Marketwatch: Aflac Slumps on Preferred Impairment

Aflac slumps on concern about investments
Insurer may be exposed to hybrid securities issued by troubled financial firms

By Alistair Barr, MarketWatch
Last update: 6:44 p.m. EST Jan. 22, 2009

SAN FRANCISCO (MarketWatch) -- Shares of Aflac Inc. lost more than a third of their value Thursday on concern about exposures within the insurer's investment portfolio.
Aflac said it's "comfortable" with its current capital position and will provide more details about its investments when the company reports fourth-quarter results on Feb. 2.
The insurer may be exposed to investment losses stemming from a recent slump in the value of hybrid securities issued by European financial institutions such as Royal Bank of Scotland PLC, according to Morgan Stanley analyst Nigel Dally.
Aflac (AFL) has $7.9 billion of exposure to hybrid securities, Dally wrote to investors Thursday. He estimated, using the statutory filings, that roughly 80% of this exposure is to European financial-services firms, with U.K. banks including RBS , Barclays PLC , and HBOS among the holdings.

"The hybrid-security prices related to these institutions were already under pressure at the end of last year," Dally said. "However, those price declines pale in comparison to the sharp fall-offs we have seen in the past week, where the investor concerns over the possibility of nationalization of some institutions has led many of these securities to decline 30% or more."
If institutions are nationalized, holders of their hybrid and preferred securities could be wiped out, according to John Nadel, an analyst at Sterne, Agee & Leach.
When Fannie Mae (FNM ) and Freddie Mac (FRE) were seized by the U.S. government last year, the preferred securities of the mortgage giants became essentially worthless, he noted.
The PowerShares Financial Preferred Portfolio (PGF) , an exchange-traded fund that tracks preferred and hybrid securities issued by financial firms, has slumped 27% in the past week on concern about the potential nationalization of RBS and other banks. The ETF fell 7.2% on Thursday.
If even a small portion of the losses on Aflac's hybrid holdings are realized, the hit to the insurer's capital ratios could be "substantial," and its overall capital adequacy could be significantly less than most investors believe, Dally warned.
Aflac shares slumped 37% to close at $22.90 on Thursday. That's the lowest level for the stock since early 2000.
"We're comfortable with our current capital position and are constantly monitoring our investment portfolio," said Laura Kane, a spokeswoman at Aflac. "We will be issuing our earnings release on Feb. 2 and specific details will be available then."

Too big to fail

Aflac has long been considered among the most conservative insurers based on its investment portfolio and the amount of capital it keeps on hand to pay claims. The company avoided big investment losses from the subprime mortgage meltdown and has always bought investment-grade securities, Dally noted.
However, the credit crisis has hit so many parts of the financial sector that even companies like Aflac may now be affected.
Indeed, State Street Corp. (STT) , known as a steady, custodial bank where investors store their securities, lost almost 60% of its market value on Tuesday after disclosing $3 billion of mark-to-market investment losses from the fourth quarter. See full story on State Street.
Aflac invested roughly 80% of its $7.9 billion hybrid preferred securities portfolio in large European financial institutions because the insurer thought governments in the region would step in to prevent the companies failing, Morgan Stanley's Dally said on Thursday.
"This indeed has proved to be accurate," he wrote. "However, there is a question of what components of the capital structure the government will backstop."
"If some financial institutions are nationalized, there is the possibility that both the common stock, regular preferred stock, and callable preferred could be essentially wiped out," Dally added.
New capital?
If Aflac suffers a 10% loss on its overall hybrid securities exposure, the insurer would still have a relatively strong risk-based capital ratio of roughly 370%, Dally estimated.
The risk-based capital ratio, or RBC, measures the amount of capital an insurer has to support its operations and the risks it has taken on.
If Aflac suffers a 15% loss on its hybrid exposures, its RBC ratio could fall to about 339%, a level that could put the insurer's credit ratings at risk and force it to raise new capital, Dally said. End of Story
Alistair Barr is a reporter for MarketWatch in San Francisco.