We all know the children’s tale of “The Three Little Pigs”, the first little pig built his house of straw, the second little pig built his house of sticks and the third little pig built his house of bricks. The big bad wolf blew down the first two houses of straw and sticks and had two little pigs for his dinner, but no matter how much he huffed & puffed, he could not blow down the third little pig’s house of bricks.
The credit crunch which has swept the globe, much like the big, bad wolf, is blowing down a lot financial institutions investment portfolios. Total losses to date are still being tallied but are close to breaching the $300 billion mark worldwide. Investment banks have mostly been in the firing line but insurers have their fair share of problems also.
In an effort to chase higher yields, many US property & casualty insurers invested in structured asset securities as well as corporate bonds over the last few years. At Fairfax Financial’s (FFH, Financial) recent AGM, CEO Prem Watsa indicated that at the end of 2007, the US Property & Casualty Insurance industry’s investment portfolio had, on a composite basis, nearly 50% of its investments in corporate bonds and asset-backed & mortgage-backed securities, which equates to a whopping $700 billion or 230% of shareholders equity.
Now until recently, these securities have performed well for insurers as credit markets have been relatively benign. But with the credit crunch beginning in August 2007, insurers have been writing down their structured asset backed securities to reflect the expansion in credit risk spreads and increasing defaults on their portfolios. In the IMF’s Global Stability report released recently, the IMF has forecast $945 billion in expected losses for the financial sector from the credit crisis. The IMF says insurance companies globally including the US are forecast to sustain up to $130 billion in losses on investment securities, including residential and commercial asset-backed securities .
Fairfax Financial’s concern over the potential problems in the asset backed security arena, as well as increasing corporate debt defaults, has led them to adopt a very conservative stance with their fixed income portfolio confined largely to US treasuries and cash. Fairfax Financial’s warning over the health of the US Property and Casualty insurance industry’s investment portfolios ought to be taken seriously, particularly in view of Fairfax ’s uncanny ability to substantially outperform industry averages in the fixed income investment area. As of December 31, 2007, Hamblin Watsa , Fairfax’s investment manager, has racked up an impressive 10.1% return on their fixed income/ bond portfolio over a 15 year stretch, a outperforming the Merrill Lynch US Corporate index which recorded 6.5% over the same time period.
I decided to take a look at a few insurers in the US and Canada to gauge their potential exposures to asset-backed structures and corporate bonds. I would qualify these observations with the comment that this is not an attempt to assess the individual credit quality of their securities but simply to identify the size of their exposure in the context of their balance sheets.
Two smaller insurers with large exposures to asset-backed structures and corporate bonds include the excess and surplus lines insurer American Safety Insurance(ASI) and the Canadian non-standard auto insurer Kingsway Financial (KFS). American Safety had $435 million invested in corporate bonds and asset backed securities at December 31st 2007 , this represented 68% of their total investments and 188% of shareholder equity. Kingsway Financial (KFS) , in turn, had a substantial exposure to corporate bonds, over 63% of their portfolio or $2 billion was invested in corporate bonds. This represented 213% of shareholder’s equity.
Two larger US based insurers Allstate(ALL) and American International Group(AIG) also hold large investments in asset and mortgage backed securities. Allstate recently reported March 2008 quarter results including a pre-tax investment loss of $655 million and fixed income security writedowns of $347 million related to residential mortgages and other structured securities. Allstate had around $16 billion in ABSs & MBSs as of 31st December 2007 and $38 billion invested in corporate debt securities, these securities combined represented 46% of Allstate’s investment portfolio of $118 billion or 245% of shareholder’s equity.
American International Group has a large exposure to ABSs & MBSs as well as corporate debt. As of 31st December 2007 , AIG had $134 billion in MBSs,ABSs & CDOs and $241 billion invested in corporate bonds. AIG domestic life business principally holds the bulk of AIG’s corporate bond investments, which are in mostly investment grade corporate debt, as well as mortgage and asset-backed securities. With $862 billion in invested assets , asset-backed structures and corporate bonds represent 41% of this total and they equate to around 350% of AIG’s shareholder’s equity. AIG reported $6.7 billion in writedowns on residential mortgage-backed securities in 2007.
The gold standard in the insurance business is surely Warren Buffett’s investment company Berkshire Hathaway. Berkshire Hathaway ‘s (BRKA/B) exposure to the corporate sector and residential mortgages is much lower than the US property and casualty industry averages , reflecting a more risk averse approach. Berkshire ’s mortgage backed securities and corporate bonds represented less than 10% of total invested assets and 11% of shareholder’s equity as at 31st December 2007 .
These are testing times for insurers who face headwinds from a soft market , higher inflation rates and now writedowns on their investment portfolios. Until now, insurers have generally shunned the safest of all fixed income investments, US Government treasuries, and have preferred placing their faith in the credit ratings on asset-backed structures and buying higher yielding corporate bonds. The size of write downs on insurer’s asset-backed structured securities will ultimately determined by the level of ultimate actual defaults on their portfolios. Insurers certainly have maintained an almost universal line that the actual default losses on their portfolio’s will be much lower than the mark to market losses they have recorded to date. Given that 50% of US insurer assets are invested in these securities, there is little room for error and these insurers will be hoping actual defaults are indeed lower than their marks.
Disclosure: I own shares of BRKB and FFH
The credit crunch which has swept the globe, much like the big, bad wolf, is blowing down a lot financial institutions investment portfolios. Total losses to date are still being tallied but are close to breaching the $300 billion mark worldwide. Investment banks have mostly been in the firing line but insurers have their fair share of problems also.
In an effort to chase higher yields, many US property & casualty insurers invested in structured asset securities as well as corporate bonds over the last few years. At Fairfax Financial’s (FFH, Financial) recent AGM, CEO Prem Watsa indicated that at the end of 2007, the US Property & Casualty Insurance industry’s investment portfolio had, on a composite basis, nearly 50% of its investments in corporate bonds and asset-backed & mortgage-backed securities, which equates to a whopping $700 billion or 230% of shareholders equity.
Now until recently, these securities have performed well for insurers as credit markets have been relatively benign. But with the credit crunch beginning in August 2007, insurers have been writing down their structured asset backed securities to reflect the expansion in credit risk spreads and increasing defaults on their portfolios. In the IMF’s Global Stability report released recently, the IMF has forecast $945 billion in expected losses for the financial sector from the credit crisis. The IMF says insurance companies globally including the US are forecast to sustain up to $130 billion in losses on investment securities, including residential and commercial asset-backed securities .
Fairfax Financial’s concern over the potential problems in the asset backed security arena, as well as increasing corporate debt defaults, has led them to adopt a very conservative stance with their fixed income portfolio confined largely to US treasuries and cash. Fairfax Financial’s warning over the health of the US Property and Casualty insurance industry’s investment portfolios ought to be taken seriously, particularly in view of Fairfax ’s uncanny ability to substantially outperform industry averages in the fixed income investment area. As of December 31, 2007, Hamblin Watsa , Fairfax’s investment manager, has racked up an impressive 10.1% return on their fixed income/ bond portfolio over a 15 year stretch, a outperforming the Merrill Lynch US Corporate index which recorded 6.5% over the same time period.
I decided to take a look at a few insurers in the US and Canada to gauge their potential exposures to asset-backed structures and corporate bonds. I would qualify these observations with the comment that this is not an attempt to assess the individual credit quality of their securities but simply to identify the size of their exposure in the context of their balance sheets.
Two smaller insurers with large exposures to asset-backed structures and corporate bonds include the excess and surplus lines insurer American Safety Insurance(ASI) and the Canadian non-standard auto insurer Kingsway Financial (KFS). American Safety had $435 million invested in corporate bonds and asset backed securities at December 31st 2007 , this represented 68% of their total investments and 188% of shareholder equity. Kingsway Financial (KFS) , in turn, had a substantial exposure to corporate bonds, over 63% of their portfolio or $2 billion was invested in corporate bonds. This represented 213% of shareholder’s equity.
Two larger US based insurers Allstate(ALL) and American International Group(AIG) also hold large investments in asset and mortgage backed securities. Allstate recently reported March 2008 quarter results including a pre-tax investment loss of $655 million and fixed income security writedowns of $347 million related to residential mortgages and other structured securities. Allstate had around $16 billion in ABSs & MBSs as of 31st December 2007 and $38 billion invested in corporate debt securities, these securities combined represented 46% of Allstate’s investment portfolio of $118 billion or 245% of shareholder’s equity.
American International Group has a large exposure to ABSs & MBSs as well as corporate debt. As of 31st December 2007 , AIG had $134 billion in MBSs,ABSs & CDOs and $241 billion invested in corporate bonds. AIG domestic life business principally holds the bulk of AIG’s corporate bond investments, which are in mostly investment grade corporate debt, as well as mortgage and asset-backed securities. With $862 billion in invested assets , asset-backed structures and corporate bonds represent 41% of this total and they equate to around 350% of AIG’s shareholder’s equity. AIG reported $6.7 billion in writedowns on residential mortgage-backed securities in 2007.
The gold standard in the insurance business is surely Warren Buffett’s investment company Berkshire Hathaway. Berkshire Hathaway ‘s (BRKA/B) exposure to the corporate sector and residential mortgages is much lower than the US property and casualty industry averages , reflecting a more risk averse approach. Berkshire ’s mortgage backed securities and corporate bonds represented less than 10% of total invested assets and 11% of shareholder’s equity as at 31st December 2007 .
These are testing times for insurers who face headwinds from a soft market , higher inflation rates and now writedowns on their investment portfolios. Until now, insurers have generally shunned the safest of all fixed income investments, US Government treasuries, and have preferred placing their faith in the credit ratings on asset-backed structures and buying higher yielding corporate bonds. The size of write downs on insurer’s asset-backed structured securities will ultimately determined by the level of ultimate actual defaults on their portfolios. Insurers certainly have maintained an almost universal line that the actual default losses on their portfolio’s will be much lower than the mark to market losses they have recorded to date. Given that 50% of US insurer assets are invested in these securities, there is little room for error and these insurers will be hoping actual defaults are indeed lower than their marks.
Disclosure: I own shares of BRKB and FFH
