Rising insolvencies. Tens of billions in high-risk investments. Lax regulators.
Sound familiar? No, it’s not the savings-and-loan industry or commercial banks, but their brethren in insurance who are now experiencing distress.
With recession fears increasing, the speculative excesses of the 1980s are also haunting the insurance industry. Anxieties are being fueled by the fact that the life-insurance industry has about 20% of its assets, or roughly $265 billion, tied up in the depressed commercial mortgage business; insurers hold another $60 billion in the wobbly junk-bond market.
The prospect of more insurers failing is setting off alarm bells. Industry insiders are worried that the current system of state regulation is ill-equipped to handle major failures and curb growing financial woes. “They’re lacking actuaries and a sufficient number of examiners,” says Kenneth Merin, who recently stepped down as New Jersey insurance commissioner.
Even some leading insurance executives like Wilson Taylor, chairman of Cigna Corp., who for years have generally regarded federal intervention in the industry with dismay, now indicate that some federal help with monitoring solvency problems would be welcome. And one industry maverick, John Byrne, the chairman of Fireman’s Fund Insurance Co., who has long criticized industry accounting practices for masking problems, is reiterating his calls for upgrading accounting rules “so that we can properly measure and control our financial health.”
Unlike banking, the insurance industry does not have a federal safety net to ensure that policyholders are protected. Instead, it has long depended on a network of state guaranty funds supported by healthy insurers. The stakes are enormous:
--Both property-casualty and life-insurance insolvencies have been rising in recent years. From 1969 through 1988, there were 150 property-casualty insolvencies, but half of these occurred in just the last five years. Similarly, after averaging five insolvencies per year in the 1970s, life-insurance failures climbed to 10 in 1988 and last year were a record 29.
-- A report by a congressional subcommittee earlier this year saw ominous parallels between the growing solvency problems of property-casualty insurers and the early stages of the savings-and-loan crisis. The study noted that failures in both industries were characterized by weak regulatory scrutiny, poor accounting procedures, undercapitalized companies, risky investments and insider fraud. The three biggest property-casualty failures alone are likely to cost the public about $5 billion, the study predicts, concluding that the insurance industry is “vulnerable to the types of mismanagement and fraudulent activity that led to the savings-and-loan crisis.”
-- Some of America’s biggest insurers such as Travelers Corp. and the Equitable Life Assurance Society of the United States have recently had sizable losses due to their high-risk investments. Travelers, for example, which posted a $337-million loss in the second quarter of 1988 because of real-estate loans in the Southwest that soured, announced an even larger loss--$499 million--in the third quarter of this year because of other real-estate problems.
What ails insurers? Part of the answer is that their basic businesses have been in the doldrums. The property-casualty business, which has always been a highly cyclical one, has become more volatile due to more unforeseen liabilities and more intense price-cutting wars. Hurricane Hugo and the San Francisco earthquake both struck in 1989, setting record disaster losses.
In the life-insurance industry, which has about $1.3 trillion of the $1.75 trillion in insurance assets, the last decade has been tumultuous; banks and savings and loans now compete with them to provide financial services. So life insurers in the early 1980s began offering new higher-yielding, interest-sensitive insurance products such as annuities. These products spurred many insurers to increase their investments in risky areas, such as junk bonds and commercial mortgages, to offer better returns.
With the glut of commercial real estate, however, more and more insurers are feeling pain. The delinquent mortgages held by the industry have gone from an average of 1% of mortgages in 1985 to about 3% at the end of the first half of this year, according to the American Council of Life Insurance. Similarly, foreclosures on commercial properties, which totaled $1.6 billion in 1987, were almost that high in just the first half of 1990.
Insurers played a big part in the overbuilding of America during the 1980s as lenders for office buildings, hotels and shopping centers, says Anthony Downs, a senior fellow at the Brookings Institution. Mortgage investments went from under $200 billion at the end of 1986 to about $265 billion in mid-1990.
Downs notes that lending officers of insurance companies have been under tremendous pressure to put out money because of growing competition. “My father used to say that if a lending officer couldn’t make good deals, he’d make bad deals, and if he couldn’t make bad ones he’d make terrible ones, and then he’d make horrible ones.”
The industry has also been guilty of making overly sanguine assumptions about real estate. Downs says insurers often based mortgage loans on estimates of 5% vacancy rates that were way off the mark. The industry’s optimism has also extended to what companies set aside to cover their mounting losses. Another analyst says many insurers are under- reserved and are fooling their managements and the public.
The insurance foray into junk bonds is similar. Executive Life Corp. recently took an $859-million writedown on its junk-bond portfolio of almost $8 billion (more than half its assets), and life insurers now have about 4% of their assets invested in bonds considered below investment quality.
Not surprisingly, as more and more of the leveraged buyout deals that insurers helped finance with junk bonds come apart and companies fail, insurers are taking some sizable losses. In recent years, they have backed some of the best known buyouts, like Revco D.S., the bankrupt drugstore chain.
Worried about what this means for you? Given the industry’s mounting woes, consumers ought to check the financial strength of insurers carefully before buying policies. One way of doing that is to examine the ratings given insurers by various agencies such as A.M. Best & Co., Moody’s Investors Service and Standard & Poor’s.
And where have the regulators been all this time? As critics have long pointed out, many state insurance departments lack basic tools--computers, sufficient examiners and actuaries, etc.--to keep tabs on the industry.
The investments of the insurance industry that are vital to their financial well being have received short shrift from regulators. Only two states, New York and Arizona, have enacted any curbs on junk bonds despite their fast rise in popularity. More surprising is the fact that insurers are not required to set up any reserves for mortgage problems.
Earlier this year, a House subcommittee summed up the weakness in state regulation, saying that it suffers from “inadequate resources, lack of coordination, infrequent regulatory examinations, poor information and uneven implementation.” The present regularly system also was attacked for not fully investigating why companies failed and for inadequately “punishing the persons who are responsible.”
The recent calls by some industry leaders for federal help in overseeing solvency matters are long overdue and should be embraced by all insurers. One consumer advocate, Robert Hunter, who heads the National Insurance Consumer Organization, suggests that the federal government could help in setting minimum solvency standards. Further, Hunter says that the federal government should help regulators deal with the massive amounts of data they must monitor to enforce solvency standards.
Given these concerns, Rep. John Dingell (D-Mich.), the subcommittee chairman, plans to introduce a bill in the new Congress setting minimum federal solvency standards for insurers.
To be sure, the industry is not yet near the parlous condition that the savings-and-loan business has reached. But to ensure that a repetition of that debacle does not occur, insurance regulation needs to be quickly enhanced at the state level and instituted at the federal level.