Moody's says some US life insurer ratings may be cut

NEW YORK, Oct 3 (Reuters) - Moody's Investors Service warned on Friday it may downgrade credit ratings on some U.S. life insurers as a financial crisis takes a toll on their investment returns.

Shares and bonds of life insurers rebounded from a sharp sell-off on Thursday, however, after independent research service CreditSights said the major players were not facing liquidity and solvency issues.

Moody's said it was changing the outlook for the overall life insurance industry to negative from stable, reflecting the likelihood that conditions will worsen significantly through 2009.

Life insurers continue to be in healthier condition than most other financial services sectors, Moody's said in a report.

Higher investment losses, pressure on variable annuities and weakening economic conditions will hurt earnings and capital adequacy of insurers, the rating agency said.

"We expect to take negative rating actions (downgrades and/or negative outlooks) on certain life insurers that are most exposed and vulnerable to these negative trends," the agency said.

Although earnings will weaken, the industry is still well-positioned to move through the credit crisis and economic downturn in strong financial condition, Moody's said.

Life insurers' stocks and bonds were battered earlier this week amid mounting worries about the companies' exposure to troubled financial firms. Many insurers owned bonds or preferred shares of Lehman Brothers, Washington Mutual or American International Group, analysts said.

The cost of protecting insurers' debt with credit default swaps fell on Friday after the CreditSights report. For details on the report click on [ID:nN03325627].

MetLife's (MET.N) five-year credit default swaps traded around 685 basis points on Friday, or $685,000 a year to protect $10 million of debt, while Prudential's (PRU.N) swaps traded around 715 basis points and Hartford Financial's (HIG.N) traded around 670 basis points, according to data from CMA DataVision.

All three companies' swaps had closed on Thursday at about 11 percent upfront, or $1.10 million a year to protect $10 million of debt, plus $500,000 in annual premiums.

Losses in life insurers' investment portfolios are likely to increase materially over the next few quarters, hurting profits, Moody's said. Some life insurers have large holdings of subprime mortgage-backed securities that are declining in value, the agency said.

Although the insurers' investments are well-diversified, many asset classes are coming under pressure at once, including asset-backed bonds, corporate bonds and loans, Moody's noted.

Life insurers typically prepare for about 20-to-25 basis points of credit losses for their fixed-income investments, but losses will likely be more than 100 basis points for some companies, "wiping out their annual earnings and impacting capital adequacy," Moody's said. (Reporting by Dena Aubin; Editing by Dan Grebler) (dena.aubin@thomsonreuters.com; +1-646-223-6325; Reuters Messaging: dena.aubin.reuters.com@reuters.net))