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| Why Some Insurance Companies
Go Broke
What Can You Do To Protect Yourself? How To Get Help In Evaluating Insurance Companies
A number of financial writers have been predicting the insurance industry will be the next to go through a series of breakups and bankruptcies, just as the S & L industry has. The insurance industry is quick to claim the potential danger is greatly exaggerated and unjustified. Meanwhile, some insurance rating services have been downgrading their ratings in response to criticisms of excessively high ratings on companies that became insolvent. The National Association of Insurance Commissioners has also instituted a new "Risk Based Capital" formula to measure how much capital a company should have. Major change rarely come from within an industry. It's often forced on the industry from outsiders. The insurance industry should be a business that makes bankers look like commodity traders by comparison. The bulk of the money entrusted to the industry should be invested in low risk, moderate yield investments like (1) government bonds, (2) top grade corporate bonds, (3) some preferred stocks, (4) high quality single family mortgages, and (4) a "blue chip" selection of big company stocks. During the seventies, part of the industry focused on the investment features of annuity and life insurance policies. To get more people to buy insurance, many companies resorted to competing on the basis of promised yields. One of the first big annuity companies to go broke was Baldwin-United. In the next ten years, a number of bigger companies were reorganized or liquidated, including (1) First Capital Life of California, (2) Mutual Benefit of New Jersey, (3) Executive Life, (4) Fidelity Bankers Life, and (5) Monarch Life of Massachusetts. According to Bill Comer, there have been 226 insurance company failures from 1983 through 1989. Most of the failures have been due to overly aggressive marketing which forces the companies to engage in more speculative investments in order to get higher yields. Excessive Real Estate DependenceThe industry has always invested in real estate, but in the last twenty years, some of the bigger companies have been heavily invested in commercial real estate or in loans backed by commercial real estate - including shopping malls. Doug Casey, in his July, 1992 newsletter, Crisis Investing offered the opinion that "it's the insurance companies, who lent the malls almost all their money, who are really going to get tagged" when some of the malls aren't able to meet their mortgage payments.The Junk Bond FiascoMany insurance companies jumped into the high yield "junk bonds" that emerged from the corporate takeover mania of the eighties. Bill Focht, in a training presentation sponsored by A.M. Best, said the total industry capital and surplus is just 6.5% of total assets. Then he said the "junk bonds" owned by insurance companies equal 6.4% of total assets. In fairness, the worst of the junk bonds have already been written off. In addition, many companies that issued junk bonds have converted their high interest bonds to common or preferred stock.The AIDS EpidemicIf you like to read horror stories, I invite you to read Bill Clinton and Al Gore's book, Putting People First. Here's a real prescription for fiscal disaster. On page 37, they say, "Provide quality health coverage to all Americans with HIV as part of a broader national health-care program. ... oppose needless mandatory HIV testing in federal organizations (and allow) HIV (to) be removed from the immigration restrictions list." On page 40, they say, "Forbid health insurance companies from denying coverage to HIV positive applicants. Prohibit all health insurance companies from adopting discriminatory caps or exclusions. ... No American will be denied coverage because (of) a pre-existing condition." Relax. It's not the law. Not yet. But I have the feeling it's coming at us like a run-a-way train.National Health Care & Mandated CoveragesAs for Hillary and Bill Clinton's continuing effort to create a comprehensive national health care system, I don't believe they have any concern about the solvency of the insurance industry. They are both overtly against the free market system and want to replace it with federally managed programs. They weren't able to get public support for a single huge new law, so they have been adopting the same proposals on a piece meal basis. (The Health Insurance Portability Act of 1996 actually included many of the provisions that were in the earlier national health care proposed law.) As time passes, it will be difficult for health insurance companies to make a profit because of laws that require them to provide costly coverages without being able to charge more for the added risk.Concentrated Natural DisastersHurricanes on the Southeast coast. Floods in the Midwest. Raging fires in California. The property and casualty insurance companies are reeling from the cost of these huge disasters that have occurred in a short time span. Meanwhile, yields have fallen on their investment portfolios.Limited Protection From State Guaranty FundsWhen people argue that there is no form of insurance or safety net for policyholders, industry insiders are often quick to tell the outsiders about the state guaranty fund. When an insurance company goes broke, it is taken over by the state insurance department. Basically, its losses are allocated to the other insurance companies that do business in that state. However, in some states, the insurance companies get to deduct the cost of bailing out their defunct competitors from future premium taxes. In other states, they are allowed to increase their premium rates in the affected state. So, in the long run, the taxpayers or policyholders pay the bill. This system works fairly well for protecting consumers from smaller bankrupt insurance companies. It's been strained to the breaking point with the recent breakup of Mutual Benefit Life, one of the larger insurance companies.Furthermore, the various guaranty funds set limits on the amount of a single claim. In most states, it's $300,000 but in two states it's as low as $100,000. Longer Life Spans For AnnuitantsInsurance companies that specialize in retirement annuities may be hit hard in the next twenty years by longer life expectancies due to dramatic gains in medical research. I believe the breakthroughs will occur because of the widespread availability of inexpensive and powerful computers. The segment of the population that buys annuities is far less likely to be afflicted with AIDS, so there won't be any offsetting mortality gains for the companies that sell life income annuities.Rising Interest RatesWhen market interest rates fall, the market value of all outstanding bonds go up. Interest rates have been falling steadily for about ten years. The market value of bond portfolios have been rising. Insurance companies typically invest 50% to 70% of their money in bonds and mortgages. Some observers believe we are near the bottom of the fall in interest rates. When (if) interest rates go back up, the market value of bonds and mortgages will fall. Recent changes in accounting rules will reflect more of the impact of interest rate changes in insurance company financial statements.Falling Real Estate PricesThe Congress just doesn't seem to get it. They reduced the economic value of real estate after the 1986 tax law and set off a chain reaction of losses in real estate and the S & L industry. Then, Clinton's 1993 tax law increased the depreciation period on commercial real estate from 31.5 years to 39 years for property acquired after 1993. According to my calculations, that will reduce the annual depreciation deduction on commercial real estate by about 20% and will reduce the value of all existing commercial real estate by about 10%. That will wipe out about 50% of the equity available on real estate loans to shield the lenders from losses. Since most commercial real estate is financed by the insurance industry, they will bear the brunt of this change in the tax law.Mushrooming Liability AwardsUntil we can put a limit on the preposterous damage awards that are being given by judges and juries, the insurance industry will be a bigger and bigger target for scams and fraud of every kind. If an insurance company knows it will have to pay at least $50,000 to litigate a frivolous claim, the company will settle for anything less than that amount. The lawyers that represent the plaintiffs know "the rules of the game" and expect to get a lot of quick, small settlements from the insurance companies, even though they represent plaintiffs with highly questionable cases.Potential Federal RegulationBecause of all the past and potential financial damage that can be caused by insolvent insurance companies, the feds are making a lot of noise about "protecting" the public from allegedly incompetent and inconsistent state insurance regulators. No matter how bad the state regulatory procedures may be, I have absolutely no doubt that federal regulation will make the situation much worse. If you really like what the feds did to the S & L industry, then you should support federal regulation of the insurance industry.
What Can You Do To Protect Yourself?Meanwhile, there are some practical steps you can take as an insurance consumer to minimize your exposure to the chance that your insurance company may become insolvent. These suggestions do not require you to become an expert at evaluating the financial strength of an insurance company. Avoid Doing All Your Business With One CompanyA basic tenant of insurance is the principle of spreading the risk. It's equally appropriate for you to spread your risk among different insurance companies. Don't let your friendly agent get you hooked into having all of your insurance with one carrier. This is particularly true for those of you who have used an insurance trust to buy large amounts of beneficiary owned permanent life insurance to bypass the federal estate tax. Spread the coverage among different companies even if it costs extra.The insurance companies and the agents may be quick to inform you that they "do this diversification for you" by re-insuring large policies with other insurance companies. Each company establishes a retention limit and reinsure the rest. For example, on a life insurance policy, a company might set a retention limit of $500,000 and then buy insurance from other insurance companies for any amount in excess of that limit. However, this doesn't protect you from poor management or investments. it only protects the insurance company from excessive risk concentration. Take A Serious Look At Some Foreign/Swiss Insurance CompaniesSwiss insurance companies haven't become insolvent. They don't offer unrealistic yields. They are so conservative they make our insurance executives look like high rollers. Their policies offer a double benefit of a hedge against the dollar. As our dollar deteriorates because of inflation, the payoff from the Swiss Franc policy will gain in value. Bill Comer, author of Freedom, Asset Protection & You states that no Swiss insurer has ever failed to make a timely payment - in full - on its policies. (However, I doubt that you could get a trustee of a U.S. life insurance trust to buy insurance from a Swiss company.)One company that has a lot of exposure in the U.S. is JML Jurg M. Latmann, AC, Germanisstrasse 55, 8033 Zurich, Switzerland. You have to contact them to request information because foreign companies apparently can't solicit business in the U.S. Insurance Brokers Can Be Your Quality ShoppersIn the past few years, some of the insurance agents that broker business with multiple companies have become astute shoppers for the safety conscious consumer. The independent brokers will switch their new business to a stronger company whenever they hear of any problems with one of their companies.Bigger Isn't Always BetterJust buying from the largest companies isn't really the safe way to buy. But there is some validity in limiting your buying to the top rated twenty or thirty companies in each insurance category. I know this makes it hard for a new company to get a foothold, but that's not really your problem.Require Top Ratings From Weiss And A.M. BestWeiss Research produces the most unfavorable ratings of the five rating agencies and they are the most independent of the industry. Best is the "old line" rating service. They both provide ratings for most of the companies. If an insurance company doesn't have a high rating from both of them, it requires some serious investigation before you make a big commitment.Avoid Small, New and Fast Growth Insurance CompaniesAll but a few of the insolvent companies have been small companies, relatively new to the insurance business and growing far faster than the industry norm. Be extra careful in buying from a company that hasn't been in business since at least 1950. Buy from the companies that have at least $100 million in surplus and buy from insurance companies that don't brag about how fast they are growing. Otherwise, limit your financial commitment.Look For Companies With Diverse CoveragesOne reason for buying from a large company is that the larger ones are more likely to be diversified in their product lines and risk exposures. A company that only issues health insurance can get into financial trouble a lot faster than one that issues life, health, annuity, property and casualty. Thus, even though I urge you not to buy all your insurance products from one company, it is still desirable to buy from companies that offer a wide range of products.Avoid The Temptation of Top YieldsWhen shopping for insurance, consumers often want top yields, the lowest premium rates and total safety. However, with insurance, you must be more concerned about safety than about small differences in premium rates or cash value projections.Invest In Variable Life and Variable Annuity ContractsA complete explanation of the difference between variable life or annuity contracts and traditional contracts is far beyond the scope of this report. Very briefly, a variable contract gives the investment risk to the policyholder. The insurance company doesn't guarantee a certain rate of return. As a policyholder, you can instruct the company to allocate your cash value or your annuity value among three or more different "funds". One will be like a money market fund, another will be a bond fund, and a third will be a common stock fund. You can switch from fund to fund without any tax on any gains and at a minimal cost.The biggest benefit of a variable contract is that the money in that
contract is segregated from the other obligations of the insurance company.
If an insurance company goes broke, the assets in a variable account will
be separate from the other assets and debts of the company. However, you
might have some problems with the trustee of an insurance trust if you
want them to buy variable life policies because there are no "guarantees".
How To Get Help In Evaluating Insurance CompaniesThe easiest way to start is with some independent agents who represent many different companies. Let them know you are first interested in the financial safety of the company. They will eagerly flood you with information about the ratings of different companies. And call the agents of your existing carriers to request information about the solvency ratings of each company. Weiss Research, Inc.Weiss is the most controversial of the insurance company rating firms and is generally belittled by those in the industry. However, since he was the only rating service to downgrade some large companies before they became insolvent, I think he should be given his due. He is also the only rating service that tries to measure the ability of a company to survive a recession.For $189, you can purchase a copy of the Weiss Insurance Safety Directory. For $45 you can order a 16 page analysis of a single company. For $15, you can get information about a single company over the phone. (Call 1-800-289-9222) To write to them, write to Weiss Research, Inc., 2200 N. Florida Mango Rd., West Palm Beach, FL, 33409. A.M. Best CompanyThe industry still looks to A.M. Best as the mainstay in the ratings business. Information on the ratings of the A.M. Best Company are usually available in most public libraries. If you want to contact them for information, write to A.M. Best & Co., Ambest Road, Old Wick, NJ, 08858. I'm told that A.M. Best charges each company a flat $500 for the rating and that they rate every insurer that sends them a copy of their annual "Blue Book". Their phone number is (201) 439-2200.Standard & PoorsStandard & Poors charges from $15,000 to $32,000 to rate an insurance company and a lot of companies won't pay the fee. Recently, they published a book of "qualified solvency ratings" of insurance companies that didn't subscribe to their regular service, using data from the companies annual statements. However, they use a different rating scheme in this book, which appears to be like the lower ratings in their regular service. If copies aren't available in your public library, you can contact S & P for information by calling 800-765-8362 or writing to S & P Insurance Rating Services, 25 Broadway, New York, NY, 10004.Moody's Investors ServicesMoody's Investors Service also charges for ratings of insurance companies. (The fees apparently range from $5,000 to $100,000.) Their information should be available in the public library or you can contact the company at 99 Church St., New York, NY 10007. Their phone number is (212) 553-0300.The Vital Signs Software ProgramIf you have your own computer and prefer to do-it-yourself, you can buy an insurance company software rating program from United Systems, Inc., 2053 Sidewinder Drive, Park City, UT, 84060. The initial price of the software is $295 for the life/health version and another $295 for the property/casualty version. Their phone number is 800-682-5202. The software gives you the ratings of three of the rating services and three pages of details from the company's annual statement. You can enter the A.M. Best or Weiss ratings manually for comparison. They tell me their software includes data for the largest 350 companies.Further details about protecting your assets from future lawsuits are available in our subscriber's web site. Changes in the tax laws and various federal and state laws affecting various asset protection devices are provided in our monthly newsletter on Asset Protection Strategies.
NOTICE: This Information is intended only for educational purposes and may be regarded as controversial by some legal experts. Readers should consult with a qualified professional who is familiar with their specific financial and tax circumstances before adopting any ideas that are discussed in this article. About the author: Vernon Jacobs is a CPA/CLU who works as a tax author and consultant. He sponsors and moderates a free discussion group on asset protection and offshore topics. His email address is vkj@rpifs.com. He can be reached by phone or fax at (913) 362-9667.
Sponsored by Offshore Press, Inc., Copyright, 2001, all rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. (913) 362-9667. Email to rpi@rpifs.com. |
