Spike in life insurance CDS spreads said overdone

NEW YORK, Oct 3 (Reuters) - A sharp increase in the cost of insuring U.S. life insurance companies' debt against the risk of default is overdone as the major players are not facing any liquidity or solvency issues, research firm CreditSights said on Friday.

"While nearly all of the major life insurers we cover are going to see material hits on their investment portfolios, which in many cases will result in net third-quarter losses, we do not expect to see a repeat of AIG," CreditSights analyst Rob Haines said in a note.

American International Group, or AIG (AIG.N), had to be bailed out with an $85 billion government loan in September after a liquidity crisis.

Credit default swaps on MetLife Inc (MET.N) Prudential Financial (PRU.N) and Hartford Financial Services (HIG.N) widened sharply on Thursday and shares tumbled after Senate Majority Leader Harry Reid said a major insurer was on the verge of collapse if financial market turmoil was not calmed.

Credit spreads on insurers were already steadily rising on concerns about exposure to recent corporate failures, including AIG, Lehman Brothers (LEHMQ.PK) and Washington Mutual (WAMUQ.PK).

A spokesman for Reid later played down the remark and said the Senator was not referring to any specific company, but his comments did little to quell the panic. For more see [ID: nN02276320].

Five-year credit default swaps on the three companies continued to trade upfront on Friday, reflecting heightened concerns of potential defaults.

MetLife CDS were trading at 10.5 percent upfront, or at a rate of $1.05 million a year to protect $10 million of debt for five years, plus $500,000 in annual premiums, according to data from CMA DataVision.

CDS trade on an upfront basis when a company is considered distressed and sellers of protection want to be paid more at the outset of the contract.

Hartford Financial was trading at 11 percent upfront, unchanged from late Thursday. and Prudential was trading at 11.5 percent upfront, up from 11 percent on Thursday.

"In our opinion Hartford, MetLife and Prudential are not facing any liquidity or solvency issues," said Haines.

Investors should note that insurance companies are not funded with deposits or repos, and are therefore not subject to a run on the bank scenario, he said.

AIG's downfall was not caused by weakness in its insurance business, but by massive collateral calls due to ratings downgrades tied to losses in its financial products unit, said the analyst.

"The irony of AIG's liquidity crunch is that if management had operated its structured credit financial guarantee business out of a regulated insurance subsidiary, it would never have faced the collateral calls that ultimately were responsible for the government takeover," he said.

While CreditSights is expecting spreads in the sector could continue to widen in the near term, it is recommending long-term cash bond investors maintain a 'hold' strategy. (Reporting by Ciara Linnane; Editing by James Dalgleish)