Ratings agency turns negative on insurers

The outlook for the Canadian insurance industry has taken another hit, as the entire sector was downgraded by U.S. financial service ratings agency, A.M. Best. The agency has revised its outlook on the Canadian life insurance sector from “stable” to “negative.”

“While nearly all life insurers in Canada have been negatively impacted in some way by the financial turmoil, those entities with large exposure to equity markets — either through segregated fund products or as asset managers — have been most affected,” the firm said in a press release.

The company went on to say that it expects to issue a number of negative ratings revisions for both issuer credit ratings and financial strength ratings over the coming months.

“As recently as September 2008, A.M. Best viewed the Canadian life [insurance] industry as stable,” the company says. “While the Canadian economy remained resilient at that time, market conditions have deteriorated significantly and expectations for growth in Canada in 2009 have recently been revised to be modestly negative.”

Canada’s insurance carriers have been tapping credit markets and issuing preferred shares in order to meet their capital adequacy requirements. Unfortunately, they have been paying a premium to do so, the agency says, because of the relative lack of liquidity in those markets.

There is anecdotal evidence that segregated fund sales have picked up during the market downturn, as investors embrace the guarantees they include. But these guarantees are precisely the problem with the sector, A.M. Best says. If insurers are forced to pay out on equity-linked products before the stock markets recover, they could face huge investment losses.

“Although the ultimate financial impact cannot be assessed at this time and remains largely dependent upon future stock market performance, A.M. Best expects the overall operating performance for companies with large exposures to deteriorate,” the firm says.

While all insurers have enterprise risk management strategies in place, the market downturn is testing these to the limit for the first time.

“Continued deterioration in economic fundamentals would lead to higher credit defaults, ongoing equity market volatility, lower consumer confidence and higher unemployment,” according to A.M. Best. “As a result, life insurers would be pressured by weakening of product sales, earnings and capital adequacy.

“While A.M. Best notes that any negative rating actions will continue to be company-specific, the ongoing macroeconomic deterioration has led to a change in outlook for the entire segment.”

A.M. Best is not alone in its downcast opinion. On Wednesday, Moody’s lowered its rating on the insurance financial strength of three Manulife subsidiaries — Manufacturers Life Insurance, John Hancock Life Insurance and John Hancock Life Insurance (USA) — from Aa1 to Aa3.

(03/19/09)