Subprime exposure afflicts Security Benefit Life Insurance

Analysts concerned about Security Benefit Life Insurance Co.'s investments in subprime-mortgage-backed securities have cut the firm's financial ratings and are keeping a careful eye on the Topeka, Kan., carrier. "This company has the highest [subprime] exposure [of an insurer] as a portion of total capital," said Bradley S. Ellis, director of the insurance group at Fitch Ratings Ltd. Security Benefit has $323 million of its assets in subprime debt — approximately 50% of its capital — according to Standard and Poor's of New York. "Our opinion is that there's high risk that the company would have difficulty performing its obligations," Mr. Ellis added. Over the last two months, SBL has seen its insurance financial-strength ratings cut by New York-based Moody's Investors Service to Baa1, from A3, and by Chicago-based Fitch Ratings to BBB-, from A. Standard & Poor's reduced its counterparty credit and financial-strength ratings on SBL to BBB+, from A. When asked to respond to questions about the company's current financial situation, a spokeswoman for Security Benefit Life said that no one was available for comment. The latest blow to the firm's standing was a June 24 downgrade by A.M. Best Co. Inc. of Oldwick, N.J., a leading ratings organization for insurance companies. It cut SBL's financial-strength rating and its credit rating to A-, from A.

PREDICTIONS VARY

Opinions on the severity of SBL's situation vary among the ratings companies. "At the present time, the company has sufficient assets to support its general-account liabilities and liquidity needs," said Raj Shah, an analyst at A.M. Best. "They're hit hard right now, but not all of their collateralized debt obligations are subprime. It's a mixed bag, and we're in the process of reviewing them." More than half of SBL's assets are dedicated to back variable annuity policies and are supported by stocks, mutual funds and other assets — but not CDOs, he said. Also, the CDOs held by SBL and its intermediate parent, Security Benefit Corp., have unrealized losses, but they are currently performing and aren't considered impaired assets, Mr. Shah said. None of those CDOs is below investment-grade, and none has defaulted. "Holdings in CDOs have been recorded at fair value and some have declined in price," said Mr. Shah. "Some have been impaired, and others need to be assessed going forward." Analysts have also expressed concerns about how SBL's January purchase of Rydex Holdings Inc. of Rockville, Md. will affect the firm's finances. SBL paid $463 million for a 60.6% stake in Rydex; parent SBC owns the remainder. "We view that acquisition as manageable for [SBL], but there's integration risk, and it's a big investment for them on a relative basis if you compare their capital to the size of the acquisition," said Adrian Pask, associate director at S&P. Mr. Ellis agrees. "Their capital position is much less conservative than it was prior to the acquisition, and there's less cushion for losses in subprime CDOs," he said. "It's really a waiting game to see how the CDOs develop." Registered representatives and broker-dealers who sell SBL's annuities have also been waiting and eyeing the company's performance. "We haven't turned away from SBL, but the fact that they've been downgraded to something below an A+ — we want to weigh this new information," said Douglas W. Gill, chief executive officer of SummitAlliance Investment Group in Dallas. SummitAlliance has been speaking to its producers about the annuities and examining where these products have been sold. Mr. Gill, who normally tracks the asset sizes and credit ratings of carriers, said something is amiss with SBL. "They haven't had declining credit ratings trickling in over the last year or two," he said. "This is an event: They've had their credit rating reduced, and we don't know if it's just the first step down." "Our concern — and it should be the concern of anyone taking a look at this — is what's at risk for policy owners: the ability of the carrier to make good on the guarantees it provides to the contract owners if there's a decline in the value of the sub-accounts," Mr. Gill observed. If Security Benefit's risk-based capital were to fall below levels set by Kansas insurance regulators, the state insurance commissioner might intercede by asking for a corrective business plan from the carrier. It also could monitor the company as it raises capital. When contacted about Security Benefit, the Kansas Office of Insurance declined to comment. "The steps taken depend on the magnitude of the problem," said Louis Quan, supervising insurance examiner in the California Department of Insurance, the regulator that seized Executive Life Insurance Co. of Los Angeles in 1991 when it became insolvent. While many carriers hold CDOs, only a few have large exposure. New York-based American International Group Inc. wrote down more than $15 billion in the first quarter due to credit default swaps and mortgage-backed securities. "Overall, our belief is that the insurance industry wasn't heavily exposed to the CDO market, the way the banks and securities firms were," Mr. Shah said. "Only a few companies have exposure that could be considered a little out of the norm." Security Benefit is one of those insurers, he said, adding its recovery depends on whether it can stanch the CDO bleeding and contain their market value losses going forward. In the meantime, the insurer can raise capital, Mr. Shah added. Until then, registered reps will continue to watch the company. "Something smells fishy here," a rep who asked not to be identified wrote in an e-mail. "It pays to do better due diligence on your carrier. You never know these days." E-mail Darla Mercado at dmercado@investmentnews.com.