Buying Insurance Without Getting Stung
Whom do you trust? That’s the question of the day as California Insurance Commissioner John Garamendi completes the financial examination of Executive Life Insurance Co., which he may soon take over to protect policyholders.
Even investors facing no risk with the giant insurer, which was propelled by junk bonds to fantastic growth in the 1980s, are asking if any investment is safe--and if so, how does the ordinary person know it’s safe?
As one insurance buyer said plaintively: “These policies were not presented as risky investments. Executive Life was an A-rated company.”
True enough. Until January, 1990, the chief insurance company raters, A. M. Best Co. and Standard & Poor’s, gave Executive Life their top rating for ability to meet financial obligations. Moody’s gave it an A, which is not as good but doesn’t sound like a danger signal either.
So with the company about to be taken over by the insurance commissioner--and its parent, First Executive, near bankruptcy--the question arises: How could the ratings agencies ignore the fact that more than half the assets backing Executive Life’s high-interest annuities and policies were risky junk bonds?
The short answer is the raters were taken in by the long years of easy money and spurious gains of the 1980s. But they were not alone in being fooled, say insurance experts, and that mistake doesn’t invalidate the usefulness of their ratings as a guide for small investors.
But more on ratings later. The immediate issue is what Executive Life policyholders have to look forward to. And beyond that, what should an insurance buyer or investor look for in the future?
In fact, how safe is the gigantic insurance industry anyway? Sure, it’s big, with $9 trillion in life insurance outstanding, $1 trillion in investments and 2,500 companies. But the savings and loan industry was big.
Troubles in commercial real estate have sunk the S&Ls; and are now shadowing the banks. Can insurance companies--investors in and lenders to real estate--be far behind?
Here are some answers:
On Executive Life, the insurance commissioner taking control is not the worst thing that could happen. He would do so to stem the tide of policyholders cashing out or exchanging their policies for those of another company. Ultimately such an outflow would weaken the insurance pool by leaving only higher mortality risks still holding Executive Life policies.
The precedents for insurance being taken over are not bad. Integrated Resources, another junk bond wonder of the 1980s (it went into bankruptcy in February, 1990), managed to sell its insurance subsidiary to Loyalty Life of Des Moines, Iowa, in 1989--with policyholders kept whole. That was before junk bonds really crashed, as they have now. But given the vagaries of insurance accounting, Executive Life may still be able to pull off a sale of some of its business.
A precedent for big failure is Metropolitan Life taking over a lot of the business of Baldwin United after it collapsed in 1983. The workout took four years, but policyholders came away with their principal and a little bit of interest.
The real truth about Executive Life at the moment remains uncertainty, according to an insurance expert. There is a ways to go before the full extent of losses is known.
Otherwise, what should insurance buyers and investors look for? In the new decade, the emphasis will be on safety, says Joel Goldhirsh, an insurance agent with Connecticut General in Irvine. Look for companies with top ratings from all three agencies--that is, with A-plus from Best and AAA ratings from Standard & Poor’s and Moody’s.
Out of 400 companies selling insurance nationwide, and more than 2,000 others selling regionally, there are only 11 such top-rated companies: Aetna Life Insurance, Connecticut General, Guardian Life, John Hancock Mutual, Massachusetts Mutual, Metropolitan Life, Nationwide Mutual, New York Life, Northwestern Mutual, Principal Mutual of Iowa--formerly Bankers Life--and Prudential Insurance.
Beyond the ratings, William Stolzmann, general counsel of Minneapolis’ IDS Life, says to look for diversity of investments. If there is a concentration of junk bonds or over-investment in a particular type of real estate or other business, beware.
But the industry overall is sound. Richard Weber, of the Patterson & Weber insurance agency of Lafayette, Calif., an expert on insurance accounting, explains that the industry is different from banks, S&Ls; or securities brokers. “It’s a long-term industry,” he says. “Insurance companies don’t tend to own leveraged real estate--rather they are the equity investors. If values go down, they sit with them; if rents are lowered, there are reserves.”
Still, the best approach for the average investor is good sense and skepticism. If annuity sellers in this new decade promise extraordinarily high interest, question how the company proposes to earn such returns. If something sounds too good to be true, it is.
Which brings us back to the question: How could the ratings agencies go so wrong on Executive Life? “Simple. They were blindsided because Executive Life looked so good,” says one insurance expert. The company had been making big gains with high-yield bonds since the 1982 recession. It looked solid, just as the junk bond market itself looked good for a long time. It didn’t really collapse until late 1989, when Drexel Burnham Lambert’s troubles had become glaringly apparent.
It was a decade of rapid economic change, but also fast dealing--when sharp people foisted off questionable merchandise and financial experts proclaimed that the rules your grandparents knew about debt and business had been repealed.
Now we have the aftermath. The rules your grandparents knew apply again.
