Institutional Investment Products

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Moody's Investors Service research report published in April 2000.

The report discusses U.S. life insurance companies' participation in the institutional investment products market including products such as Funding Agreement Note Issuance Programs (FANIPs) and Guaranteed Investment Contracts (GICs). The report also contains short reviews of the leading life insurers active in this market at the time.

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Institutional Investment Products

  1. 1. April 2000 Special Comment Phone New York Patrick Finnegan Laura Bazer Ann Perry Arthur Fliegelman Robert Donohue Rajiv Gupta Christina Slattery Scott Robinson Ellen Fagin Natasha Gouey Robert Riegel 1.212.553.1653 Institutional Investment Products: The Evolution Of A Popular Product: Institutional Investment Products: The Evolution Of A Popular Product: Contact Special Comment
  2. 2. Moody's Insurance Research Internet Address: www.moodys.com/insurance Authors Senior Associates Senior Production Associates Arthur Fliegelman, Christina Slattery Ellen Fagin Natasha Gouey Susan Heckman John Lentz © Copyright 2000 by Moody’s Investors Service, Inc., 99 Church Street, New York, New York 10007. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS COPYRIGHTED IN THE NAME OF MOODY’S INVESTORS SERVICE, INC. (“MOODY’S”), AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided “as is” without warranty of any kind and MOODY’S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. Pursuant to Section 17(b) of the Securities Act of 1933, MOODY’S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY’S have, prior to assignment of any rating, agreed to pay to MOODY’S for appraisal and rating services rendered by it fees ranging from $1,000 to $1,500,000. PRINTED IN U.S.A. 2 Moody’s Special Comment
  3. 3. Table of Contents Summary Opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Why Are Insurers Interested In The Institutional Investment Marketplace? Separate Accounts’ Growth Outstripping Growth In The General Account Strong Insurer/Client Relationships Are Important . . . . . . . . . . . . . . . . . .6 . . . . . . . . . . . . . . . . . . . . . . . . . . 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Reliance On Institutional Investment Products Should Be Limited Assured Liquidity Is Crucial . 6 . . . . . . . . . . . . . . . . . . . . . . .6 Insurers See Funding Agreements As A Means To Expand The General Account How We View the Institutional Investment Products Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 “Cash Capital” Analysis – What Every Institutional Investment Product Issuer Needs To Do . . . . . . . . 10 Institutional Investment Products Rating Criteria – Key Factors Moody’s Uses In Evaluating An Institutional Investment Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Operational Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Liquidity Or Maturity Risk Asset Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Liability Optionality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Yield Curve Movements Spread Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Diversification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Funding Agreement Note Issuance Programs (FANIPs) Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 The Number Of Funding Agreement-Backed EMTNs Is Growing . An Expected Surge In Insurer Participation Moody’s Rating Process For FANIPs . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Legal Standing Determines Priority Of Claims Of Funding Agreements Perfected Security Interest An Evolving Market . . . . . . . . . . . . . . . . . . . . . . . 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 The Institutional Investment Product Marketplace Appendix 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exhibit 1- Prominent Issuers’ Institutional Investment Products Outstanding Exhibit 2 - Selected Public Market FANIP Issuance Exhibit 3 – Moody’s Rated FANIP Programs Prominent Issuer Reviews And Statistics 19 . . . . . . . . . . . . . . . . . . . . 20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 AEGON USA Life Insurance Companies – Monumental Life Insurance Company . . . . . . . . . . . . . . . 24 Moody’s Special Comment 3
  4. 4. Table of Contents (cont’d.) AIG Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Allstate Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Business Men’s Assurance Company of America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 CIGNA Corporation - Connecticut General Life Insurance Company Combined Insurance Company of America . . . . . . . . . . . . . . . . . . . . . . . . . . 32 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 First Allmerica Financial Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 GE Financial Assurance - GE Life and Annuity Assurance Company . Hartford Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . 38 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 ING U.S. Life Insurance Companies – Life Insurance Company of Georgia Jackson National Life Insurance Company John Hancock Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Massachusetts Mutual Life Insurance Company Metropolitan Life Insurance Company . . . . . . . . . . . . . . . . . . . . . 42 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Mutual of Omaha Life Insurance Companies – United of Omaha Life Insurance Company . Nationwide Life Insurance Company New York Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Ohio National Life Insurance Company Pacific Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Principal Life Insurance Company Protective Life Insurance Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Prudential Insurance Company of America Security Benefit Life Insurance Company SunAmerica Life Insurance Company Travelers Insurance Company 4 Moody’s Special Comment . . . . . . . . . 52 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
  5. 5. Summary Opinion Moody’s believes that insurance companies take on additional risks in marketing funding agreement (FA) or GIC contracts, especially compared to those contained in some life insurance products. However, Moody’s continues to hold the view that insurers can issue these contracts if balanced with an appropriate risk management system. An insurer’s overall exposure to institutional investment products needs to be carefully managed and controlled on an aggregate and detailed basis for the insurer to have an appropriate risk/reward tradeoff. Moody’s expects the new funding agreement backed global programs currently being developed by several large insurers will be a primary source of new investable funds for institutional investment product providers during 2000. These programs, an expansion of the existing EMTN programs, will also permit the issuance of these notes to U.S. domestic investors. Moody’s expects that most issuance will be fixedterm, non-callable and will be typically in the three to ten year maturity ranges. Moody’s expects that additional product variations will be developed over time, and that FAs will continue to grow in popularity. However, Moody’s believes that the more established general account GICs sold to 401(k) and other employee retirement savings plans are likely to show only modest growth absent a significant change in market conditions. As insurers continue to grow their institutional investment products books of business, Moody’s will rigorously evaluate the characteristics and the amounts outstanding of this business. As part of this review, we will pay careful attention to the processes and procedures used to manage the business, liquidity needs and resources, asset risks, and the company’s asset/liability management risk tolerance. Moody’s determines what we believe to be the appropriate degree of institutional investment products’ exposure for each company on a case-by-case basis. Moody’s includes in our evaluation criteria the insurer’ asset/liability management capabilities, ratings level, experience, investment track record, and the predictability of their liability structure. Moody’s believes that combined institutional spread-based product liabilities in the range of 20% to 30% of general account liabilities could be reasonable for an experienced company. However, insurance companies issuing institutional investment products need to be cognizant of the fact that these instruments are a form of operating leverage. Moody’s factors the extent to which an insurer continues to operate as an insurance company as an important criterion in our rating process. When institutional investment products reach a point where the company is overly dependent on these products, Moody’s will reduce the extent to which we primarily evaluate the institution as an insurance company. Alternatively, an insurer primarily or even exclusively managed as an institutionally focused banker will be rated on a basis comparable to the other institutional spread-based businesses that Moody’s rates, such as investment banks (with their matched books) and commercial finance companies. Moody’s credit analysis of FA backed securitizations revolves primarily around whether the investor has a perfected interest in the underlying funding agreement (FA) and whether that interest is pari-passu with other policyholder obligations. Moody’s Special Comment 5
  6. 6. Why Are Insurers Interested In The Institutional Investment Marketplace? SEPARATE ACCOUNTS’ GROWTH IS OUTSTRIPPING GROWTH IN THE GENERAL ACCOUNT The changing purchasing habits of the individual retail clients from insurance buyer to investor has had significant ramifications on the insurance industry. Clients have heavily migrated from purchasing fixed income products (fixed rate annuities and other guaranteed products) to equity-based products (variable annuities and mutual funds) during the last few years. This, in turn, has caused the general accounts of many insurers to experience slow or no growth. Fixed annuity sales remain depressed as compared to several years ago and surrender activity continues at historically high levels. To make matters worse for insurer’s general accounts, the best selling life insurance product is variable universal life insurance, which is becoming the product of choice in many situations. Therefore, it comes as no surprise that during the five years ended December 31, 1998, general account reserves have grown at a compound annual rate of less than 5% while separate accounts, which are largely equity-based, have grown 27% annually. Insurers typically have earned considerably wider spreads on fixed annuities than on variable annuities. This is due to several factors including that most insurers use external managers to manage the underlying funds in their equity-based separate accounts. INSURERS SEE FUNDING AGREEMENTS AS A MEANS TO EXPAND THE GENERAL ACCOUNT Demand for funding agreements has been growing in recent years. They offer investors a favorable combination of yield, maturity and security. In addition, for many investors, these new insurance company credits permit the portfolio manager to diversify the portfolio’s credit risk. Consequently, insurance companies view this market as a good opportunity to expand their general account business. Structured transaction products, such as EMTNs and global programs, can enable a life insurer to grow its general account balance sheet much more quickly and inexpensively than selling numerous annuity contracts in the retail market. Also, the funding agreements are sold with very minor marketing costs compared to those on almost all insurance products sold in the retail market. This results in a much reduced or eliminated surplus strain to the issuer for the issuance of these products compared to retail products. While funding agreements may not be the only game in town for insurers desirous of growing their general account liabilities, they may well be the most attractive alternative for many insurers. How We View The Institutional Investment Products Market STRONG INSURER/CLIENT RELATIONSHIPS ARE IMPORTANT An important criterion that Moody’s uses in evaluating business lines is the nature and strength of the relationship that exists between the insurer and the client. Moody’s believes that the existence of a strong, long term relationship between the two parties can lessen the risk to the insurer of contractual provisions such as surrender provisions. New Markets More Credit Sensitive Than Traditional Life Insurance Moody’s believes that the institutional investment product market is more credit sensitive than traditional life insurance, or even other insurance products such as retail marketed annuities. This is in part because these products are marketed to sophisticated institutional buyers in millions of dollars amounts at a time. These funds are often managed by a professional investment manager with a fiduciary obligation to the ultimate holder of the instrument. In cases such as these, Moody’s believes that it is unrealistic to believe that the investor will give significant forbearance to an insurer during a period under which it is undergoing financial stress. The investment manager must at all times take actions in the best interest of his clients, regardless of the detrimental effect these actions might have on the insurer. 6 Moody’s Special Comment
  7. 7. By definition, little if no business relationship exists between the investor and issuer when FAs are used to back EMTN issuance. In the short-term putable FA market, there may or may not be a broader relationship between the two parties. Evidence of a broader relationship could include direct contact between the insurer and the client, long term vendor relationships, and contractual provisions specifying rolling maturity dates. Even then, Moody’s believes that these products are in large measure institutional investments and are subject to the same credit forces affecting the commercial paper and medium term note market. Short-term Putable Contracts Present The Greatest Credit Risks Moody’s most serious credit concerns are directed to short-term putable contracts that give the insurer 60 days or less to respond to a request for funds. Moody’s believes that the short-term FA market is particularly credit sensitive due to Securities and Exchange Commission’s 2a-7 rule governing the primary buyers of these instruments, money market funds. The credit sensitivities of the remaining buyers of these products, security lenders, separate accounts and other short-term institutional lenders, are similar. Qualifying a product for the “liquid” basket of a money market fund, typically through the use of the put option, is also an important marketing consideration for this product. Moody’s believes that the institutional investment product market is more akin to banking than to insurance. In fact, for years the investment banking community has distributed investment vehicles similar to FAs as a means of financing their purchase of securities. Moody’s believes that there is a higher level of risk to an insurance company in marketing FA or GIC contracts than in marketing life insurance. However, Moody’s continues to believe that insurers can appropriately issue these contracts given appropriate risk management while maintaining a balance within the company’s overall product mix. However, an insurer’s overall exposure needs to be carefully managed and controlled on an aggregate and detailed basis. RELIANCE ON INSTITUTIONAL INVESTMENT PRODUCTS SHOULD BE LIMITED Moody’s believes that a highly rated insurer, having carefully developed experience and expertise in this product area, can support a moderate level of institutional spread-based liabilities. One method of evaluating an insurer’s exposure to this sector is as a percentage of general account liabilities. Moody’s believes that a highly rated insurer could have approximately 20% to 30% of general account liabilities in such products assuming the product line is appropriately managed. Moody’s will also evaluate the exposure to this sector relative to the company’s overall capital. While companies typically earmark a specific amount of capital to support the institutional investment product business, in reality the company’s entire capital base supports all product lines. Highly-rated Insurers Must Maintain Adequate Capital Moody’s believes that for a highly rated insurer, in addition to needing an appropriate degree of operating leverage in the institutional investment products business, overall capital levels must remain adequate to enable the insurer to meet all obligations even in times of unexpected stress. Moody’s will evaluate what we believe to be an appropriate degree of exposure for each company to this sector at its rating level on a case-by-case basis depending upon the individual facts and circumstances of the company under consideration. We include in our evaluation the insurer’s asset/liability management capabilities, investment track record and the predictability of its liability structure. In special circumstances, where relationship oriented clients are the primary product purchasers, we might feel comfortable even with a moderately higher level of exposure to this sector. Parental Support Is An Important Factor In Moody's Analysis While Moody’s begins with an analysis of the financial capability of the legal entity directly responsible for the liability, Moody’s is also mindful of the likelihood and ability of external financial support being supplied when needed by a corporate parent or affiliate. This is especially important in circumstances Moody’s Special Comment 7
  8. 8. where a formal support agreement exists, and Moody’s believes that the terms of the support agreement are sufficiently rigorous to be legally enforceable. In such a case, the capacity of the insurer to offer institutional investment products can be considerably increased beyond what Moody’s would consider appropriate on a stand-alone, unsupported basis. However, Moody’s will evaluate the effect of the explicit or implicit support on the financial strength and resulting rating of the combined organization. In some cases, with strong parent/affiliate support arrangements, Moody’s will evaluate the exposure of the overall entity to this business, instead of the specific legal entity issuing these products. An insurance company issuing institutional investment products needs to be cognizant of the fact that these instruments are a form of operating leverage. At times these products can also be a form of financial leverage, but since they are rarely used as funding vehicles for corporate acquisitions and other corporate purposes, Moody’s does not normally include them in computing financial leverage. In addition, market participants must be mindful of the fact that funding opportunities could quickly disappear, especially at inopportune moments, emphasizing the need for product, market and customer diversification. As an insurer becomes increasingly dependent upon these institutional investment products, Moody’s will begin to evaluate the institution less as an insurance company. Moody’s will instead begin to evaluate the institution more like the other institutional spread-based businesses we rate, such as investment banks (with their matched books) and commercial finance operations. ASSURED LIQUIDITY IS CRUCIAL Tolerance For A/L Mismatches Is An Important Measure Of Credit Risk Moody’s believes that the level of mismatching a company is willing to undertake is an important measure of the level of risk that a company assumes in operating an investment products program. Almost all institutional investment product issuers attempt to match their expected asset and liability cashflows for this product line to some degree. Some companies match as closely as possible as a matter of company policy. Other companies are willing to tolerate some level of intentional mismatch in an effort to benefit from expected future market movements. The more tightly run programs have strict limits on the level of mismatch permitted and regularly recalibrate their exposures to the permitted level. Non-securitized Commercial Mortgages Can Carry Significant Cash Flow Uncertainty Moody’s has serious concerns about the inclusion of non-securitized commercial mortgages in institutional investment product asset portfolios. Some companies like to include substantial amounts of these assets in their portfolios to benefit from their favorable yields. However, Moody’s believes that these assets offer a low level of liquidity when it is most needed, and have historically been prone to severe credit deterioration on a cyclical basis. During the early 1990s commercial mortgages that were supposed to mature were instead often extended or refinanced by insurers, even when the insurer had a pressing need for the funds to service maturing liabilities. Moody’s recognizes that the risk assumed by an insurer in making a specific commercial mortgage loan depends upon the loan’s specific characteristics with examples being loan-to value ratio, amortization period, maturity term, and collateral type. However, Moody’s remains of the general opinion that commercial mortgages are a questionable choice to support liabilities with firm, unalterable maturity dates. Moody's Analysis Focuses On The Insurer's Ability To Service Its Obligations As part of our rating process, Moody’s carefully evaluates the insurer’s ability to service its obligations. Moody’s believes that a highly rated insurer with defined liabilities, such as institutional investment products with specific maturity dates, should support them with assets with an equally well defined maturity date. Exceptions to this thinking would be when the insurer can demonstrate unquestioned access to the necessary funds in some other alternative manner. Our evaluation will include not only normal circumstances, but also the likelihood and consequences of reasonably possible stress scenarios. Even in stress scenarios, a highly rated insurer should display an unquestioned ability to service obligations as they mature. While Moody’s would normally expect that 8 Moody’s Special Comment
  9. 9. these liabilities would be serviced by operating cashflows and maturing assets, other sources of funds might be relied upon in exceptional stress circumstances. Moody’s will pay particularly heavy attention to assuring the adequacy and reliability of projected cash flows to service obligations as they come due. This will include a review of the sensitivity of these projected cash flows to interest rate and other market movements, credit events and other uncontrollable factors. Moody’s believes that an analysis of the line’s asset and liability cash flows, and any gap between them, is critical in evaluating the risk being assumed in writing this business. This analysis should be completed on a current interest rate base case basis, and also under stressed conditions of both rising and falling interest rates. The review of a cash flow variability analysis that has been accomplished in a manner consistent with that developed by the National Association of Insurance Commissioners’ (NAIC) Life Risk-Based Capital Interest Rate Risk Project (C-3) is especially helpful in determining the level of cash flow variability risk being assumed by the insurer in this line of business.1 Short-term Putable Products Are In Special Need Of Cautious Management Moody’s believes that short-term putable products are prone to “runs” compared to other insurance company products. Highly rated companies offering these products should have specific contingency plans in place at all times to deal with such a possibility – even and particularly under stressful circumstances. In the ideal situation, assets with maturity dates equivalent to the liabilities’ put date would support the liabilities, but other alternative liquidity mechanisms may be available to the insurer. If assets with dissimilar maturities are used, adequate provision must be made to account for any realized losses that could be incurred in premature market sales of these instruments. Most Insurers We Rate Have Sound A/L Management In Moody’s opinion, the vast majority of insurers have sound asset/liability management programs. They have also limited their involvement in the riskiest products, especially short-dated paper such as 7-day put contracts. As Moody’s stated in our 1998 report, “Funding Agreements – The New Frontier of Stable Value”, our concern with shorter dated liabilities is based upon the belief that “the shorter the put, the less room there is to maneuver if problems develop.” Assurance Of Adequate Liquidity Is Crucial For Short-term Put Products Moody’s continues to believe that the availability of adequate liquidity is fundamental for the issuance of short-term put products. As Moody’s has stated in the past, “the less liquid and lower quality the asset portfolio, the higher the potential for losses and increased probability of the funding agreement issuer becoming troubled.”2 However, Moody’s believes that the liquidity and asset problems that General American Life Insurance Company (General American) experienced during August 1999 were exceptional. General American’s exposure to 7-day put funding agreement contracts was far beyond life insurance industry norms both in terms of absolute dollar size and relative to the size of the institution’s balance sheet, capital and liquidity. General American’s reliance upon an unusually large reinsurance contract with a lower rated reinsurer only compounded this already outsized exposure. This reinsurance contract effectively ceded control of over $3 billion of General American assets to another party while leaving General American contingently at risk. In the ensuing weeks after the default, several other insurers also encountered relatively high levels of put activity. However, every one of them met their obligations with little strain and without absorbing significant investment losses. Most of these puts were not related to investor concerns regarding the financial strength of the insurer, but were instead due to a reconsideration by the investor of the appropriateness of this relatively new and previously untested asset class. 1 For more information on this project see the NAIC’s web site at http://www.naic.org/finance/interest_rate_risk_project_c3.htm. 2 See Moody’s Special Comment, Funding Agreements –The New Frontier of Stable Value, April, 1998. Moody’s Special Comment 9
  10. 10. “CASH CAPITAL” ANALYSIS – WHAT EVERY INSTITUTIONAL INVESTMENT PRODUCT ISSUER NEEDS TO DO Moody’s believes cash capital analysis can be an important method for testing spread-based product lines such as an institutional investment product portfolio. Cash capital analysis values liabilities to their put date. In addition, the method incorporates the existence of any other embedded options in the valuation process. Once the initial valuation process is complete, asset values are measured applying appropriate haircuts to account for the possible loss of value and liquidity discounts. Alternative stress scenarios can then be calculated to estimate the company’s ability to cover, through asset sales or other means, an unusual surge in liability redemptions. This methodology, commonly performed by investment banks for their matched book business, is not fool proof, but provides a significant degree of comfort that the insurer can handle any reasonably foreseeable occurrence. Another useful test is to engage in a “spread at risk” examination where assets are “marked-to-market” as are the liabilities. This test measures any unrealized losses that exist within the book of business. Moody’s believes that this measure can be a more accurate profitability gauge than the more conventional spread analysis method of using the book yield of assets minus any expense charges and liability crediting rates. This approach is of importance primarily if the liabilities can be withdrawn before their expected maturity date. If the liability cash flows are completely predictable, this test is of a reduced degree of importance. Institutional Investment Products Rating Criteria – Key Factors Moody’s Uses In Evaluating An Institutional Investment Program Moody’s assigns financial strength ratings to entire companies, not lines of business and usually not specific products. Nonetheless, as part of the rating process, Moody’s carefully reviews and evaluates the degree of risk in each business line and the relationship between the financial and business performance of these various lines. OPERATIONAL LEVERAGE Operational leverage is expressed as the business lines’ ratio of liabilities to internally assigned statutory capital. The level of this parameter is a crucial determinant of the economic attractiveness of the institutional investment products to an insurer. A high amount of operational leverage permits the program to improve its return on equity (ROE), but at a higher level of risk to the insurer. Conversely, a conservative, lower level of operational leverage reduces program risk, but can quickly make the program uneconomic due to a low resulting ROE. Moody’s is frequently asked to express our views regarding the degree of operational leverage we view appropriate in the operation of these programs. As discussed above, Moody’s rates companies, not lines of business, so we only secondarily look at the amount of leverage attributed to any specific line; our primary attention remains focused on the combined organization. However, during our review process, Moody’s expects that the degree of operational leverage attributed to any specific line should be consistent with the risks assumed in operation of the line. Insurers should be able to explain the operational leverage used in managing this line, just as they would with any other business. Some of the risks that Moody’s compares capital levels to are options embedded in the liability portfolio, asset credit quality, liquidity, volatility and interest rate sensitivity of the underlying asset portfolio. Moody’s believes that an appropriate operating leverage for this business is 11:1 to 15:1, dependent upon factors such as the company’s rating level, experience and management of the business, its other businesses, and its risk tolerance. This leverage range was based on a risk-based capital assessment for this line of business, assuming a typical investment allocation for companies active in this market. Moody’s views this range as appropriate for a well managed business, assuming the risks discussed below are carefully measured and managed in a manner consistent with what is expected from a highly rated entity. 10 Moody’s Special Comment
  11. 11. Under certain circumstances, Moody’s would consider operational leverages outside of this range, either up or down, as appropriate. Such circumstances could include especially risky asset or liability portfolios, relative inexperience in operating the business, or explicit parental or third-part support. LIQUIDITY OR MATURITY RISKS As institutional investment products become an increasingly important component of insurers’ balance sheets, liquidity or refinancing risk becomes increasingly important. This risk describes the ability of the insurer to service the liabilities as they come due, either on an expected or, more importantly, on an unexpected basis. Rollover risk is the risk that if new liabilities need to be issued to finance maturing liabilities, the issuer may be unable to do so. It is a given in financial markets that such circumstances occur during the most inopportune moments. General Account Assets Support All Business Lines For some companies, the institutional investment product line is operated on a standalone basis. For other companies, the business is operated as an integral part of a larger business. In either case, from a legal perspective, the resources of the entire organization support all the liabilities, including the institutional investment products. Spreading Liability Maturities Help Disperse Risk One method for managing this risk is to carefully disperse liabilities’ maturities over time – a laddered maturity structure. It is normally less risky to have liability maturities spread out over a wide time spectrum rather than highly concentrated in a short time period. Special care should be taken in environments like now, when issuers are writing large amounts of new liabilities during a fairly tight time frame, to ensure that the resulting liability portfolio is well diversified over time. Without appropriate attention, the liability portfolio could end up being highly concentrated. The spreading of the liability structure is especially crucial if mismatches can occur between asset and liability maturities. It is less important if asset cash flows are sufficient to service the liabilities as they mature. Any mismatch, either expected or unexpected, could require the insurer to dispose of assets at an inopportune time in order to service its liabilities if the insurer is also simultaneously unable to issue new liabilities as the old ones mature. One simple but effective method to reduce the level of maturity risk assumed by the insurer is to create a laddered liability maturity structure where each year’s maturities are limited to a specified percentage of the total institutional investment products outstanding. Under this approach, the adverse financial affect of stressful market conditions or specific company credit problems can be managed over an extensive time period, instead of having to be resolved quickly under stress. Other useful precautions that can be taken include matching near term liability payments due with short-term assets, ownership of adequate amounts of liquid securities, and the development of alternative liquidity facilities such as committed bank lines. Moody's Introduces Short-term Insurance Financial Strength Ratings Constant access to adequate liquidity resources is especially crucial to issuers of short-term funding agreements. Moody’s believes that 90-day putable FAs need to be considered for liquidity testing purposes as 90-day liabilities, even if they are unlikely to be put. To qualify for a Moody’s Prime-1 short-term insurance financial strength rating, significant issuers of short-dated put products need to have available access to alternative liquidity, which can be in the form of back-up lines of credit, liquidity facilities, unused securities reverse purchase facilities, or readily-available marketable securities. ASSET RISK Moody’s believes that asset risk is important. However, asset management principles such as diversification, careful underwriting, and adequate credit quality are not much different than those that apply to other product lines. One important consideration is that given the tight margins involved in institutional investment products, insurers do not have much room for error in their institutional investment management portfolios. Any significant level of investment losses will rapidly push the line into marginal profitability or worse. Moody’s Special Comment 11
  12. 12. LIABILITY OPTIONALITY Another potential source of risk are options embedded in the institutional investment product liabilities. Some liabilities have no embedded options, such as funding agreements used to back most FANIP programs. Moody’s views institutional investment product programs that issue liabilities without embedded options as a favorable credit factor. Benefit Responsive GICs Contain Weak Embedded Option Other liabilities have weak options embedded in them. Examples include most benefit responsive GICs marketed to defined contribution plans. While these GICs contain put options, these options are difficult to exercise and expose the insurer to limited losses even when exercised. In addition, most issuers have considerable expertise in evaluating and underwriting this risk. Consequently, Moody’s has typically not been especially concerned regarding the limited optionality embedded in these liabilities. Moody’s most serious concerns arise with liabilities containing short or unusual put provisions. Examples include short-term putable funding agreements and funding agreements containing unusual put or index provisions. Moody’s believes that an issuer of such a product carefully understand and manage the option risk, and carefully controls the amount of the exposure. The issuer should also be able to demonstrate that it can satisfy these option obligations, even under exceptional circumstances, without compromising the institution’s financial strength. Downgrade Provisions In Muni-GICs Compound Other Risks Moody’s views the incorporation of “downgrade” provisions in contracts as substantially increasing the risk level of the contract both to the insurer and to policyholders not benefiting from this provision. These provisions permit the contract holder to put the contract back to the insurer prior to the contract’s normally scheduled maturity date. This special put is triggered when the insurer’s insurance financial strength rating is downgraded by a designated rating agency below a predefined threshold. Contracts with these provisions are typically issued to municipalities and are consequently referred to as “muni-GICs”. Puts exercised under these provisions are by definition exercised at a time when the insurer is already under financial stress. This stress is further exacerbated by the fact that there is no realistic method for the insurer to hedge this risk. YIELD CURVE MOVEMENTS Moody’s expects that highly rated institutional investment product issuers will carefully evaluate and manage risks assumed from yield curve movements. This can be accomplished directly through the liabilities issued and assets purchased, or indirectly through hedging transactions. Hedging transactions used to hedge yield curve movements include interest rate futures and, more notably, interest rate swaps. Cash Matching Is Lowest Risk But Impractical In Practice When the block is managed on a cash matched basis, the issuer’s entire exposure to yield curve movements is automatically eliminated. However, Moody’s believes few if any companies manage their portfolio on this basis since cash matched portfolios leave issuers very limited flexibility in managing their program. It is also difficult to manage a program in this manner profitably. Consequently, issuers manage these blocks on another basis, permitting them more flexibility in the program management, but with the need for more sophisticated analysis to control the program’s risk profile. Moody’s believes that to limit the risk of a duration-managed program to the sponsoring insurer, financial affects of both parallel and non-parallel yield curve shifts have to be evaluated and controlled. Parallel yield curve shifts can be more easily managed and are evaluated on a duration basis. Non-parallel Yield Curve Shifts Are Most Common And Are Harder To Manage However, yield curve shifts are almost never completely parallel. Non-parallel movements are both the rule and considerably more challenging to manage. Therefore management requires partial duration analysis along with the construction of carefully designed hedging programs. 12 Moody’s Special Comment
  13. 13. SPREAD RISK Even programs managed on a “perfectly matched” interest rate risk basis remain exposed to potential spread risk, or the risk that asset yield spreads will vary from those expected against their Treasury or LIBOR benchmark rates. These spread deviations occur regularly in financial markets, although typically in more modest fashions than for interest rate movements. Unfortunately, spread movements are especially difficult, although not necessarily impossible to hedge. Moody’s believes that almost all insurers elect to assume spread risks, and consequently need to have sufficient capital to absorb reasonably anticipated spread movements. Spread risk is relatively unimportant if the insurer will not need to sell the asset prior to its maturity to generate liquidity. This would be true in cases when the assets’ maturity is matched to the liability, or when funds are available from other sources to service the liabilities. However, if these assets may have to be sold, spread risk becomes much important. This is especially true if the assets under consideration are relatively illiquid or prone to significant spread moves. An example of the potential importance of spread risk is the General American situation. Moody’s believes that spread risk, and not interest rate movements, caused much of the problem that lead to its insolvency. DIVERSIFICATION Moody’s carefully evaluates both the risks of the program and its effect on the insurer’s overall risk profile during our rating process. Institutional investment products, while not without risk on a stand-alone basis, may permit the insurer to better manage the over all risks assumed by the insurer. For example, the presence of a book of institutional investment products may help lower the overall risk profile of an insurer that had previously just written retail immediately surrenderable deferred annuities. In such a case, longer dated institutional investment products may serve as a base of stable, predictable liabilities while the deferred annuities’ surrender experience varies considerably over time. Funding Agreement Note Issuance Programs (FANIPS) BACKGROUND Moody’s credit analysis of funding agreement backed securitizations, such as the widely marketed EMTN programs, revolves around the primary question of whether the investor has a perfected interest in the underlying FA and whether that interest is pari-passu with other policyholder obligations. Under a funding agreement note issuance program (FANIP), whether it is an EMTN program or a domestic Medium Term Note Program (MTN), a special-purpose, bankruptcy-remote vehicle (SPV) is established. The SPV’s sole purpose is to issue notes to investors and then use the proceeds to purchase funding agreements from the sponsoring insurance company. The funding agreement therefore serves as the sole asset collateralizing the SPV’s debt issuance. (See EMTN Program Structure below.) EMTN Program Structure Funding Agreements Insurer Principal + Interest Proceeds EMTN Notes Special Purpose Vehicle Assign Funding Agreement Principal + Interest Noteholder Proceeds Trustee/Paying Agent Moody’s Special Comment 13
  14. 14. The indenture governing the program will ensure that the terms of the funding agreements will mirror the terms of the notes issued by the SPV in order to eliminate any mismatches. As subsequent notes are issued by the SPV, this matching principle is reapplied. If mismatches occur, the SPV would assume risk and would need to be adequately capitalized to absorb any potential losses. Programs are designed to issue a series of notes up to an initially authorized program limit, which can be raised at a later date. FANIP SPVs are created in non-US jurisdictions with favorable tax laws such as the Cayman Islands. The notes issued by these vehicles are rarely marketed in the U.S. for a variety of reasons, including their not being registered with the SEC. Instead of registering the instruments with the SEC, these offerings are instead subject to “Regulation S” of the Securities Act of 1933, as amended, for non-U.S. investors. The notes are marketed to numerous investors around the world outside the U.S., most prominently Europe, Asia and Australia. Many of these transactions are publicly placed and are listed on a European exchange in an effort to improve their liquidity. In many cases insurers have also issued FANIPs in private transactions under these programs in response to investor “reverse inquiry.” Such issues are customer tailored for the need of a specific buyer, often are of smaller size, and usually offer the investor lesser liquidity than public deals. THE NUMBER OF FUNDING AGREEMENT-BACKED EMTNs IS GROWING Moody’s believes that currently the amount outstanding of EMTNs backed by funding agreements approximates $20 billion. The tables at the end of this report supply further detail on the actual issuance that has taken place. To date, most notes have had bullet maturities ranging from three to twenty years in length. Coupons are usually set at a fixed-rate. Notes with floating rates or step-up coupons have been issued when the allin cost for doing so was favorable. Until recently, legal and regulatory issues limited the use of domestic MTNs backed by FAs. One major impediment was that the New York Insurance Department (NYID) believed that transactions such as these constituted the marketing of an insurance policy by an intermediary. In the NYID’s view, such a transaction is not permitted under New York law unless the intermediary and its employees are licensed as insurance agents. This is very rarely the case for investment banks and their employees. However, the NYID has subsequently reconsidered its view on this issue and it is believed that this is no longer an obstacle to launching a domestic program. AN EXPECTED SURGE IN INSURER PARTICIPATION Moody’s believes that several insurers are in the process of developing domestic programs and that approximately 10 to 15 U.S. life insurers will access the market domestically during the next 24 months. To date only Protective Life has issued notes domestically to U.S. investors through a domestic Delaware SPV trust. Moody’s believes that the volume that will be eventually issued in the domestic U.S. market could easily exceed that of the Europe market, and that this may well occur in a fairly short period of time. This will be driven by the fact that the insurers will often be able to place debt domestically at more favorable levels than that required in Europe. These savings will result from a variety of factors including the more liquid U.S. bond market, improved issuer name recognition in the domestic market, and the fact that at least some of these issuers have name scarcity value. MOODY’S RATING PROCESS FOR FANIPs When Moody’s assigns a rating to a FANIP program, it is usually equal to the underlying insurer’s insurance financial strength rating (IFSR). The IFSR rating is the most senior rating that Moody’s assigns to insurance company obligations. This rating applies only to the insurer’s most senior policyholder obligations. A crucial part of the evaluation process in assigning this rating is that Moody’s determines that the funding agreements supporting this obligation are pari-passu with other senior policyholder obligations. When an individual program draw takes place, Moody’s rates the specific drawdown. “Plain vanilla” tranches or notes without unusual features will carry the program rating. However, in some cases the drawdown may contain a credit linked or other embedded derivatives and might be rated lower than the program rating. 14 Moody’s Special Comment
  15. 15. The actual documentation reviewed by Moody’s in its analysis done to assign a FANIP rating will vary depending on the details of the transaction. Typical documentation in these transactions include the following: • Indenture governing issuance of debt by SPV • Legal opinions - Priority status of FA - Perfection of security interest - Tax opinion - Corporate opinion • Incorporation documents for the SPV • Form of Funding Agreement • Offering document • Dealership agreement LEGAL STANDING DETERMINES PRIORITY OF CLAIMS OF FUNDING AGREEMENTS In the U.S., insurance companies are primarily regulated by the insurance department of their state of domicile. Consequently the laws of that state determine the priority of claims in the case of the insurer’s insolvency, and therefore, have a bearing on the ultimate rating assigned to an issue. Under some state insurance laws or regulations, FAs and/or GICs are specifically mentioned as being considered policyholder liabilities and therefore receive the highest priority of claims. In other states, FAs or GICs may not be explicitly mentioned in the state insurance regulations, making the priority of claims for these instruments in the event of an insolvency unclear, or even worse, subordinate to other policyholder obligations. As a result, some issuers of FAs in states with unclear regulatory environments have sought and received legal opinions from an attorney familiar with that state’s insurance laws and regulations. Moody’s approach is to review the state of domicile’s insurance law as well as relevant legal opinions. If the state insurance law and/or legal opinions suggest that the FA/GIC may be relegated below policyholders in standing under an insolvency or other regulatory action, Moody’s rating assigned will most likely reflect that increased risk profile. In such a case the FANIP rating would usually be one notch lower than the insurer’s financial strength rating. Additionally, Moody’s will monitor the state insurance laws to determine whether the regulations or opinions have changed since the ratings were initially assigned. To date, Moody’s has determined that only one state, Massachusetts, has insurance laws where funding agreements are subordinate to other policyholder obligations. Recently, the Massachusetts State Senate passed a bill which would make funding agreements pari-passu with othr insurance obligations. The legislation additionally needs House and Governor approval to become law. If this change takes place, Moody’s expects to treat funding agreements issued by Massachusetts domiciled life insurance companies consistent with our practice for companies domiciled in other states.3 PERFECTED SECURITY INTEREST Each SPV note issuance is secured by a funding agreement issued by the sponsoring insurer. The notes themselves are non-recourse to the insurer. Moody’s, in our ratings process, will need to establish that holders of the SPV notes have a perfected interest in the supporting funding agreement and that it will continue to serve as their collateral. Under New York law, which is generally regarded as the industry standard for securitizations, funding agreements usually constitute collateral that is excluded from New York Uniform Commercial Code (NYUCC). The economic equivalence of a security interest in the funding agreement can be achieved by assigning the funding agreement to the indenture trustee for the benefit of the note investors. In addition, 3 See Moody’s Special Comment, All Funding Agreements Are Not The Same – Priority of Claims Varies And is Determined By The Issuer’s State of Domicile, June, 1999. Moody’s Special Comment 15
  16. 16. the insurer will change its books and records to reflect the assignment and will acknowledge such actions with a notice to the trustee. The trustee, who takes possession of the funding agreements, thereby achieves perfection of the security interest. In the event that funding agreements are interpreted as eligible collateral covered under NYUCC, the trustee will have achieved security interest perfection by filing Uniform Commercial Code (UCC-1) financing statements with relevant New York local offices, naming the SPV as debtor, and the trustee as secured party for the benefit of the note investors. In an effort to ensure perfection under non-New York jurisdiction, the trustee will also file UCC-1 statements in the state where the insurer is domiciled.4 The Institutional Investment Product Marketplace AN EVOLVING MARKET The institutional investment products market has rapidly been transformed during the last decade. It has evolved from simple fixed rate, fixed maturity general account GICs sold primarily to 401(k) plans into a marketplace containing a multitude of products purchased by a wide assortment of institutional Sales Activity Survey* investors. Some of the products now sold include (Billions of dollars) synthetic GICs, short-term funding agreements, 1999 1998 separate account GICs, funding agreement note General Account GIC $16 $17 issuance programs, and other securitized programs. Moody’s expects that new products will continue to be developed, that the relatively new FAs will continue to grow in popularity, while the older traditional general account GICs sold to 401(k) plans will likely enjoy only modest growth, at best. General Account FA Separate Account Products $34 $8 $25 $7 Total $58 $49 *Source: LIMRA-SVIA Stable Value and Funding Agreement Products 1999 Sales and Assets Survey, dated March 9, 2000 Short-term FAs Sales Have Resumed During the first six months of 1999, sales of shortterm funding agreements continued to quickly expand. Several new issuers entered the market and more money market funds began buying shortterm FAs. However, the General American default in early August caused sales of short-term “putable” FAs to stop almost overnight. Even some financially strong issuers were subject to put activity by investors reconsidering their commitment to this asset class. Institutional Investment Products Assets Under Management as of December 31, 1999 (Billions of dollars) Stable Value Funding Agreements $235 $62 Total $298 *Source: SVIA-LIMRA Stable Value and Funding Agreements Products 1999 Sales and Assets Survey. The market for these products has stabilized in late 1999 and early 2000, and some sales have resumed on a deliberate basis. However, it is too early to tell whether both insurers will fully resume their marketing efforts and if investors will purchase these products with their previous enthusiasm. Popularity Of GICs May Have Peaked For Now Traditional GICs, separate account GICs and synthetic GICs all can be expected to experience slow growth in the near term. Traditional GICs may attract additional attention if interest rates rise and spreads widen further, but the dynamics of the 401(k) business (advent of 404c5, the life insurance defaults of the early 1990’s, and the favorable performance of equity markets) have lowered the demand considerably for traditional GICs. 4 See also Moody’s Special Comment, A Brave New World – U.S. Life Insurers Get Innovative with European Medium Term Note Program Backed by Funding Agreements, April, 1999. 5 Under Federal law, ERISA Section 404c, a company can reduce its fiduciary liability by allowing plan participants to take control of their assets in the plan. 16 Moody’s Special Comment
  17. 17. Additionally, pressures on synthetic GIC fees have been in place for years. This has substantially lowered the profitability on notional value for all providers of this product. Because of this, only a few insurance providers remain committed to the business. New Domestic And Global MTN Programs Offer Best Chance For Growth If growth in the institutional investment products business is to occur in the near term, it will be through the new domestic MTN programs and related trust structures that can benefit from the large corporate debt market in the United States. The potential issuers of the funding agreements backing domestic MTN instruments have little debt outstanding today so investors may be enticed by the diversification these offerings afford compared to bank debt, industrials or finance companies. Moody’s Special Comment 17
  18. 18. 18 Moody’s Special Comment
  19. 19. Appendix Following are three exhibits and a discussion by Moody’s analysts of the credit characteristics of the prominent institutional investment product issuers. Exhibit 1 is a table of Prominent Issuers and their institutional investment products exposures. This measures the amount of institutional investment product business written by the insurer and expresses this exposure as a percent of liabilities and capital. Several of the legal entities listed are affiliates of larger insurance groups. In many cases, membership in the group significantly influences the insurance financial strength rating Moody’s has assigned the company. Exhibit 2 includes selected public market FANIP issuances during 1999 and 2000. The listing is useful for those investors that have or are considering investing in this sector. Private issues and certain public issues may not be included in this list. Additionally, Exhibit 3 lists all FANIP programs currently rated by Moody’s. Following the exhibits, Moody’s discusses the credit characteristics of the prominent institutional investment product issuers. This includes a discussion of the company’s insurance financial strength rating, the rating outlook and selected statutory statistics for the company. In cases of more than one company in a group active in the institutional investment products market, statistics are published only for the group’s primary issuer. This section also briefly discusses the management approach of the company in this market. For further information on these companies, please refer to the company’s annual Moody’s report. Moody’s Special Comment 19
  20. 20. Exhibit 1 Prominent Issuers’ Institutional Investment Products Outstanding Data as of September 30, 1999 Dollars in Millions Company Name 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Principal Life Insurance Co * John Hancock Life Insurance Co Prudential Insurance Co of America ** New York Life Insurance Co Sunamerica Life Insurance Co Monumental Life Insurance Co Metropolitan Life Insurance Co Travelers Insurance Company Pacific Life Insurance Co Jackson National Life Insurance Co Transamerica Life Insurance & Annuity Co Allstate Life Insurance Co GE Life and Annuity Assurance Co Protective Life Insurance Co Hartford Life Insurance Co First Allmerica Financial Life Ins Co Peoples Benefit Life Insurance Co United of Omaha Life Insurance Co Ohio National Life Insurance Co Connecticut General Life Insurance Co Business Men’s Assurance Co of America AIG Life Insurance Company Life Insurance Co of Georgia Combined Insurance Co of America Massachusetts Mutual Life Ins Co American Int'l Life Assurance Co New York Security Benefit Life Ins Co Nationwide Life Insurance Co IIPs as % of Policy Moody’s Policy Res IIPs as % of IIPs Reserves IFSR Rating & Liabs Capital Outstanding and Liabs Aa2 Aa2 A1 Aa1 Aaa Aa3 Aa2 Aa3 Aa3 Aa3 Aa3 Aa2 Aa2 A1 Aa3 A1 Aa3 Aa3 A1 Aa3 A1 Aaa Aa2 A1 Aa1 Aaa A2 Aa2 48% 36% 14% 23% 59% 55% 8% 28% 32% 19% 50% 20% 44% 46% 16% 50% 26% 17% 31% 4% 42% 15% 39% 31% 2% 13% 23% 2% 420% 249% 92% 146% 605% 793% 75% 118% 434% 218% 521% 184% 559% 466% 116% 355% 202% 178% 205% 48% 378% 234% 479% 145% 14% 146% 113% 22% $17,346 12,895 12,576 12,541 10,048 9,342 8,557 6,549 6,300 5,906 5,668 5,351 3,952 2,670 2,272 2,210 1,495 1,406 1,181 1,088 1,054 873 858 842 709 685 594 344 $36,499 35,994 90,692 55,442 17,141 16,874 104,292 23,061 19,466 30,547 11,447 26,737 8,935 5,748 13,855 4,436 5,660 8,252 3,824 28,107 2,488 5,729 2,209 2,751 37,922 5,414 2,590 19,690 * Company did not provide data. Estimated from Liabilities line 10.2 + 10.3, Guaranteed Interest Contracts and Other Contract Deposit Funds, of quarterly statement. ** Includes $6.2 billion of institutional spread business issued by Prudential Insurance Company and backed by commercial paper issued by PruFunding Corp. IIP = Institutional Investment Products Policy Reserves & Liabilities is the sum of Liabilities lines 1 thru 11.3 in the quarterly statement. 20 Moody’s Special Comment
  21. 21. Exhibit 2 Selected Public Market FANIP Issuance January 1999 to Present Dollars in thousands Ann Date Issuer Maturity Date Final Coupon Currency Amount (‘000) Amount Moody’s (US $’000) Rating 2-Jun-04 2-Jun-04 26-Jan-05 25-Nov-05 6-Oct-03 8-Dec-04 25-Nov-05 8-Dec-04 25-Nov-05 6-Oct-03 26-May-04 25-Nov-05 6.2500 6.2500 1.2000 5.0000 6.3750 4.7500 5.0000 4.7500 5.0000 6.3750 6.5000 5.0000 US$ US$ JPY EUR US$ EUR EUR EUR EUR US$ STG EUR 250,000 500,000 50,000,000 150,000 100,000 200,000 50,000 300,000 100,000 250,000 100,000 250,000 250,000 500,000 476,644 154,500 100,000 203,000 51,560 312,000 106,380 250,000 158,000 269,542 3,086,626 Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa 14-Jan-10 4.2500 25-Jul-04 3mth Libor + .30% SFR US$ 250,000 250,000 157,710 250,000 407,710 NR NR 7-Jun-99 19-May-99 17-Jan-00 4-Jan-00 8-Dec-99 30-Nov-99 18-Nov-99 17-Nov-99 11-Oct-99 27-Sep-99 25-Aug-99 12-Aug-99 AIG SunAmerica Institutional Funding AIG SunAmerica Institutional Funding AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG SunAmerica Institutional Funding II AIG Sun America Subtotal 30-Nov-99 14-Jul-99 Allstate Life Funding Allstate Life Funding Allstate Subtotal 26-Jan-00 25-Jan-00 13-Jan-00 18-Mar-99 Jackson National Life Funding Jackson National Life Funding Jackson National Life Funding Jackson National Life Funding LLC Jackson National Subtotal 28-Aug-03 3.5000 8-Feb-05 US$Libor+20 bps 15-Nov-02 BBSW+25 bps 6-Apr-04 3mth Libor+0.20% SFR US$ AUD US$ 250,000 250,000 250,000 300,000 155,280 250,000 166,980 300,000 872,260 Aa3 Aa3 Aa3 Aa3 11-Jan-00 2-Nov-99 26-Aug-99 9-Jul-99 7-Jun-99 2-Jun-99 6-May-99 22-Mar-99 17-Mar-99 22-Jan-99 7-Jan-99 John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Global Funding Ltd John Hancock Subtotal 31-Jan-05 30-Nov-04 15-Feb-06 13-Aug-09 22-Jun-04 6-Jul-04 30-Mar-09 18-Feb-04 30-Mar-09 8-Feb-06 18-Feb-04 7.5000 5.2500 6.7500 4.0000 6.5000 4.3750 6.1250 2.5000 6.1250 3.8750 2.5000 US$ EUR AUD SFR US$ US$ US$ SFR US$ EUR SFR 300,000 300,000 300,000 300,000 300,000 150,000 350,000 150,000 250,000 300,000 182,017 300,000 315,300 189,000 190,913 300,000 86,972 250,000 102,585 250,000 347,705 182,017 2,514,492 NR NR NR NR NR NR NR NR NR NR NR 23-Jun-99 MassMutual Global Funding LLC 7-Jul-06 7.0000 US$ 300,000 300,000 NR 20-Jan-00 1-Dec-99 19-Nov-99 30-Sep-99 16-Apr-99 Monumental Global Funding Monumental Global Funding Ltd Monumental Global Funding Ltd Monumental Global Funding Ltd Monumental Global Funding Ltd Monumental Global Subtotal 28-Feb-05 3.5000 31-Mar-03 3.2500 31-Mar-03 3.2500 20-Oct-04 3mth Euribor+.15% 15-Jul-09 4.3750 SFR SFR SFR EUR EUR 200,000 50,000 200,000 500,000 250,000 125,172 31,490 129,030 533,650 269,426 1,088,768 NR NR NR NR NR 5-Jan-00 9-Nov-99 14-Jul-99 Nationwide Financial Funding LLC Nationwide Financial Services Nationwide Financial Services Nationwide Subtotal 8-Feb-05 SFR Libor+15 bps 24-Nov-06 5.3750 18-Aug-04 3.0000 SFR EUR SFR 250,000 250,000 500,000 161,436 260,075 316,670 738,181 Aa2 Aa2 Aa2 Pacific Life Funding LLC Pacific Life Funding LLC Pacific Life Funding LLC Pacific Life Funding LLC Pacific Life Subtotal 15-Sep-05 15-Mar-07 23-Dec-03 15-Mar-07 SFR SFR SFR SFR 200,000 50,000 100,000 350,000 131,580 32,560 70,651 246,600 481,391 Aa3 Aa3 Aa3 Aa3 17-Aug-99 2-Jun-99 18-Feb-99 1-Feb-99 3.5000 3.0000 2.5000 3.0000 Moody’s Special Comment 21
  22. 22. Exhibit 2 Selected Public Market FANIP Issuance (cont.) January 1999 to Present Dollars in thousands Ann Date Issuer 11-Nov-99 4-Nov-99 3-Mar-99 12-Jan-99 27-Jan-00 Principal Financial Global Funding LLC Principal Financial Global Funding LLC Principal Financial Global Funding LLC Principal Financial Global Funding LLC Principal Global Financial Principal Subtotal 21-Jun-99 5-May-99 22-Apr-99 10-Mar-99 16-Feb-99 2-Feb-99 SunAmerica Institutional Funding SunAmerica Institutional Funding SunAmerica Institutional Funding SunAmerica Institutional Funding SunAmerica Institutional Funding SunAmerica Institutional Funding SunAmerica Subtotal 9-Jun-99 24-Feb-99 Travelers Insur Co Institutional Funding Ltd Travelers Insur Co Institutional Funding Ltd Travelers Subtotal Total Source: Warburg Dillon Read and Capital Data Bondware 22 Moody’s Special Comment Maturity Date Final Coupon Currency Amount (‘000) Amount Moody’s (US$’000) Rating 7-Apr-04 15-Oct-02 7-Apr-04 22-Jan-09 17-Feb-05 2.2500 6.7500 2.2500 4.5000 5.6250 SFR AUD SFR EUR EUR 250,000 150,000 250,000 300,000 300,000 161,290 95,610 172,521 346,580 301,000 1,077,001 Aa2 Aa2 Aa2 Aa2 Aa2 SFR EUR STG SFR US$ US$ 150,000 500,000 250,000 250,000 150,000 850,000 97,428 528,989 403,551 170,381 150,000 850,000 2,200,349 Aaa na na Aaa Aaa Aaa EUR EUR 250,000 300,000 257,626 332,853 590,479 Aa3 Aa3 27-Apr-04 2.0000 21-May-02 3mth Euribor+0.05% 7-Dec-09 5.3750 27-Apr-04 2.0000 15-Feb-09 5.7500 15-Feb-09 5.7500 16-Jun-06 5-Mar-09 4.2500 4.5000 13,357,257
  23. 23. Exhibit 3 Moody’s Rated FANIP Programs Dollars in Millions Issuer AIG SunAmerica Institutional Funding Federal Kemper Life Assurance Company* Jackson National Life Funding LLC Nationwide Financial Funding LLC Pacific Life Funding, LLC Principal Financial Global Funding, LLC Protective Life U.S. Funding Trust AIG SunAmerica Institutional Funding II & III Transamerica Global Funding Corporation I Transamerica Global Funding Corporation II Travelers Insurance Co. Institutional Funding Ltd. Program Rating Aaa Aa3 Aa3 Aa2 Aa3 Aa2 A1 Aaa Aa3 Aa3 Aa3 Amount Market Type US$ 5,000 US$ 300 US$ 2,000 US$ 2,000 US$ 5,000 US$ 2,000 US$ 200 US$ 12,500 US$ 2,000 US$ 2,000 US$ 2,000 Global Multiple Euromarket Global Euromarket Euromarket United States Euromarket Euromarket Euromarket Euromarket *Premium Asset Trust Certificates is actual issuer Moody’s Special Comment 23
  24. 24. Institutional Investment Products Review AEGON USA Life Insurance CompaniesMonumental Life Insurance Company Company Overview Moody’s Aa3 insurance financial strength rating and P-1 short-term financial strength rating of Monumental Life Insurance Company (MLIC), and the other members of the AEGON USA and Transamerica life companies reflect the group’s good profitability and established market positions in its core business segments, as well as its strong liquidity, its good-quality investment portfolios, and its sound group capitalization. The rating also incorporates the financial strength of the group’s ultimate parent, Netherlands-based AEGON N.V. (AEG). These strengths are tempered by the group’s focus on commodity-like accumulation products, financial leverage at the parent company level and the group’s exposure to interest rate and derivatives basis risk. MLIC and the other members of the AEGON USA Life insurance group have a stable ratings outlook. AEG acquired Transamerica Corporation (TA), a significant U.S.-based insurer on July 21, 1999. TA is functionally a sister company of AEGON USA. The acquisition further strengthens the group’s significant position in several markets including individual annuities, life insurance, and GICs as well as giving AEG entry into the life reinsurance and Canadian insurance markets. The chief risks include increased leverage at AEG, the issue of integration of TA into AEG, and TA’s commercial finance and leasing operation, which has a higher risk profile than the insurance operations. On November 30, 1998, three sister companies (Commonwealth Life Insurance Company, Peoples Security Life Insurance Company and Capital Security Life Insurance Company) were merged into MLIC, creating a legal entity with close to $16 billion in assets. Institutional Investment Products AEGON USA and Transamerica provide investment only products such as fixed and floating rate GICs, synthetic GICs, separate account GICs, and other investment products to various institutional pension plans – public, union, and corporate, both defined contribution and defined benefit. Aggregate spreadbased business (funding agreements and GICs) totaled almost $21 billion, and fee-based operations (synthetic GICs) amounted to over $17 billion as of June 30, 1999. In addition, the company has also developed an EMTN program that has issued over $1.1 billion of funding agreement backed notes. A significant percentage of the company’s spread-based business has embedded put options. Moody’s believes the potential exists for high levels of unexpected withdrawals in this operation. However, the company protects itself by utilizing a fixed-to-floating investment philosophy to match fund its operations and by issuing contracts (most have a 365 day put feature compared to the industry average of 90-days) with less near-term withdrawal risk than most of its competitors. Moody’s views AEGON USA’s market leading fee-based synthetic GIC business as incurring a low level of underwriting risk, but being very sensitive to fee pressures. 24 Moody’s Special Comment
  25. 25. Monumental Life Insurance Co. (AEGON) 1998 1997 1996 1995 1994 15,199 17,276 913 159 1 1,072 4,122 1,143 5,358 400 329 18 -11 318 3,990 3,990 267 44 0 311 584 290 931 98 63 11 0 63 4,067 4,067 256 43 0 299 606 291 948 68 35 1 -1 35 3,949 3,949 244 38 0 282 663 283 988 76 40 0 -5 35 3,651 3,651 193 31 0 224 685 256 969 67 41 -13 -5 36 33.1 0.9 19.9 0.5 44.8 0.2 42.3 0.2 54.7 0.6 0.1 0.5 39.3 0.2 57.8 0.6 0.1 0.6 37.0 0.2 60.0 0.6 0.1 0.7 36.8 0.3 59.8 0.7 0.1 0.9 15.3 1.6 11.3 1.6 65.7 0.1 42.3 2.7 17.9 10.0 0.0 -1.3 40.2 2.5 19.8 10.8 0.0 1.1 35.3 2.3 28.8 10.1 0.0 1.2 32.5 2.1 35.5 7.9 0.0 2.5 75.1 0.9 17.1 0.3 2.6 1.4 2.6 85.2 0.0 11.4 0.6 2.0 0.4 0.4 85.7 0.3 10.6 0.6 1.8 0.1 0.8 86.0 0.4 9.2 0.6 1.8 1.4 0.6 86.8 0.4 9.5 0.8 1.8 0.2 0.5 6.5 0.0 3.2 0.6 3.8 0.0 7.8 0.9 4.4 0.0 6.1 0.7 4.9 0.0 10.5 1.0 5.1 0.2 11.4 1.1 2.99 45.98 12.0 13.03 12.68 6.76 7.83 3.04 1.56 20.67 10.9 7.68 7.87 25.53 22.34 3.24 0.86 11.92 11.8 7.72 7.72 26.24 19.51 2.95 0.93 13.93 13.7 7.92 7.99 22.20 16.45 2.87 1.04 16.79 15.1 7.81 7.77 19.22 15.58 3.06 192 9 55 14 51 2 37 -1 24 5 0 0 21 0 9 1 0 1 20 2 10 3 0 0 26 1 10 -1 0 -2 7.1 136.9 294.7 0.0 88.3 — 236.6 7.6 5.4 7.8 149.0 290.9 0.0 46.8 414.6 147.5 11.1 0.0 7.3 136.6 269.3 0.0 57.4 435.9 146.6 8.8 2.5 7.1 129.6 250.7 0.0 66.4 447.4 132.5 13.5 2.3 6.1 109.6 212.9 0.0 80.0 563.2 162.6 19.9 2.2 Fundamentals ($mil) General account assets Total assets Surplus Investment reserve 50% of dividend reserve liab. Capital Insurance revenues Net investment income Total revenues Gain fr ops pre - tax & div Gain Before Real Capital Gains Real Cap Gains bef IMR transfer Real Cap Gains after IMR transfer Net Income Segment Analysis (as % policy reserves & liabilities) Individual life Individual health Individual annuities Group life & health Group pension Other Segment Analysis (as % of total net premiums) Individual life Individual health Individual annuities Group life & health Group pension Other Investment Profile (as % of cash and invested assets) Bonds Common & preferred stock Mortgage loans Real estate Policy loans Cash & short term investment Other invested assets Asset Quality Below Inv Grade Bonds as % of Invested Assets Bonds in or near default as % of Invested Assets Underperf Mtgs+Fclsd RE as % of Total Mtgs+Fclsd RE Underperf Mtgs+Fclsd RE as % of Invested Assets Profitability ROA (%) ROE (%) Ordinary life lapse ratio (%) Net investment yield Total investment return Commissions/Premiums Total general expenses/Premiums Total general expenses/Avg assets Gain (loss) from operations ($mil) Individual life Individual health Individual annuities Group life & health Group pension Other Capitalization (%) Capital/Assets Moody's Risk adjusted capital ratio NAIC Risk based capital ratio Surplus Notes/Capital Below inv grade bonds/Capital CMO's and Loan-Backed Bonds/Capital Mortgages + RE/Capital Total Underperforming Assets/Capital Total Affiliated Inv/Capital Moody’s Special Comment 25
  26. 26. Institutional Investment Products Review AIG Life Insurance Company Company Overview Moody’s Aaa insurance financial strength ratings of AIG Life Insurance Company (AIG Life) and American International Life Assurance Company of New York (AI Life)(The AIG Life Companies (US)) are based on the explicit support provided by American International Group, Inc. (AIG), which is the ultimate parent of the life insurance companies. The companies benefit from their diversified earnings sources and distribution channels and their high quality investment portfolios. These strengths are offset somewhat by the companies’ concentration in interest-sensitive annuity liabilities that present some interest rate risks and by the competitive markets in which they operate. The rating outlooks for AIG Life and AI Life are stable, but are dependent on the financial strength of the parent, AIG. Institutional Investment Products The AIG Life Companies’ stable value business consists of traditional GICs of $1.3 billion as of September 30, 1999 and $300 million in putable funding agreements. Asset/liability management for the company is focused on balancing its short duration and long duration annuities. For its traditional GIC portfolio, the company’s assets and liabilities are tightly matched and the company does not take any call risk because it does not invest in mortgage-backed securities to back this product. AIG Life and AI Life enjoy the explicit support of their ultimate parent, AIG. The support agreements between AIG and the AIG Life Companies (US) contain net worth, liquidity provisions, and policyholder rights language that effectively guarantees that AIG will provide the necessary funds to the companies to ensure the timely payment of those companies’ policyholder claims. AIG may terminate this support agreement upon 30 days of written notice to the AIG Life Companies (US); however, even in the event of a termination of the agreement, the obligations to AIG under the support agreement for all contracts written before the termination would still apply. 26 Moody’s Special Comment
  27. 27. AIG Life Insurance Company 1998 1997 1996 1995 1994 5,959 7,930 298 55 0 353 2,397 444 2,890 36 28 5 1 29 5,536 6,740 285 41 0 327 1,526 381 2,087 52 34 3 1 35 4,662 5,307 222 38 0 260 1,575 504 2,074 69 47 0 0 47 5,573 5,763 177 34 0 210 2,325 434 2,768 55 39 1 1 40 3,193 3,277 145 30 0 175 1,664 237 1,910 70 45 3 2 47 43.9 0.1 15.2 1.0 38.7 0.1 46.4 0.0 16.0 1.0 35.1 0.2 56.9 0.0 14.2 0.9 26.6 0.3 67.1 0.0 10.4 0.8 19.7 0.9 54.5 0.0 15.4 1.3 25.7 1.4 36.4 0.2 27.0 1.6 25.9 0.0 15.3 0.0 33.3 13.4 26.5 0.0 46.5 0.0 27.5 1.4 14.5 -0.1 71.1 0.0 8.8 0.7 12.7 0.8 78.2 0.0 5.2 0.8 6.6 1.8 70.4 0.5 8.3 0.0 17.4 2.4 1.0 52.3 0.2 6.7 0.0 27.7 12.1 0.8 48.4 0.4 6.7 0.1 41.4 2.0 1.1 34.4 0.3 4.7 0.1 55.9 3.5 1.2 43.9 0.4 6.0 0.1 45.0 2.7 1.9 5.9 0.0 0.0 0.0 4.5 0.0 0.0 0.0 3.0 0.0 0.0 0.0 1.4 0.0 0.0 0.0 2.2 0.4 0.0 0.0 0.39 8.47 10.1 8.12 8.17 5.24 4.16 1.36 0.59 12.05 17.6 7.83 7.87 7.27 5.05 1.28 0.85 20.01 1.9 10.42 10.47 6.12 4.99 1.42 0.88 20.59 2.5 10.49 10.53 2.89 3.53 1.82 1.85 30.99 3.0 10.22 10.39 2.98 4.27 2.80 -4 -3 5 1 22 1 14 -1 2 2 9 3 24 0 -3 0 14 7 13 -1 4 0 15 -3 36 0 1 -1 10 -10 5.9 129.1 221.2 0.0 97.7 — 136.7 0.0 2.9 5.9 155.8 276.8 0.0 74.2 132.0 111.9 0.0 3.2 5.6 149.5 245.3 0.0 52.5 164.8 118.2 0.0 4.0 3.8 138.2 193.5 0.0 35.4 210.6 118.4 0.9 4.2 5.5 148.6 196.5 0.0 37.4 245.2 106.6 7.1 5.0 Fundamentals ($mil) General account assets Total assets Surplus Investment reserve 50% of dividend reserve liab. Capital Insurance revenues Net investment income Total revenues Gain fr ops pre - tax & div Gain Before Real Capital Gains Real Cap Gains bef IMR transfer Real Cap Gains after IMR transfer Net Income Segment Analysis (as % policy reserves & liabilities) Individual life Individual health Individual annuities Group life & health Group pension Other Segment Analysis (as % of total net premiums) Individual life Individual health Individual annuities Group life & health Group pension Other Investment Profile (as % of cash and invested assets) Bonds Common & preferred stock Mortgage loans Real estate Policy loans Cash & short term investment Other invested assets Asset Quality Below Inv Grade Bonds as % of Invested Assets Bonds in or near default as % of Invested Assets Underperf Mtgs+Fclsd RE as % of Total Mtgs+Fclsd RE Underperf Mtgs+Fclsd RE as % of Invested Assets Profitability ROA (%) ROE (%) Ordinary life lapse ratio (%) Net investment yield Total investment return Commissions/Premiums Total general expenses/Premiums Total general expenses/Avg assets Gain (loss) from operations ($mil) Individual life Individual health Individual annuities Group life & health Group pension Other Capitalization (%) Capital/Assets Moody's Risk adjusted capital ratio NAIC Risk based capital ratio Surplus Notes/Capital Below inv grade bonds/Capital CMO's and Loan-Backed Bonds/Capital Mortgages + RE/Capital Total Underperforming Assets/Capital Total Affiliated Inv/Capital Moody’s Special Comment 27
  28. 28. Institutional Investment Products Review Allstate Life Insurance Company Company Overview Moody’s Aa2 insurance financial strength rating and P-1 short-term insurance financial strength rating of Allstate Life Insurance Company and of four of its life subsidiaries– Northbrook Life Insurance Company, Lincoln Benefit Life Company, Glenbrook Life and Annuity Company and Allstate Life Insurance Company of New York – is based on their established positions in the markets for life insurance, individual annuities, and group pensions, as well as on their broad product portfolios and extensive multiple channel distribution network, which position the companies well for future growth. Additional rating factors include reinsurance agreements between Allstate Life and three of these four subsidiaries; and the brand name, financial support, distribution, and other benefits of ownership by the multiline Allstate Insurance Company. These strengths are tempered by the companies’ narrow focus on highly competitive interest sensitive life and annuity products, and by the revenue and earnings volatility associated both with these products and the opportunistic sale of structured settlements and GICs. The rating outlooks of Allstate Life and its life insurance subsidiaries, which are closely linked with the ratings of Allstate Insurance, are stable. Institutional Investment Products Group pension products are sold only by Allstate Life and Allstate Life of New York. Products consist primarily of guaranteed investment contracts (GICs) marketed by independent brokers to medium- and large-sized pension funds. Other products include separate account GICs, short-term indexed funding agreements (IFAs) and synthetic GICs. Allstate Life has also established a funding agreement backed EMTN program to access longer dated fixed maturity contracts. Although Allstate Life participates in the market on an opportunistic basis, we anticipate sales of indexed funding agreements may grow thereby exposing the company to some liquidity risk. This risk is somewhat mitigated as Allstate’s strategy is to focus principally on long put IFAs over 365 days. We do not expect the aggregate amount of GICs and funding agreements to exceed 20% of consolidated insurance reserves for the Allstate Life insurance companies. As of September 30, 1999, total general and separate account short-term funding agreement exposure was $1.6 billion, which represented less than 6% of general account liabilities and approximately 4% of total liabilities on a consolidated basis. Allstate Life segments its portfolio by product, and duration matching and/or cash flow matching is established for each product segment. Investment decisions are made on a company wide basis. The organization has a disciplined asset/liability management process and we believe that Allstate Life will manage the institutional investment products portfolio well. Because Allstate Life sells GIC products on an opportunistic basis when appropriate investment yields are available, premiums associated with this business are likely to remain volatile. Allstate Life has good operating cash flow as well as over $16 billion of publicly traded investmentgrade bonds, mitigating liquidity risk. Additionally, Allstate Corporation maintains a US $1 billion commercial paper program initiated in 1996, supported by a $1.5 billion back-up bank credit facility. 28 Moody’s Special Comment
  29. 29. Allstate Life Insurance Company 1998 1997 1996 1995 1994 27,429 29,145 2,425 365 0 2,790 5,741 1,886 7,882 279 204 265 149 353 26,393 27,499 2,205 358 0 2,563 4,828 1,903 6,781 384 269 133 68 338 25,420 26,517 1,850 443 0 2,293 5,009 1,825 6,848 283 181 4 5 185 24,061 24,854 1,642 396 0 2,038 4,720 1,756 6,481 283 189 26 9 198 22,404 22,952 1,446 358 0 1,804 4,337 1,634 5,974 171 58 0 -21 37 19.1 0.0 50.4 0.4 29.7 0.1 18.2 0.0 49.5 0.3 31.6 0.1 17.1 0.0 47.6 0.2 34.5 0.3 16.1 0.0 45.3 0.1 37.9 0.3 15.6 0.0 50.4 0.1 33.4 0.3 18.6 0.1 38.4 1.7 38.6 0.7 21.3 0.1 40.1 1.8 34.0 0.3 20.1 0.1 38.3 1.4 36.2 1.3 18.1 0.1 45.4 1.0 31.6 1.1 18.1 0.1 49.8 0.6 27.7 1.2 79.1 4.7 11.8 0.1 2.0 1.6 0.8 79.5 4.7 11.1 0.9 1.9 0.5 1.3 77.6 5.2 12.4 1.2 1.9 1.0 0.7 76.0 5.2 13.6 1.5 1.8 1.1 0.7 74.9 5.2 14.4 1.6 1.7 1.6 0.5 5.9 0.1 3.0 0.4 5.0 0.0 4.2 0.5 4.7 0.0 9.0 1.1 3.7 0.2 10.4 1.4 4.2 0.2 8.3 1.2 1.25 13.20 10.4 7.32 8.16 10.33 6.12 1.24 1.25 13.90 11.1 7.69 8.44 10.26 7.22 1.29 0.72 8.55 10.5 7.72 8.42 9.43 6.86 1.34 0.83 10.29 9.1 7.91 8.34 9.00 6.89 1.36 0.17 2.25 9.0 7.91 7.81 7.92 6.92 1.36 126 0 35 -17 54 0 93 1 104 -10 63 8 52 1 64 -11 64 1 43 1 88 -5 56 1 17 1 30 -2 14 -1 10.2 140.8 311.9 0.0 57.1 — 114.5 4.6 26.5 9.7 133.7 312.2 0.0 50.4 167.0 121.6 4.8 27.7 9.0 120.0 256.9 0.0 50.8 171.3 147.7 12.4 31.1 8.5 112.9 238.3 0.0 42.5 188.2 175.4 19.4 32.3 8.1 106.2 211.9 0.0 51.2 198.4 194.5 16.9 31.8 Fundamentals ($mil) General account assets Total assets Surplus Investment reserve 50% of dividend reserve liab. Capital Insurance revenues Net investment income Total revenues Gain fr ops pre - tax & div Gain Before Real Capital Gains Real Cap Gains bef IMR transfer Real Cap Gains after IMR transfer Net Income Segment Analysis (as % policy reserves & liabilities) Individual life Individual health Individual annuities Group life & health Group pension Other Segment Analysis (as % of total net premiums) Individual life Individual health Individual annuities Group life & health Group pension Other Investment Profile (as % of cash and invested assets) Bonds Common & preferred stock Mortgage loans Real estate Policy loans Cash & short term investment Other invested assets Asset Quality Below Inv Grade Bonds as % of Invested Assets Bonds in or near default as % of Invested Assets Underperf Mtgs+Fclsd RE as % of Total Mtgs+Fclsd RE Underperf Mtgs+Fclsd RE as % of Invested Assets Profitability ROA (%) ROE (%) Ordinary life lapse ratio (%) Net investment yield Total investment return Commissions/Premiums Total general expenses/Premiums Total general expenses/Avg assets Gain (loss) from operations ($mil) Individual life Individual health Individual annuities Group life & health Group pension Other Capitalization (%) Capital/Assets Moody's Risk adjusted capital ratio NAIC Risk based capital ratio Surplus Notes/Capital Below inv grade bonds/Capital CMO's and Loan-Backed Bonds/Capital Mortgages + RE/Capital Total Underperforming Assets/Capital Total Affiliated Inv/Capital Moody’s Special Comment 29
  30. 30. Institutional Investment Products Review Business Men’s Assurance Company of America Company Overview Moody’s A1 insurance financial strength rating of Business Men’s Assurance Company of America (BMA) is based on the company’s developed life reinsurance business, its improved earnings and capitalization, and its strategic importance to Assicurazioni Generali S.p.A. (Generali), its ultimate parent. These strengths are offset somewhat by the relatively small scale of operations, rapid growth in interest sensitive liabilities, and high – though declining – expense structure. BMA also has a large investment in commercial mortgage loans as well as a significant exposure to mortgage- backed securities and other structured securities. BMA recently exited the group life and accident market (primarily disability and dental products), a business line which had produced a volatile earnings pattern in recent years, from losses to small gains. BMA provides life insurance, life reinsurance, and asset accumulation products including individual annuities, mutual funds and guaranteed investment contracts (GICs). Growth during the last several years has occurred in the GIC and fixed individual annuity operations – together they account for over 68% of liabilities. The mutual fund operation has also enjoyed success. The life reinsurance operation remains a top 15 reinsurer of U.S. life insurance. BMA’s rating outlook was changed to negative from stable following an outlook change to negative from stable at Generali. The effect of Generali’s outlook change on BMA is pronounced in that BMA’s rating reflects substantial implied support from Generali. The outlook change came about from an apparent shift in Generali’s future tolerance for financial leverage, as evidenced by recent statements made in context of its bid for Istituto Nazionale delle Assicurazioni S.p.A. Institutional Investment Products Since BMA entered the GIC business in 1991, it has grown into over $1 billion in liabilities. Most of the contracts range in size between $500,000 to $5 million, are lump sum deposits and have been sold largely through stable value managers and consultants to mid-sized 401(k) plans. The marketing source is somewhat diversified, but upwards of 25% of contracts have been placed through a single stable value manager, and an additional 20% placed through a second entity. BMA successfully introduced a credit enhanced GIC product in the third quarter of 1997. The product, which is placed in the company’s separate account, functions similarly to the general account GIC product, but has special provisions including an external liability guarantee from MBIA, a “Aaa” rated financial guarantor, on a contract-by-contact basis which would be enforced if BMA was unable to satisfy its contractual obligations. Approximately 90% of all GIC contracts issued are benefit responsive at book value under a variety of terms. Approximately 5% are non-benefit responsive and the remaining 5% are nonqualified, sold to money market funds as 90-day “putable” funding agreements. BMA’s benefit responsive withdrawal experience has been minimal, but some of the “putable” funding agreements have been exercised. We believe this has been the case due to the failure of an unrelated funding agreement provider, not an issue directly related to any change in BMA’s financial strength. We note that BMA’s involvement in the “putable” funding agreement business has been modest ($100 million at its peak); the company’s true exposure is to the longer-term pension GIC market which accounts for a significant percentage of the company’s total liabilities and profits. 30 Moody’s Special Comment
  31. 31. Business Men’s Assurance Company of America 1999 1998 1997 1996 1995 2,469 2,890 251 34 0 285 643 168 805 33 29 7 4 33 2,388 2,689 226 32 0 259 657 169 828 46 36 13 8 45 2,392 2,469 188 36 0 224 562 168 756 21 19 -1 -4 15 2,211 2,211 171 27 0 199 526 146 730 14 11 3 -1 10 1,890 1,890 155 23 0 178 442 126 724 10 8 6 1 9 35.0 0.7 27.6 1.5 33.1 0.0 35.2 0.8 27.1 1.2 34.0 0.0 33.4 2.0 27.3 1.1 34.2 0.0 34.4 1.7 27.2 1.0 33.3 0.0 39.0 1.8 25.4 1.1 30.6 0.0 26.5 0.7 11.5 10.6 45.1 0.0 24.2 1.6 5.3 7.6 58.1 0.0 28.4 3.0 8.9 7.1 47.2 0.0 27.8 3.1 14.8 7.8 37.4 0.0 31.7 3.1 35.3 8.7 15.1 0.0 52.2 3.2 36.5 0.4 2.4 4.0 1.3 52.9 3.2 37.7 0.5 2.5 1.3 1.9 55.0 3.9 36.2 0.5 2.6 1.6 0.1 59.2 2.6 32.8 0.8 3.0 1.4 0.2 60.0 2.7 28.6 1.1 3.6 3.8 0.2 0.8 0.0 0.1 0.0 0.0 0.0 0.7 0.3 0.1 0.0 1.2 0.4 0.3 0.1 2.6 0.9 0.3 0.0 3.8 1.1 1.18 12.10 12.3 7.33 7.27 9.98 10.53 2.43 1.73 18.49 12.9 7.50 7.57 8.63 10.61 2.70 0.62 6.87 13.6 7.72 8.13 10.64 13.56 3.26 0.51 5.51 14.5 7.52 7.51 11.00 12.99 3.33 0.55 5.32 14.0 7.76 7.91 14.83 17.39 4.46 26 1 1 -4 9 0 12 8 3 0 10 0 11 -7 5 -1 11 0 9 -3 3 0 6 0 10 -3 -2 -1 7 0 11.5 139.4 293.4 0.0 6.9 — 314.3 0.3 4.8 10.8 136.0 312.4 0.0 0.3 — 345.6 2.5 6.5 9.4 123.5 275.5 0.0 1.1 232.8 384.0 4.6 7.2 9.0 122.8 274.2 0.0 3.5 231.5 366.9 10.8 7.6 9.4 133.9 267.0 0.0 3.1 223.0 305.7 11.4 8.8 Fundamentals ($mil) General account assets Total assets Surplus Investment reserve 50% of dividend reserve liab. Capital Insurance revenues Net investment income Total revenues Gain fr ops pre - tax & div Gain Before Real Capital Gains Real Cap Gains bef IMR transfer Real Cap Gains after IMR transfer Net Income Segment Analysis (as % policy reserves & liabilities) Individual life Individual health Individual annuities Group life & health Group pension Other Segment Analysis (as % of total net premiums) Individual life Individual health Individual annuities Group life & health Group pension Other Investment Profile (as % of cash and invested assets) Bonds Common & preferred stock Mortgage loans Real estate Policy loans Cash & short term investment Other invested assets Asset Quality Below Inv Grade Bonds as % of Invested Assets Bonds in or near default as % of Invested Assets Underperf Mtgs+Fclsd RE as % of Total Mtgs+Fclsd RE Underperf Mtgs+Fclsd RE as % of Invested Assets Profitability ROA (%) ROE (%) Ordinary life lapse ratio (%) Net investment yield Total investment return Commissions/Premiums Total general expenses/Premiums Total general expenses/Avg assets Gain (loss) from operations ($mil) Individual life Individual health Individual annuities Group life & health Group pension Other Capitalization (%) Capital/Assets Moody's Risk adjusted capital ratio NAIC Risk based capital ratio Surplus Notes/Capital Below inv grade bonds/Capital CMO's and Loan-Backed Bonds/Capital Mortgages + RE/Capital Total Underperforming Assets/Capital Total Affiliated Inv/Capital Moody’s Special Comment 31
  32. 32. Institutional Investment Products Review CIGNA Corporation Connecticut General Life Insurance Company Company Overview Moody’s A3 senior debt rating of CIGNA Corporation primarily reflects the strong market position of Connecticut General Life Insurance Company (CG Life) in the medium and large case group employee life and health benefits markets. That position is enhanced by CG Life’s integrated indemnity and managed health care products, large, stable blocks of experience-rated pension business, and strong technological capabilities. Additionally, CG Life maintains an overall good quality investment portfolio, with an improving risk-adjusted capital position. The sale of its entire property and casualty insurance operations reaffirms CIGNA’s commitment to focusing on its core businesses. CIGNA is now a broad-based employee benefits company, with a full range of customized health care products complemented by a portfolio of disability, life and accident, investment and retirement savings products. The rating outlook for CIGNA Corporation and its life and health subsidiaries – Connecticut General Life Insurance Company (insurance financial strength at Aa3) and Life Insurance Company of North America (insurance financial strength at A1) – was changed to stable from negative on March 19, 1999. The change was primarily based on CIGNA’s overall improved risk profile resulting from the divestiture of its domestic and international property and casualty insurance operations. Institutional Investment Products Management has taken a conservative position by restraining the amount of competitively priced and nonservice-intensive products it sells, such as guaranteed investment contracts (GICs) and single-premium annuities that are associated with pension plan terminations and terminal-funding contracts. A significant proportion of the company’s assets back experience-rated pension contracts, where investment experience is shared with policyholders. More recently, CG Life is considering plans to enter the long-term funding agreement market, also referred to as European GICs (EuroGIC) or Global GICs. Our concerns with this product are similar to those for traditional GICs. However, in light of the fact that EuroGICs are non-benefit responsive and non-putable, they carry lower liquidity risk, compared with traditional GICs, over the long term. However, the Euro GICs are sold in tranches larger than those sold to a pension plan. Thus we believe Euro GICs have higher refinancing risk. We note that the company does not have any exposure to short-term putable funding agreements that expose companies to short-term liquidity risk. As of September 30, 1999, institutional spread based business was $1.1 billion, less than 4% of general account liabilities. We do not expect the aggregate spread-based institutional business to exceed 20% of consolidated insurance reserves. CG Life manages its asset/liability matching risks well and has minimal liquidity needs. It has established separate investment portfolios for its principal lines of business, which specifically recognize the interest sensitivity and the liquidity needs of the products within each line. Assets supporting the GIC liabilities are located in CG Life’s separate accounts; the GIC portfolio is immunized by duration matching. For those products that are highly sensitive to interest rate changes, the degree of duration match is usually kept within half a year. Also, the type of assets used generally excludes CMOs and other callable securities, which are capable of altering the portfolio duration as rates change. Most of the company’s private securities contain make-whole provisions, which offset their call risk. CIGNA Corporation maintains a commercial paper program of $300 million (Moody’s rating of P-2), with committed back-up lines of credit for 100% of the program’s maximum borrowings. The company also has additional lines on an advised basis for a total of $135 million. Since the sale of the P&C operations, including its premium finance company, commercial paper has fallen to zero, and is likely to fluctuate between $0 and $150 million, with occasional spikes above that level. Proceeds from commercial paper are used predominately for working capital needs such as temporary investment mismatches related to the settlement process. 32 Moody’s Special Comment

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