ADDRESSING THE FINANCIAL CRISIS

1
ADDRESSING THE FINANCIAL CRISIS

• Federation of Regulatory Counsel, Inc.
• Michael Moriarty
• Deputy Superintendent
• NY Insurance Department
• May 7, 2009
• New York, NY

2
Agenda

• Financial Crisis
• Financial Guaranty Insurers
• Role of the Rating Agencies
• AIG
• The Insurance Industry
• State Insurance Regulation
• Q A

3
FINANCIAL CRISIS

• Driven by US Real Estate Bubble
• Pipeline of Profit
• Mortgage Brokers (and Borrowers)
• Lenders (Banks and Non-Banks)
• Funneled to the Securitizers (Investment Banks
  and Fannie/Freddie)
• Hyper-Finance of Securitized Loans
• Over-Reliance on Rating Agencies

4
Financial Guaranty Insurers

• Problems in the Credit Market Began to Manifest
  in the Bond Insurers Towards Middle of 2007
  (Proverbial Canary in the Coal Mine)
• Lack of Transparency and Structured Security
  Complexity
• Mark-to-Market Uncertainties
• Downgrades from the Rating Agencies (Moving
  Target in Needed Capital Impact of Downgrades)
• Difficulty in Raising Capital

5
Implications of The FGI Problems

• Volatility In, and Increased Costs for, Municipal
  Financing
• Pressure on Banks That Are Counterparties
• Deteriorating Effect on an Already Fragile Credit
  Environment

6
Impact on Public Finance Market

• Downgrades Wrecked Havoc on Muni Bond Market
• Auction Rate Securities Market Crushed
• Forced Restructuring - Cancellation of Policies
  Forfeiting of Premium
• Additional Costs to Taxpayers
• Questioning Need for Bond Insurance for Public
  Finance Market (or Should There be Alternatives)

7
Dealing with Stressed Bond Insurers

• Problems Stem Exclusively from Structured
  Security Exposure
• Counterparties to Structured Deals are
  Banks/Broker-Dealers
• Solutions
• Reduce Exposure via Commutation
• Restructure Companies
• Run-Off (w/o munis)
• May be Role for Federal Funds to Assist in both
  (1) Stabilizing a Broad Swath of Toxic Assets (2)
  Provide Capacity for Public Finance Market

8
Role of Rating Agencies

• Clearly Play an Important Role in Capital Markets
• Changes Likely in How They Do Business and/or How
  They are Regulated
• Buy-Side Model Would Seem to Align Incentives and
  Mitigate Conflicts
• Ratings Impact State Regulation
• RBC Calculation
• In Laws and Regs
• Insurers Ratings
• Superintendent Dinallo Co-Chairing NAIC Rating
  Agency Working Group

9
AIG

• Mark to Market WriteDowns Surprised Market in
  First Half of 2008
• Was Still Able to Raise 20 Billion in Mid-2008
• CEO Martin Sullivan Leaves
• AIG Was to Announce Restructuring on in Late
  September
• Not Able to Get There - On Friday September 14th,
  Standard Poors Puts AIG on Negative Watch
• Worsening Weekend
• On September 16th, Fed Announces 85 Billion
  Lifeline

10
AIG Issues

• Non-Insurance Issues AIG Financial Products
• Credit Default Swaps, Guaranteed Investment
  Contracts Very Rating Sensitive Products
• Mortgage Backed Securities In Investment
  Portfolios, Primarily In Securities Lending by
  Life Insurance Companies
• Continue to Work with Company, with the Federal
  Authorities and with Other States to Steer AIG
  Through Its Restructuring

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Impact of Financial Crisis on Insurance Industry

• P/C Industry
• P/C Industry Still Strong Despite Relatively
  High Catastrophe Losses, Reduced Investment
  Income and Volatility, and a Soft Market, 81 of
  AM Best Rating Actions Were Affirmations, Just
  3.8 Were Downgrades and 4 Upgrades.
• 2008 Year End Underwriting Ratio 105
• US P/C Surplus Down from 518 Billion _at_ 12/31/07
  to 455 Billion at 12/31/08
• Insurance Markets Continue to Operate Normally
  (No Credit Markets Like Freeze on Insurance
  Underwriting)
• Unlike Mortgages, Underwriting Matters
• Low Leverage
• Conservative Investment Philosophy
• Transparency
• Solvency Regulation a Priority

12
Impact on Life Insurers

• Different Companies have Different Stress Areas
• Exposure to Structured Securities
• Variable Annuity Programs with Guaranteed
  Benefits that Could Be a Stress Point
• Loss of Financial Flexibility
• Some Companies Exposed to Hybrid Securities
  Market
• Downgrades (to Investments and Insurers)
• Loss of Business Due to Economy
• The More Lengthy and Deep the Recession goes, the
  More Problematic These Issues Will Become

13
Impact on Life Insurers (contd)

• Continue to Believe Issues are Manageable
• Laws/Regulation Mandate Reserves, Capital
• Policy Provisions Provide Some Defense Against
  Policyholders Movements

14
When Will Things Get Better

• CREDIT MARKET THAWS
• DELEVERAGING IS FURTHER ALONG
• INFLATION IS FORESTALLED
• HOUSING PRICES BOTTOM OUT

Source Insurance Information Institute
15
State Regulation

• Continue to Believe Insurance Industry has Fared
  Far Better than Other Financial Services
  Industries
• Focus on Solvency and Treatment of Policyholders
• Good Track Record for Both
• Some Redundancies and Issues Where More
  Consistency would Be Helpful
• Dont See Glaring Deficiencies
• A Systemic Regulator Could Address Some Holes
• Do Not Support an Optional Federal Charter A
  regulated entity should not be able to choose its
  regulator

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QUESTIONS

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