Are We OK?
By Kate Kinkade, CLU, ChFC

Thanks to the recent Wall Street debacle, we are back in the business again of explaining insurance company financials and defending the stability of some of the strongest financial institutions in the world. I use the word “debacle” consciously. This article isn’t about that, but I would be interested in the perspective of any reader who would like to take issue with that language. Meanwhile, this article is about the impact of the unregulated actions of the rest of financial world on our world. It has been 10 years since most of us have had to field regular questions from clients about insurance carrier solvency, and we have to relearn our lessons and go forth to do so again.

Insurance company stock prices have been falling for the past three weeks–precipitously in the week prior to this writing. Hopefully, by the time you are reading this, some sanity will have prevailed in the market and that decline will have leveled if not reversed. But, to start with stock prices. We all have to remember that, unfortunately, in this environment the fall of a company’s stock (any company) doesn’t necessarily reflect the value or stability of the company itself. It does affect a company’s ability to go out to get capital if they need it. But it doesn’t indicate that they are in any financial or operational stress. In the case of insurance companies, most have more than enough capital for operations. Due to strong insurance regulation, they are not overly exposed to the financial instruments that have caused the market crisis. Stock prices are not the conversation.

What about actual risk? It is also important to remember that the biggest and most public “insurance company” crisis, with AIG, was not an issue of the insurance companies themselves but of the holding company’s unwise investment strategy. The underlying companies continue to be strong. The life insurance company may be (is likely to be) merged or sold due to the crisis, but not due to any instability of the carrier itself. This is as true of the other insurance companies that have been in the news as well; the problems have not been with the insurance operations, but with the investment operations. And while insurance companies or their parents have invested in some of the instruments that are causing the current crisis, their exposure is not anywhere near as high as with other financial institutions. Ask how much the carrier had invested with Lehman Brothers; not in dollars, but what percentage of their portfolio. One carrier executive shared their exposure to Lehman was .4% of their portfolio – that is .004 in decimal talk. Ask about carrier liquidity. How much do they have in cash? This carrier has about 11.5 billion in cash. These numbers help us provide perspective to our clients.

How do variable annuities affect insurance company financials in this market? There are two issues here: the part that VA fees, etc. play in the company’s operational profit and the pressure of guarantees on their reserves. Ask some questions if you are selling products with a carrier that has a significant portion of its product mix in VAs, specifically recently purchased VAs with guarantees. The drop in the value of subaccounts will affect their income. How much? Probably very little proportionately, but ask. How did they “insure” their VA guarantees?  It is likely that the guarantees on the VAs on the books today are higher than the returns. This is only an issue, of course, if a large number of annuitants decides to withdraw based on guarantees. But most carriers reinsure a portion of their guarantees and buy hedges to offset the remaining portion. One carrier executive recently explained that their VA guarantees were covered up to a 40% fall in the S&P, which is “only” down 10% at this point.

What about regulations? Those of us who were around when Mutual Benefit and Executive Life were taken over are aware of risk based capital ratios. If you don’t know what they are, find out. These regulations evaluate the quality of investments and give higher “credit” for less risky, more liquid, investments to create a ratio of the level of risk in a carrier’s portfolio of investments. If a carrier has lower than a 350 ratio it will hurt their ratings; lower still will bring them to the attention of regulators. Ask what the carriers RBC is or go onto their website and find it in their financials. One of the carriers I spoke to this week has a ratio of 650.

What about ratings? Ratings are OK; look for them to be affirmed. Be on the lookout for a series of downgrades. These help guide you as the professional. The only problem will promoting ratings is that the carrier you just lauded as a AAA could become a AA+ for some very legitimate reason next week and you just caused yourself a problem. Ratings are a guide for someone who understands the purpose of ratings.

Are stock companies better than mutuals? Mutuals better than stock? If you listen to the PR from mutual companies in the past few weeks you would assume the latter is true. Mutuals do have to file quarterly financial statements, so all of the risks, evaluations, and questions above apply. They don’t have an external reaction mechanism like stock values. Dividends do not reflect actual performance since a company can declare anything a dividend that they choose to support. If I were in charge of dividend rates for a mutual today, I would support the dividend for a period of time to reassure policyholders and attract new ones. The fact is that insurance company insolvencies, as rare as they have been, have been equally divided between stock and mutual companies.

Are clients at risk? Most of us are well aware that policyholders have been protected every time an insurance company has become unstable. In the majority, other companies have taken over the “at risk” carrier and policyholders have not lost anything. In others, the regulators stepped in for a while until that could be accomplished.

Regulation has been successful protecting AIG in the midst of the parent company meltdown. As confirmed by NAIC President and Kansas Insurance Commissioner Sandy Praeger, “The key distinction here is that AIG’s insurance subsidiaries did not cause this crisis — rather, they will play a critical role in the solution...State regulatory oversight has kept the AIG insurance subsidiaries solvent despite the actions of its federally regulated parent and non-insurance entities. If future developments challenge that solvency, there are state insurance regulatory safeguards in place to protect policyholders.”

Is this a marketing opportunity for unscrupulous agents? Unfortunately, yes. But we should all be very clear; selling against an insurance company today using fear tactics and threats of insolvency is extremely damaging for the industry. Consumers will not distinguish between one or two “bad carriers” and the industry at large. Just look at the performance of the stock market in the past few weeks. Consumers who are running from life insurance companies will need a longer-term recovery than the stock market. It is one thing to understand and reassure the consumer about the stability of the carriers you represent. To make a sale based on the lack of financial security of any other company is unprofessional and short sighted at best. Let’s hope that most of us have good long range vision and commitment to this industry. If we do, we will not only survive this period, but we will also excel.