A handful of elite life insurers sporting triple-A credit ratings are expected to suffer a downgrade from Standard & Poor's in line with the downgrade of the U.S. government Friday.
More broadly, the rating firm's move means insurers that hold Treasurys in their investment portfolios may well end up required to set aside capital to back up those holdings.
In mid-July, when the U.S. government was warned of possible action by S&P, the ratings firm also put the five insurers holding its coveted triple-A rating on CreditWatch negative. S&P said the move was the "downstream effect" of its action on the nation's credit rating; under S&P's criteria, a nation's rating constrains the financial-strength ratings on insurers.
The insurers currently rated triple-A by S&P are Knights of Columbus, New York Life Insurance Co., Northwestern Mutual Life Insurance Co., Teachers Insurance and Annuity Association of America, and United Services Automobile Association.
In recent interviews, the companies said their financial strength justified continued triple-A ratings, and that they remain confident in the strength of their business models.
"The Knights of Columbus has earned a rating of AAA from Standard & Poor's for 19 consecutive years, and we have every confidence in our continued success because we have a fundamentally solid business model which continues to serve us well," a Knights of Columbus spokesman said last month.
A New York Life spokesman noted earlier this summer that S&P had affirmed New York Life's AAA counterparty-credit and financial-strength ratings in April.
"The change to CreditWatch was not in response to any new initiatives of the insurers; rather S&P tells us that no financial institution can carry a higher rating or outlook than its sovereign," the spokesman said. "We believe our diversified $165-billion portfolio of cash and invested assets continues to be of outstanding quality, and along with our mutuality, our leadership position in life insurance, and the strength of our career agent distribution system, fully justifies our continued triple-A ratings.
Purisima said the downgrade should prompt policymakers around the globe to coordinate in instituting actions that would somehow shield their economies from the ill-effects of the United States’ fiscal and economic problems.
Given the links of emerging markets to the US, any unfavorable event in the world’s biggest economy is expected to somehow dampen even their performance, according to economists.
Purisima said the Philippines will also be affected by the downgrade because the country’s foreign exchange reserves are denominated in US dollars and are mostly invested in US Treasuries.
The United States’ lower credit rating could reduce the value of US Treasuries in the international bond market, thus adversely affecting the Philippines’ reserves of foreign currencies.
The Philippines’ gross international reserves (GIR)—the reserves of foreign currencies that determine the country’s ability to purchase imports, pay debts to foreigners, and engage in other commercial transactions with the rest of the world—stand at about $69 billion and the bulk of these are invested in US Treasuries.
According to US Treasury data, the Philippines holds $23.6 billion in US securities, now rated AA+ by S&P with a negative outlook.
The US is also its top export market, main provider of foreign military aid, and a key host for the Philippines’ nine million-strong overseas workers whose remittances help fuel household consumption in the Philippines.
Purisima said the US credit rating downgrade should encourage policymakers to talk about considering other “more stable” reserve currencies as alternatives to the US dollar and US Treasuries.
S&P said that in addition to the downgrade, it is issuing a negative outlook, meaning that there was a chance it will lower the rating further within the next two years.
One analyst suggested the downgrade might move Congress to take concrete steps to fix the nation’s budget problems.
“It’s a downgrade and it’s bad, but if it spurs more conversation about bringing down spending and maybe more intelligent tax policy, it could be a good thing in the long run,” said Frank Barbera, a portfolio manager of the Sierra Core Retirement Fund.
The downgrade announcement came after markets closed for the weekend, but there was no evidence of any immediate disruption.
A spokesperson for the Federal Reserve said the decision would not affect the ability of banks to borrow money by pledging government debt as collateral, a statement that could set the tone for the reaction of the broader market.
The statement was issued to make sure banks did not feel that the downgrade would affect the amount of capital that regulators require the banks to hold against possible losses.
The downgrade is likely to have little to no impact on how the US finances its borrowing, through the sale of Treasury bonds, bills and notes. This week’s buying proves that.
“Investors have voted and are saying the US is going to pay them,” said Mark Zandi, chief economist of Moody’s Analytics. “US Treasuries are still the gold standard.”
He noted that neither his parent organization, Moody’s, nor Fitch, the other of the three major rating agencies, have downgraded US debt.
The ratings agencies were sharply criticized after the financial crisis in 2008 for not warning investors about the risks of subprime mortgages. Those mortgages were packaged as securities and sold to investors who lost billions of dollars when the loans went bad.
Japan had its ratings cut a decade ago to AA, and it didn’t have much lasting impact. The credit ratings of both Canada and Australia have also been downgraded over time, without much lasting damage.