Sunday, November 1, 2009

Moody’s Examines Life Insurance Creditworthiness, Outlook On Brokers

This past week Moody’s Investors Service in New York released two interesting reports: one that examines life insurance creditworthiness and a second that takes a look at the outlook for insurance brokerages.

The life insurance report, examines the difference between Moody’s ratings and market measures and why the difference exists. The report starts with the divergence between the market which “has at times signaled a high likelihood of default on some insurers that Moody’s has rated within the investment grade category. Moody’s maintains that its ratings have proved accurate given the events in the market and consequently, sought to find out why the divergent opinion exists, according to Scott Robinson, Moody’s senior vice president, explained. The report is based on interviews with both buy and sell-side analysts, he adds.

One potential reason for the difference, Robinson explained, was that the market view may reflect the “extraordinary volatility” in the life insurance market over the past year. But, he noted that since March of this year, the market view has moved back toward Moody’s credit ratings. Even so, the Moody’s report found that the continued gap between the market’s assessment and Moody’s assessment of life insurers suggest that the market believes that the life insurance sector remains under pressure.

Among the reasons cited for the divergence in assessing the industry is the view by some investors that life insurers may still be hurt by investment losses in asset classes including residential mortgage-backed securities, hybrid securities and commercial real estate investments which may face additional losses in the future. Some investors, according to the Moody’s report, may be basing their expectations on the actual market prices of investments held by life insurers rather than expected economic losses.

There was also concern about a “run on the bank” scenario in which one major life insurance failure could prompt surrenders in other insurers, the report continues.
The second report on the Insurance Brokerage Outlook notes that brokers face significant challenges in light of a soft commercial P&C insurance market, the global economic downturn and high financial leverage among privately held firms which were purchased through LBOS or recapitalizations in 2006-2007. These leveraged, private firms have fallen short of their revenue and profit projections but are countering that shortfall with reduced costs and investments that have stable operating margins, the report states.

One of the strength of these brokers, according to Bruce Ballentine, vice president and senior credit officer, is that their largest expense, a variable one, is salaries and benefits at approximately 50-65% of revenues. Capital expenditures, typically less than 20% of a broker’s EBITDA, are limited and mainly related to management information systems.

Consequently, cash flows are fairly consistent, the report continues. When debt maturity approaches in 2013-2015, financial flexibility should improve as these smaller private brokers prepare for a refinancing or full recapitalization. At this point, according to Ballentine, there should be more consolidation in this segment of the industry.

The Moody’s report offers a picture of a “highly fragmented” market. It says that “For instance, there are approximately 890 regional firms (yearly revenues of $5 million to $500 million per firm) and 5,100 local firms (yearly revenues of $1.25 million to $5 million per firm). Together these two categories account for approximately $23 billion or 44% of yearly brokerage revenues in the US. Logical acquisition candidates include firms whose owners are nearing retirement age as well as firms eager to tap into the additional resources that a national or global firm can offer.”

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