?There aren’t issues as long as you make the risk-reward clear,? says the banker. ?Life offices have complete histories of their policyholders. There might not be the same amount of historical data as there is for corporate debt, but closed life funds shouldn’t be beyond the rating agencies.?
In April, Moody’s reported that in the US trust-preferred securities issued by insurance companies ?may eventually become a notable part of the collateral backing cashflow CDOs?. Insurers that issue trust-preferred securities are the smaller companies that cannot otherwise access the capital markets, rather than the big institutional buyers of structured credit.
