Is it really that bad? Plenty of insurers are in fine condition, and no one is advising consumers to cancel their policies. But after months of bad news, even the experts are worried about the overall health of the insurance industry. “It’s a real problem,” says former Massachusetts insurance commissioner Peter Hiam. “Most of the companies are not in a position to ride out a severe or long-lasting recession.” And while most of the troubled insurers in Texas are tiny, elsewhere in the country some big names are involved. “It’s not just the small regional companies,” contends Barbara Stewart, an industry consultant. “It’s large national and international companies that could have problems.”
The “insurance industry” is actually two very different industries. Many life and health insurers have bet heavily on real-estate mortgages, junk bonds and other assets that have fallen in value or gone into default. For those insurers, future costs are very predictable, but the strength of their assets is in question. Property and casualty insurers, which handle everything from standard homeowners’ insurance to custom-designed policies on pitchers’ arms, generally have much sounder investment portfolios. Their problem is pricing: many of them sold policies too cheaply and don’t have enough reserves set aside to cover losses that may not be known for years.
Last year, 41 “multistate” insurers bit the dust, down slightly from 1989 but far more than in any other recent year. The worst is probably yet to come, since insolvencies traditionally lag behind the economy. Although the recession is likely to end in the summer, the full extent of the industry’s ills may not be apparent for another year or more. So far this year, Standard & Poor’s, the financial-rating service, has downgraded 20 insurers and related entities - and upgraded none. No wonder experts, painfully aware of the mounting bill for bank failures and the costly collapse of the savings and loan industry, worry if an insurance crisis is next.
The comparison is exaggerated. Unlike the thrifts, the insurance industry as a whole is profitable and has plenty of capital to back its promises. Unlike banks, insurers have not lost core businesses to new competitors, and their obligations are far enough in the future that many currently troubled investments may yet pay off. The concern is whether companies will be able to pay claims that may be filed in years to come, not whether they can pay claims today. Says one nervous New York money manager: “It’s more than a long-term problem, but it’s not an imminent problem.”
Nonetheless, many large insurers are ailing. Equitable Life Assurance Society, the nation’s third biggest life insurer, saw its capital fall by $371 million last year, due largely to problems with its junk-bond and real-estate portfolios. (Last week the company tentatively settled a nasty dispute with Manufacturers Hanover Trust Co. over a soured real-estate investment in New York.) Travelers Corp. added $650 million to its reserves to cover expected losses on real estate. USF&G Corp. reported a $569 million loss for the year. Monarch Capital Corp., a Massachusetts insurance holding company weighted down by real estate, defaulted on $235 million worth of loans.
The companies are responding with drastic measures. Equitable wants to convert from a mutual company, owned by policyholders, to a stockholder-owned company - and raise $1 billion of capital in the process. Travelers has been downsizing its property-casualty business and focusing on corporate health-care programs. USF&G dropped much of its business in Texas and slashed its dividend by 93 percent. Monarch Capital may give its bankers ownership of its insurer, Monarch Life Insurance Co., in return for debt forgiveness.
Analysts judge that all these companies have the resources to weather even a lengthy storm. “While they may have their problems, I don’t see that they’re imminent candidates for failure,” says Gloria Vogel of the Wall Street firm Bear, Stearns. Others are less sanguine. Says Harry Fong, research director of Conning & Co., a Hartford investment bank, “One thing that never ceases to amaze me is how a company that appears to be solvent turns out to be not so in a very short period of time.”
Determining the health of an insurance company is hard even for experts. Projecting, say, how many product-liability claims will be filed concerning Nissan Sentras made in 1990 is sheer guesswork. And many of the assets that are supposed to pay those claims, including real estate and mortgages, are valued at whatever the insurer paid for them, not what they would be worth if put on the market today. Most insurers are required to keep separate sets of books for insurance regulators and investors, and it is entirely possible to show profits on one while suffering losses on the other. “Most accounting is done with mirrors,” says Joanne Morrissey, president of Firemark Insurance Research. “Insurance accounting is done with prisms.”
Deciding when an insurer is insolvent, then, is not such a simple matter. Take the case of Los Angeles-based First Executive Corp., which owns two large and troubled life insurers. First Executive units invested heavily in junk bonds; if they had been forced to value the junk at market prices, the insurers would have been insolvent a year ago, according to one analyst. But because current income was adequate to pay claims, regulators let them keep going under close supervision. “If the junk-bond market turned around and defaults went down to a manageable level, that company would probably be profitable in a very short period of time,” says Terence Lennon, chief examiner of the New York Insurance Department. First Executive says that with a 14 percent rise in junk-bond prices since Jan. 1, things are looking up. A.M. Best Co., which rates the soundness of insurance companies, disagrees: This month it lowered the insurance units’ ratings two notches.
For policyholders, an insurance company’s failure need not be serious. Every state has a guarantee fund to cover claims against insolvent property and casualty companies, and 47 states have similar funds covering life insurance. “Fund,” however, is a misleading description: there is no pool of money, only an obligation for insurers to contribute in future years to cover the obligations of those that failed. Those payments have risen sharply (chart), and there is a limit on the amount insurers may be forced to kick in annually - meaning that some claimants may have to wait in line. In addition, most funds guarantee only $300,000 per claim.
The funds got a scare last year when AmBase Corp., owner of Home Insurance Co., a major property insurer, ran into financial trouble. The company finally sold Home Insurance last month. “Home is such a large company that had they gone bust, many of the states would not have had enough in the till to satisfy the remaining claims,” says Fong. That would have put a crimp in government budgets, too. Jack Nelson and James Barrese of New York’s College of Insurance say that tax deductions mean that the federal government bears about 34 percent of the cost of guarantee-fund contributions, and in many states insurers also receive tax credits.
Can a crisis be avoided? That depends largely on state insurance commissioners, who have sole responsibility for overseeing the industry. Under prodding from Rep. John Dingell, whose probes of several recent insolvencies have pointed to embarrassing lapses in regulation, the states have belatedly cracked down, tightening accounting standards, demanding that insurers put up more capital and even trying to get a handle on the property and casualty industry’s weak spot, reinsurance, nearly 40 percent of which is provided by unlicensed foreign companies.
But each state generally regulates only local companies, accepting the judgments of other states about their firms. That amounts to a major hole in the regulatory net, because regulation in some states is decidedly lax. Louisiana’s insurance commissioner, Doug Green, was convicted last week in federal court for doing favors for an insurer that subsequently failed. In Arizona, you can start a life-insurance company with a paltry $450,000 stake. In Texas, which leads the nation in insolvencies, officers and directors of insurance companies are subject to background checks but controlling stockholders are not. Says insurance commissioner Philip Barnes, “I’m convinced that the more astute people who want to avoid regulation can do it.”
In the end, the combination of tighter regulation and lower interest rates should help most insurers pull through. But in the process, many of the nation’s 4,600-plus life insurers and property companies may be squeezed out of business. “We’re going to see more and more companies needing outside help and more and more mergers,” says Joanne Morrissey. As in any other type of business, poor performance will inevitably lead to a shake-out. Predicts former New York insurance superintendent James Corcoran, “What it’s going to result in is not a lot of insolvency, but smaller companies and higher prices.” That may be good in the long run - but the short run promises to be rocky.
