Post by Sapphire Capital on Sept 10, 2008 21:10:11 GMT 4
Mortgage Backed Securities and Capital of Life Insurers: Was the Industry Prepared for the Credit Crunch of 2007-2008?
Etti G. Baranoff
Virginia Commonwealth University - Department of Finance, Insurance & Real Estate
Thomas W. Sager
University of Texas at Austin - Red McCombs School of Business
The Geneva Papers on Risk and Insurance Issues and Practice, Special Competition Edition, July 2008
Abstract:
In this article we explore U.S. life insurers' exposure to Mortgage-Backed Securities (MBS) and its potential impact on capital should the credit ratings of these bonds be lowered. We analyze two years: 2003 (well before the realization of problems with these instruments) and 2006 (immediately prior). We create five potential scenarios of different severity for recategorizing MBS credit ratings and compute the theoretical impact on measured insurer asset risk, via a proxy for the C-1 component of life insurers' risk-based capital. Under all scenarios we find large increases in assessed asset risk. We then model insurer capital structure as a function of asset risk and other factors to assess whether insurers had prepared their capital structures for the possibility of problems with these instruments. Our findings indicate not only that insurers were unprepared for MBS downgrades, but also that they reduced capital as they accumulated MBS, as though acquiring MBS should raise the overall quality of the investment portfolio. Finally, we analyze possible adjustments to capital to accommodate the now recognized increased risks of MBS. Our models suggest, for example, that an insurer with median MBS exposure might be expected to increase its capital by 10% or more to maintain an historical relationship between capital and risk factors, in the event of a moderate recategorization of MBS risk
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1215191_code257996.pdf?abstractid=1215191&mirid=1
Etti G. Baranoff
Virginia Commonwealth University - Department of Finance, Insurance & Real Estate
Thomas W. Sager
University of Texas at Austin - Red McCombs School of Business
The Geneva Papers on Risk and Insurance Issues and Practice, Special Competition Edition, July 2008
Abstract:
In this article we explore U.S. life insurers' exposure to Mortgage-Backed Securities (MBS) and its potential impact on capital should the credit ratings of these bonds be lowered. We analyze two years: 2003 (well before the realization of problems with these instruments) and 2006 (immediately prior). We create five potential scenarios of different severity for recategorizing MBS credit ratings and compute the theoretical impact on measured insurer asset risk, via a proxy for the C-1 component of life insurers' risk-based capital. Under all scenarios we find large increases in assessed asset risk. We then model insurer capital structure as a function of asset risk and other factors to assess whether insurers had prepared their capital structures for the possibility of problems with these instruments. Our findings indicate not only that insurers were unprepared for MBS downgrades, but also that they reduced capital as they accumulated MBS, as though acquiring MBS should raise the overall quality of the investment portfolio. Finally, we analyze possible adjustments to capital to accommodate the now recognized increased risks of MBS. Our models suggest, for example, that an insurer with median MBS exposure might be expected to increase its capital by 10% or more to maintain an historical relationship between capital and risk factors, in the event of a moderate recategorization of MBS risk
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1215191_code257996.pdf?abstractid=1215191&mirid=1