Is your insurance company safe? Or at risk?
Editor note 2/3/16:
I wrote this article in 2012. Much of what I wrote about has happened. Rates stayed low for a long time. Many institutions like pensions, have had to boost yields and returns by adding more stocks and junk bonds. To replace low yielding government bonds.
Did insurance companies do this too? The good ones likely not. But to make sure an insurance company is safe, it would help to read the company’s financials. Focus on the assets in the general account. Those are the assets that back the insurance products offered. FYI – I recently recorded a video on this topic (right below).
Those assets you must review if you are asking “Is my insurance company safe?”
2008 – the Prologue to Where We Are Now for Insurance Companies
In the 2008 financial crisis, insurers (outside of AIG) weren’t discussed too much. Yes Metlife, The Hartford, and a few other insurers had financial problems. But considering that there are 1,500+ life insurance companies in the US, there was very little strife.
Furthermore, it wasn’t AIG’s insurance business that got it in trouble either. AIG’s life insurance units for example, held up rather well. So does that mean life insurance companies are without risk? That is a statement I would not agree with. Let’s analyze this a bit.
Is Your Insurance Company Safe?
First off, insurance companies are often (hopefully) conservative money managers. They work like a bank but are often filled with more prudent people in my opinion. They typically have a majority of their general account assets in conservative investments that
offer consistent cash flow. This typically includes government bonds, corporate bonds, real estate, preferred stocks, and dividend-paying common stocks.
And the majority of these assets are in the first two categories. With stocks representing 10% or less of the general account. Large banks historically (and still) invest in derivatives and other leveraged instruments trying to maximize profit.
Leverage of 30-1 and 40-1 were what sunk firms like Lehman Brothers. Even local banks, with smart managers, still invest in residential and commercial real estate. And even though residential real estate is rather solid long term, it’s not as solid as a government bond.
OK So How Does That Get Us to Insurers Facing Financial Risk?
Alright don’t rush me. I just wanted to set the historic stage. Here’s what’s developed since 2008. We now are facing obscenely low interest rates. This has goosed returns on bonds currently held by insurers. Rates down = value of old bonds go up.
However, insurers wishing to keep a conservative investment profile have to buy bonds at super low rates today. And these rates are not enough for insurers to keep current profit margins (IMO). Therefore, they will have to add more real estate. And more emerging market bonds And stocks and junk bonds to keep their spreads and margins.
What will that do to life insurance companies? Is your insurance company safe?
It will likely increase their risk profile and/or force them to lower dividends. I don’t care what they say – if they are taking on new business (and they are), they have to match those liabilities profitably. And on the safe side, their choice is often a long term government bond yielding 3 something percent (currently) or something higher on the risk chain. 3 something won’t cut it.
Another point to consider. Publicly held insurance companies, also known as stock companies, as opposed to mutual insurers, have pressure from shareholders to perform. So in addition to staying profitable and in business, public insurers are expected to GROW earnings each year. So that shareholders can earn growing returns.
This is often the opposite of mutual insurers. Though they are also trying to be profitable, they do not face pressure to try and force higher earnings in order to please shareholders. Though the nice dividends received by mutual policy owners could decline further in a low rate environment.
Action Plan to Help Make Sure Your Insurance Company is Safe
Excess profits (what they call dividends) on mutual insurers go to policy owners. And if company earnings are flat or lower than the previous year, there is no shareholder pressure. Therefore, due to their increased need to make profits to please shareholders, public insurers might face even more financial risk in the coming years, in my opinion.
Especially if the Federal Reserve keeps its zero interest rate policy (ZIRP).
My recommendation? A Highly Rated Mutual Insurer
When choosing an insurer, a company that you hopefully expect to be in business and strong over the next 30 years, consider choosing a strongly-rated mutual insurer if possible. Are some stock insurers good? I’ll bet some are. Are some mutual insurance companies bad? I’ll bet some are. But that’s no excuse for not putting odds in your favor. And in my opinion, choosing a mutual insurer often puts the odds in your favor.
Note: if rates were to start rising slowly, that could be a positive for all insurers. Helping to boost their income would make an insurance company safe.
A rapid increase in rates could be a problem though. One thing is certain from my perspective, the “ZIRP” policy is (and will) creating tremendous problems for money managers of all kinds. And the classic financial metrics for measuring investment value, being very distorted,
Check out how your insurance company rates using the following rating agencies: