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Insurance Companies’ Ignorance Is Definitely Not Bliss!!

Posted by Larry Doyle on April 6, 2009 5:20 AM |

I remain very concerned about potential liquidity and capital shortfalls within the insurance industry. The investment portfolios of insurance companies are chock full of the following:

1. commercial real estate loans: defaults expected to triple.
2. corporate loans and securities: defaults expected to triple
3. sub-prime and Alt-A (between prime and sub-prime) residential mortgages: defaults expected to quadruple.
4. prime mortgages: defaults expected to triple

I wrote What is Lincoln Thinkin’ to address the pressures that Lincoln Financial was facing. Those pressures are certainly not abating; in fact, the WSJ writes how Lincoln Faces Rising Stress As Its Debt Comes Due.

Over and above the pressures specific to Lincoln, the industry as a whole is facing strains due to the massive amount of annuities written by insurance companies. These annuities were written to provide policyholders a guaranteed fixed payout. With the significant selloff in the equity and bond markets, the insurance industry is facing an enormous capital shortfall on these annuities.

The WSJ addresses this capital shortfall problem within the insurance industry via a survey of brokers who sold annuities issued by insurers. These brokers maintain that the insurance companies do not fully understand or appreciate the degree of risk they have underwritten in issuing these annuities. That fact does not exactly bring a lot of comfort. The WSJ offers:

The Merrill survey suggests increasing wariness among advisers for whom the annuities are a significant portion of their business about “the risk profile” of the insurers creating the products, according to the survey authors, Edward Spehar and Roman Leal. Some 71% said they thought the insurers had taken on greater risk with recent versions, up from 68% the year before. In addition, 32% agreed that insurers “do not adequately understand the risks that they are assuming in the variable-annuity business,” up from 17%.

How are insurance companies responding to the perceived lack of understanding of the risks embedded in these annuities? When in doubt, get out!! A number of companies are largely scaling back, if not outright exiting, this product space. Moves like this do not exactly inspire confidence in the risk management capabilities of a variety of insurers. The WSJ sheds further light:

Hartford Financial Services Group Inc. showed one of the biggest drops in fourth-quarter sales of variable annuities, falling to 12th place from fourth at the end of 2007, according to Morningstar. Its market share was more than halved, to 3.6%. The decline came as the company obtained a $2.5 billion capital infusion from German insurer Allianz SE, and the main life-insurance unit faced multiple downgrades of its financial strength. In the coveted double-A category before the market meltdown, it was cut most recently by Moody’s Investors Service, to A3, from A1, last week.

A Hartford spokeswoman pointed to recent comments by the company’s chief executive, Ramani Ayer. In comments to analysts in December, he said the insurer had “ceded a lot of market share over the last several years because we felt that the annuity arms race was so strong and so aggressive,” adding that he wished it “had pulled back some more.” The goal now is “to ensure that we are derisking our annuity business” to “substantially reduce the risk and capital strain.” Of the Moody’s downgrade, he said last week: “We believe the Hartford’s capitalization is stronger than what was reflected in the actions taken by Moody’s.” The insurer says it “remains well prepared to meet” commitments to customers.

When the WSJ entitles a major story as Brokers Fear Many Insurers Are Ignorant of Annuity Risks, it does not inspire confidence.

In this case, ignorance is definitely not bliss!!

LD

  • fiscalliberal

    If I could just add to your argument, the baby boomers are the one’s that bought retirement annuity’s, and they are starting to retire. Of courst the risk there is how long they live. Short and simple.

    Hopefully the annuity issue will not be as bad as the banking industry as the regular insurance people are attuned to long term risk. If they prove to be not correct, we know the Harvard best and brightest MBA penetated their ranks also.

    I think you have talked about the municipal bond industry before, and would be interested in hearing more detail about that. Local revenues are down and I think ratings are down. If that is true, the multiplier for the government stimulus will also be jepordized.

  • Larry Doyle

    Fiscal…In regard to the municipalities, the guaranteed pensions will be crushing to their finances. Those pensions were to be funded by investment returns generated by equity and bond investments along with alternative investments as well. There are major problems in this sector. What will happen and is already happening?

    1. Taxes are going up.
    2. Services are going down.

    Both of these developmetns will occur despite the stimulus. The stimulus money is not additive but merely replaces or plugs holes….temporarily!! Will that money be used most efficiently and productively? Don’t bet on it.

    3. Look for a federal guarantee of some sort for municipal bond issuance. That guarantee will add to the pressure on the Federal balance sheet. This plays into my piece about getting the genie back into the bottle.

    On the insurance front, I will keep in touch with my friend to see what I can learn about expected rates of cash withdrawals.

    • TeakWoodKite

      What you describe, in reponse to FiscalLiberal, is akin to a dutch dyke.

      It is alarming to understand that the base line of
      the exposure you describe is a 300 percent increase.

      What time frame do you see this occuring?
      The rate of inflation shares the road with these projections and genie or not, the dam is underminded like a 14th street levy.
      Thanks.

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  • Larry Doyle

    TKW…the more that I think of it, I am struck at how quickly developments have occurred in the markets and economy. As I think of it, I firmly believe it is the widespread and overwhelming impact of the CDS (credit default swaps) across all sectors of the market. The CDS were intended to hedge risk and diminish risk. As such the concept of CDS was to be a retardant of market volatility. However, given the volume of CDS especially by non-creditworthy institutions, the CDS have been more an “accelerant” to the downturn in the ecoonomy and markets.

    To that end, I think we will see further breakdowns in the economy and market sooner rather than later. I think S&P are close to downgrading a large amount of commercial mortgages which will negatively impact a lot of insurance companies.

    Every quarter is going to be very interesting. This will not be a dull, quiet Summer.

  • TeakWoodKite

    You cited “Trading Places” earlier.

    Now I am thinking, “Backdraft”.

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