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Rating Agency: The CDS Market Is A Tough Grader

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The credit default swaps market has been more bearish about life insurers than Moody’s Investors Service has been, but Moody’s says it believes its credit ratings reflect life insurers’ true level of resilience.

The CDS market gives participants a vehicle for profiting from speculation about how likely companies and government agencies are to pay their debts.

The credit ratings that Moody’s, New York, assigned to life insurers and the ratings implied by CDS market performance were roughly comparable up until September 2006, according to Moody’s data.

The CDS market was a little more bullish on insurers from September 2006 through June 2007, and a little more bearish from June 2007 until December 2007.

Starting in December 2007, the CDS market opinion of life insurers deteriorated sharply. Earlier this year, the CDS market was implying that the typical Moody’s-rated life insurer was about 3 rating notches riskier than Moody’s said it was. Now, the gap has narrowed to about 2 notches.

The CDS market is also somewhat more bearish than Moody’s about the property-casualty market, but there the gap is only about 1-notch wide.

The market appears to be more pessimistic about life insurer fundamental, Scott Robinson, a Moody’s analyst, writes in a comment on the data.

Life insurers recently have asked the National Association of Insurance Commissioners, Kansas City, Mo., to replace use of residential mortgage-backed securities credit ratings, arguing that the RMBS ratings are too low.

But the CDS market seems to think future losses on RMBS and other asset classes will be worse than Moody’s expects, Robinson writes.

CDS players are especially nervous about commercial real estate, “a sector where losses tend to occur in the later stages of a recession,” Robinson writes.

The market appears to be incorporating the potential for a “severe CRE scenario” that is more severe than Moody’s own, grim “stress case scenario,” Robinson writes.

Life insurers also are paying a price for how opaque and hard-to-understand their balance sheets are, Robinson writes.


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