John Nadel (Photo: Allison Bell/ALM) John Nadel (Photo: Allison Bell/ALM)

S&P Global Ratings analysts kept assuring attendees at the firm’s latest insurance conference Wednesday that life insurer capital levels, investment portfolios and ratings look fine.

S&P analysts have concluded that, even though the average rating of the life insurers it rates is an A+, those insurers have 10% more total capital than they would need to qualify for an AA rating.

But guest speakers at the conference, in New York, talked often about the problems that might come along and wreck everything.

(Related: New Life and Annuity Deals May Be Complicated)

Worries about those problems might eventually blow away. But, if some of the problems show up, they could cause big changes in which companies are in what markets, and what those companies’ insurance products cost.

Here’s a look at three risks that came up often as powerful causes of nightmares.

1. Structured Finance Arrangements

Creators of collateralized loan obligations and other structured finance arrangements create pools of assets. The creator tries to cut the structured finance arrangement pie into several “tranches,” or slices. Each tranche is supposed to have a different level of risk.

John Nadel, a managing director at UBS Group AG, said the problem is that it’s hard for securities analysts like him to know what’s really in a structured financial arrangement asset pool.

The arrangements “are by their very nature opaque,” Nadel said.

Buyers have to hope the originator did a good job of verifying that the assets in a pool were good assets, and that the rating agencies that rated the different slices of the pie did a good job of rating the slices, Nadel said.

2. BBB Bonds

Under the National Association of Insurance Commissioners’ risk-based capital (RBC) ratio calculation rules, bonds or other instruments with ratings of BBB- or above, or investment-grade instruments, are much more powerful at contributing to a life insurer’s capital total than an instrument related BB+ or lower is.

Investors and others often call instruments that fall to the BB+ rating level or below, from an investment-grade rating level, “fallen angels.”

Several analysts said that life insurers have taken a relatively restrained approach to investing in bonds and other debt securities with ratings of BBB, BBB+ or BBB-, given what a large percentage of the debt securities now available have ratings of BBB- to BBB+,. But the analysts said that life insurers’ BBB-level asset total now makes up a large share of total assets simply because companies are issuing so many more BBB-rated notes and bonds than they issued in the past.

BBB-level bonds now make up about 34% of life insurers’ corporate bond holdings, and about 52% of the Bloomberg Barclays U.S. Corporate Bond Index, according to Guggenheim Investments.

Anne Walsh, a senior managing director at Guggenheim Partners LLC, who manages assets for life insurers, said that, from her perspective, one problem is that returns on BBB-level bonds are only a little higher than the rates on bonds with ratings of A- or above.

“You’re not getting paid to invest in this sector,” Walsh said.

Walsh said that another problem is that there’s no big, natural buyer for BB-level bonds, in part because of capital calculation rules that discourage life insurers and banks from buying high-yield bonds.

John Melvin, chief investment officer at Hartford Investment Management Company, emphasized the difference between BBB- bonds and BB+ bonds.

“The drop from BBB- to high-yield is a steep cliff,” Melvin said.

3. Bonds That Are Easy to Sell

Money managers refer to investments that are easy to sell as liquid, and investments that are hard to sell as illiquid.

Several analysts and money managers at the conference said mortgage loans and pools of ordinary business loans tend to be illiquid. when compared with stocks, or with the kinds of bonds with documents filed with the SEC.

Many securities analysts, regulators and money managers believe that holding liquid assets is safer than holding illiquid assets.

Walsh said liquidity is a myth.

“When you want it, it’s not there,” she said.

She said she’d rather get a higher investment yield by investing in an asset that’s seen as hard to sell than by overpaying for an asset that’s supposed to be liquid, given that liquidity may not be there when an investor actually needs liquidity.

Clarification: An earlier version of this article gave an unclear description of life insurers’ bond holdings. Life insurers’ holdings of corporate debt rated BBB- through BBB have grown more slowly than the amount of BBB-level debt on the market, but life insurers do hold a large amount of BBB-level debt.

— Read Investors Helping Life Insurers Shift to Pension Transfer Market: Analyston ThinkAdvisor.

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