ANALYSIS-UK insurers eye boost as credit storm passes

+ UK insurers build up 4 bln sterling default reserves + Some reserve releases likely this year - analysts

+ Solvency II, sovereign debt worries could delay writebacks

LONDON, April 19 (Reuters) - British life insurers could get a substantial profit boost this year as they begin releasing billions of pounds of reserves built up to absorb a wave of corporate bond defaults that never materialised.

Analysts say a sharply reduced risk of corporate default could prompt some writebacks as early as year-end, with strict new European rules on insurers' capital and worries over sovereign creditworthiness the biggest risk to the scenario.

"It has to be a possibility that we will get credit releases at the end of this year," said Nomura analyst Nick Holmes.

"I think the longer that we don't have big credit losses coming through, then the evidence becomes pretty overwhelming that these credit provisions are surplus to requirements."

Analysts estimate that the insurers with the biggest corporate bond holdings -- Legal & General, Aviva, Prudential and Friends Provident -- built up provisions of over 4 billion pounds ($6.42 billion) in the wake of the 2008 financial crisis, when a nosediving economy stirred fears of a mass corporate defaults.

Sector-watchers say that while the writebacks would provide only a short-term boost to insurance stocks due to their one-off profit impact, they would still be a welcome sign that worries over capital strength that have dogged the sector for two years are abating.

Insurance shares went into steep decline during the 2008 crisis as investors fretted that plunging bond values could dent the sector's solvency capital, forcing it to launch emergency rights issues.

YIELD RELIEF

As it turned out, those fears were overdone. A massive injection of government cash kept the financial system ticking over, holding defaults at a low level, and investor concerns about companies' creditworthiness have since receded sharply.

The average yield on bonds in the Merrill Lynch global index of large, top-rated companies is currently 44 basis points above the yield on government notes, reflecting the premium investors demand for holding riskier corporate debt.

That compares with a premium of 155 basis points in Dec. 2008, when worries over corporate defaults were at their height.

"I think there's a chance some of it (reserve releases) will be done by the year-end reporting, if not before," said S&P Equity Research analyst Tony Silverman.

"Actually releasing them will inevitably be a positive of some sort."

The insurers are under no obligation to write back their credit reserves, which are a unique feature of the British regulatory landscape aimed at giving the sector the flexibility to hold corporate bonds to maturity.

But L&G, which holds total provisions of 1.5 billion pounds after doubling them in March 2009, said last month that it would consider releasing some of the cash at the half-year stage, making it the only insurer so far to comment publicly on its intentions.

WAIT AND SEE

Sector-watchers and industry insiders believe the sector is likely to sit on its hands at least until final drafts of the European Union's proposed Solvency II capital rules for insurers emerge in the autumn.

An initial version of Solvency II last year prompted warnings from British insurers that they might have to raise up to 50 billion pounds of fresh capital to comply with the new rules when they come into force in 2012.

While the proposals likely to be diluted, the new regime is still expected to result in more onerous capital requirements, providing the sector with an incentive to keep its reserves intact.

Investors could also question reserve releases if they occur before current concerns over potential defaults on Greek and other government debt are laid to rest.

"I think (insurers) would be worried this year that if they released reserves they might suddenly have egg on their faces. Who knows what's going to happen with some sovereign issues?" said ING analyst Kevin Ryan.

"I think the market could also view it as being lacking in prudence, and making the garden look prettier than it actually is."

(Editing by Sitaraman Shankar)

REUTERS