Bond insurers active in securing guaranteed investment contracts are "unlikely" to fall prey to the forces that plagued life insurance firms, according to a report published yesterday in Standard & Poor's Corp.'s CreditWeek Municipal.
In addition, the bond insurers as a group have "ample resources to meet credit-related liquidity needs within their insured portfolios," the rating agency said in "Insurers' Liquidity Risk Profile Lends Comfort."
Inquiries from policyholders and equity investors regarding the bond insurers' liquidity strength, especially as they became more involved in insuring GICs, provided the impetus for the report, according to G. Kris Rao, a director at Standard & Poor's and author of the report.
In recent years, AMBAC Indemnity Corp. and Municipal Bond Investors Assurance Corp. began insuring GICs written by separate affiliates. While a sister company of Financial Guaranty Insurance Co. is also insuring the contracts, the bond insurer is not subject to liquidity risk from the enterprise.
The GIC industry has been tainted by the well-publicized failures of Executive Life Insurance Co. and Mutual Benefit Life Insurance Co. in the early 1990s. But the bond insurers are "better able to handle any potential liquidity problems of their own," according to Standard & Poor's.
Whereas Executive Life and Met Life were doomed by large numbers of policyholders redeeming their GICs for cash at the first signs of risk, bond insurance policies cannot be redeemed. Also, a bond insurer's obligations cannot be accelerated in an event of default and the bond insurers are not subject to "significant" third party risk, the report said.
"Unlike the property/casualty insurers, the bond insurers have stable underwriting results and their cash flows are largely predictable," the rating agency said. "Conservative underwriting and a high quality insured portfolio mitigate much of the liquidity risk associated with unscheduled payments from credit defaults and draws on debt service funds."
In part because of their strong insured and investment portfolios, the bond insurers all pass Standard & Poor's "liquidity margin of safety" measure, which "evaluates the financial flexibility of the insurer to meet scheduled and unscheduled cash payments" using a ratio of risk-adjusted liquidity resources divided by the uses of liquidity.
Standard & Poor's believes a liquidity margin of safety of at least 1.25 times is necessary for a bond insurer to maintain a AAA rating. With a liquidity margin of safety of 7.1 times at yearend 1993, Financial Security Assurance Inc. had the industry's highest ratio, with the average being 2.6 times. MBIA's and FGIC's 1.8 times tied for the industry's low.
While affirming the insurers' ability to guarantee GICs and their overall liquidity strength, the report also said that bond insurers are not well suited to providing liquidity for variable-rate transactions. Bond insurers' investment portfolios are not structured to support transactions subject to remarketing risk and, unlike banks, they do not have access to large quantities of capital necessary to provide short-term liquidity, the report said.
Through its FGIC Securities Purchase Inc. affiliate and the financial backing of its ultimate parent, GE Capital Co., FGIC is the only insurer to offer liquidity for variable-rate issues.
But through joint ventures with banks and other financial institutions, or in carefully structured commercial paper programs, the other bond insurers can also become active in providing short-term liquidity, Standard & Poor's said.