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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






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