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GIC Issuer Quality Stands Tall After Disaster

The events of September 11, 2001 have thrust the insurance industry into the spotlight with reports of insurance losses exceeding $70 billion. There is no doubt that this disaster is the worst in the industry's history. Given the substantial human and financial costs, large claims are expected in almost all insurance lines including commercial property, liability, aviation, business interruption, workers compensation, disability, auto, group and individual life, accident and health. The majority of claims from the New York City tragedy are expected to be made to domestic and foreign commercial property/casualty insurers and reinsurers, while most of the aviation-related losses will be absorbed by the Lloyds of London market. As a result, companies with loss exposures are expected to take hits to third quarter earnings and equity positions.

The magnitude of loss estimates from the disaster may at first appear shocking and lead one to believe that the entire industry may be in trouble. However, based on our analysis to date, FCM has concluded that these events will not result in a material deterioration in the financial strength or credit ratings of GIC issuers. GIC issuers are primarily life insurance companies with limited exposure to the commercial property/casualty and reinsurance businesses. A few GIC issuers are part of large insurance groups, which through other business units have commercial property and casualty operations; however, risk exposures are limited to manageable levels through significant reinsurance arrangements or syndicates that spread risk over several different parties.

Furthermore, these insurance groups are very large companies with extensive financial resources and should be able to absorb net losses with minimal impact on their overall financial strength.

Thus far, loss estimates for the life insurance industry, currently between $4 to $6 billion, represent only a small portion of the total loss exposure from the attacks. This level of loss exposure, representing less than 5% of the life industry's statutory capital, is not expected to have a material impact on the financial condition of most GIC issuers. Since the problems experienced during the early nineties, the life insurance industry has grown to be one of the most highly rated, financially strong sectors. After stable earnings growth and improved asset quality over the past several years, GIC issuers have developed strong capital positions and relatively clean balance sheets. Statutory capital is at historically high levels with the average surplus ratio (statutory capital to general account assets) at 11% compared to 7% in 1990. The quality of GIC issuers' investment portfolios has also improved with the majority of invested assets in high quality, liquid asset classes. The average percentage of commercial mortgages to invested assets has decreased from 25% in 1990 to less than 13%. At the same time, bonds have increased to nearly 70% of invested assets compared to only 57% in 1990. Bond portfolios consist primarily of investment grade issues and are generally well diversified amongst issuer and industry. Although the percentage of high yield bonds to total bonds has crept up over the past few years, current high yield positions at 8% of total bonds on average is considered to be manageable when compared to an 11% allocation in 1990. In addition, GIC issuers benefit from diversified sources of revenues through operations in several business lines. Since the events of September 11th, the rating agencies have not taken any negative actions with respect to the financial strength ratings of GIC issuers held within the FCM portfolios.

The strong financial condition of GIC issuers is even more apparent in the credit markets. Since September 11th, credit spreads on comparable high quality corporate bonds have widened between 15 and 20 basis points indicating a general flight to quality with investor demand focused more on Treasuries than Corporate issues. This spread widening reflects a general deterioration in the credit markets as corporate earnings prospects have continued to weaken along with the economic outlook. In addition, the credit agencies have increased the number of negative rating actions and placed several bond issuers on "watch status" for possible downgrade. In contrast, FCM has found that credit spreads over Treasuries for GICs have remained fairly stable since the attacks and have even tightened to some degree. From this, one can conclude that investors continue to view GIC issuers as strong, stable credits and demand for their products has increased during this volatile period. Furthermore, it is apparent that investors have found safety in GICs, which enjoy senior payment status over other debt instruments, and the relatively strong financial strength of the life insurance industry.

In conclusion, FCM feels that the life insurance industry will emerge from this crisis relatively unscathed. Although we do expect some softness in insurance earnings as a result of the stock market downturn and overall economic weakness, the financial condition of GIC issuers is expected to remain strong. FCM continues to view GICs as a valuable investment alternative for stable value portfolios and a great opportunity to find exceptional credit quality at attractive yields. Due to the inefficiencies embedded within the GIC market and our strong credit research abilities, we feel that the current environment provides opportunities to enhance portfolio performance by selecting high quality issuers, with minimal exposure to the world trade center disaster, that are attractively priced in the current market environment.