WorldCom debacle affects US insurers: S&P

WorldCom debacle affects US insurers: S&P
Our Banking Bureau
10 July 2002

New York: As the dominoes of Corporate America continue to topple, the insurance industry will rue the cost of picking up the pieces, say Standard & Poors (S&P) analysts.

Even though the demise of WorldCom Inc presents no immediate ratings consequence, it is symptomatic of an ongoing trend that spells downgrades for insurers, not just from investments gone sour but from reimbursements of top company executives facing liability payments.

The WorldCom exposure is part of a wider problem, says S&P director Jack Reichman. Theres potential for death by a thousand cuts.

According to S&P estimates, US insurers held $7.3 billion in WorldCom investments at yearend 2001. Although no single insurer has enough exposure to warrant a rating change, the accounting sins of this MCI Communications Corp affiliate are merely the latest salvo in a barrage of scandals and high-profile bankruptcies to hit financial markets since late 2001.

The headlines springing from that Pandoras box include Adelphia, Dynegy, Kmart, Global Crossing, ImClone, Qwest, Rite Aid, Tyco International Ltd., Vivendi Universal, and Xerox.

In the case of Tyco, insurers held $7.0 billion worth of investments at yearend 2001. Reichman estimates insurer losses on WorldCom and Tyco instruments at $6.3 billion and $2.7 billion, respectively, in the first half of 2002 (assuming no accumulation or disposal of these holdings in that period).

But these losses may be the tip of an ugly iceberg. Although an individual credit weakening does not create a problem in itself, the insurance industry is vulnerable to the cumulative impact of a general credit-market meltdown, S&P managing director Jay Dhru.

So far, life insurers have shown the greatest exposure to losses on investments, but other insurance sectors are not immune, says S&P managing director Bob Partridge. Property and casualty companies build investment returns into their pricing, so these developments have muddied the waters for them, too.

Some property and casualty companies are also increasingly vulnerable in their coverage of directors and officers liability (D&O). S&P warned, in its midyear 2002 outlook on the industry, of the ferocious assault insurers are facing from various forms of professional-liability coverage and that the industry is ill-prepared for the escalating pressures it could face.

Again, although any D&O payments triggered by WorldCom negligence are not a significant concern for any single insurer, they are part of an all-too-familiar pattern of systemic exposure. Our concern about D&O exposure is increasing, says Dhru.

Insurers can and do mount resistance to D&O payouts where they allege the liability arises from fraudulent practices by company executives, but S&P analysts argue that underwriters are unlikely to emerge unscathed.

There will be settlements, says Partridge, who explains that insurance companies cannot provide protection against illegal activity. D&O covers negligence or mismanagement. If you do something stupid, youre covered, but if you do something illegal, youre not.

As the rotten apples multiply in Corporate Americas barrel, S&P, according to its officials, will continue to monitor closely the effects on insurers investment portfolios and exposures arising from professional-liability coverage, but before the gangrenous spread of accounting mischief has run its course, the industry will likely see some downgrades.

List of reports on WorldCom