After AIG: Which Insurer Is Next in Line for a Federal Handout?

Now that we’ve seen the brouhaha over the AIG government bailout and subsequent payments to US and foreign banks, as well as the outcry over the AIG bonus payouts to employees of the unit responsible for the firm’s transgressions, can we derive any solace that the rest of the insurance industry is sound? Are there any other insurers that may need government help?

Apart from AIG, Are Any of the Other Insurers Next?

So far in 2009, there have been a number of bank failures, and Shenandoah Life has been placed into receivership on the insurance front, with several other insurers capturing headlines due to financial issues. Fortunately, to date there has been more investor concern than policyholder concern. Most insurance stocks remain significantly down for the year, and there has been a marked slowdown in life insurance sales, especially for certain annuity products. But there has not been a major shift to exchange insurance products from the weaker insurers into the stronger ones; we thankfully have not seen a run on the weaker insurers. Nonetheless, rating agencies continue to cut ratings, insurers continue to cut staff and dividends, and asset valuations remain tenuous. In addition, some insurers have asked state regulators for relaxation of regulatory requirements due to reduced risk-based capital ratios, sending a troubling signal to investors and policyholders alike.

Past experience indicates that the insurance industry is better positioned than the banking sector, due to the strict state regulatory standards set for insurers. In earlier market meltdowns, relatively few insurers went under, and those that did were methodically liquidated after being taken over by the states. The troubled firms were merged with stronger carriers, operations were otherwise rehabilitated, and policyholders were generally made whole. Indeed, even in the case of AIG, the insurance operations remain solvent, albeit indications that AIG is cutting prices to retain business could undermine its future insurance solidity.

Statistics Show the Story

Several recent news stories have suggested that insurers, especially the life insurers, are the next group to implode without providing much in the way of statistical justification. The data in the following table offers a more specific analysis of insurer vulnerability to potential problems based on year-end 2008 10-K statistics for some of the major life and non-life insurers.

As shown in the table, the life insurers seem far more vulnerable at the moment. Due to the longer term nature of their liabilities, life insurance assets were more exposed to mortgages and other toxic assets, and the life insurers also assumed more debt. For example, the life insurance subsidiaries of Allstate (ALL) and The Hartford (HIG) are in weaker condition than their property-casualty companies. More specifically, the ratio of equity-to-assets is significantly lower for their life insurance than for their non-life operations, while the ratio of debt-to-equity is substantially higher for their life insurance units.

In late 1990, after junk bonds imploded and real estate became an issue, some stand-alone insurers that subsequently folded had equity-to-asset ratios in the 2.5%-3.5% range. On this basis Prudential Financial (PRU) and Hartford Life currently appear to be the weakest of the companies listed in the table. However, while Hartford Life has an equity-to-assets ratio of 3.1%, its associated property-casualty firm is significantly stronger. Perhaps that is the reason why The Hartford is rumored to be looking to sell its life insurance unit. Prudential Financial also appears vulnerable, showing a substantial amount of debt on top of a low equity-to-assets ratio.

If invested asset valuations fall another 10% from year-end 2008, then shareholders’ equity will drop by a commensurate amount, while debt assumes a relatively larger share of the balance sheet. Assuming there is still some capital left, this will result in a further decline in the equity-to-assets ratio and thus the need for more capital.

Government Action is Needed

Treasury Secretary Geithner has proposed a plan to have the government and private sector buy some of the toxic assets from the banks. In Congressional testimony he also suggested that non-bank financials that pose systemic risk need greater federal oversight to better monitor and work out solutions for troubled firms. However, even in the case of the banks, the Treasury’s plan will only work if those toxic assets are truly underpriced and the banks are still solvent. Otherwise we will simply be moving those toxic assets from the banks to the taxpayers.

If the accountants agree to bypass mark-to-market accounting, at least during this period of market illiquidity when market pricing is difficult to ascertain, then there will be less of an immediate drag on balance sheets. Such a move by the accountants would give companies more leeway and time to recoup capital once markets stabilize and the economy recovers, as part of the recent trouble has been the inability to price the toxic assets held by financial institutions. But with investors clamoring for increased transparency, it is most likely that investors will nevertheless implicitly adjust stated capital for estimated market valuations. The financials will still need to boost capital to preserve solvency at a time when the markets are not receptive to providing such capital, and when the government seems to be the only provider of funds.

It’s All about Confidence

The real issue for all financials is one of maintaining consumer confidence in their financial solidity. Insurance, in particular, is sold based on the full faith and credit of the insurance company to pay the claim if and when it comes due. While there are state guaranty funds available to protect policyholders in the event of corporate default, there is currently no federal backstop for insurers on a national scale comparable to the FDIC for the banks. Treasury is correct in that the FDIC, or another federal government agency that operates in similar manner, may need to be established to provide such a backstop, especially for the large insurers that pose systemic risk. With insurers holding much of the public’s retirement funds, it is imperative that insurers remain solvent. The question remains whether the companies will be able to raise private funds or to tap government bailout money if needed, and whether a federal FDIC-type agency will instill sufficient consumer confidence to ease investor and policyholder concerns.

Comments

[abcde_98:]

PRU is next

ING and AEG are not in such great shape (each has substantial US buysiness), and have received funds from their parent-domicile government.

MFC (Manulife) was unhedged on its variable annuities and lost it's AAA rating


Just like investment banks looking for alternate ways to generate revenues (and securitization markets opening a new universefro fees), insurers also found alternate ways, such as variable annuities, etc.

Well with "life insurance" companies (pure life insurance, annuities, some health, Long-term care, etc) the contracts are of a long term and are priced/sold once, so if you make a mistake it's with you for a long time.
Compare that to Propertty & Casualty companies which offer insurance typically on a one-year term basis, and re-price it each year... provides more control.

Life insurance is a much lower ROE business than P&C.

Why does Warren Buffett buy P&C insurance entities primarily (vs Life insurance)? Hmmm, could it have anything to do with the above items

Mar 25 08:32 AM

[Tom Armistead:]

Thanks, good article

Mar 25 09:19 AM

[helplessobs...:]

Excellent article.

Mar 25 11:41 AM

[Chinese Gordon:]

Gloria, this piece is dead bang on and should be given the widest possible circulation.

Mar 25 12:08 PM

[AtTheMurph:]

Don't worry, Allstate, Pru, Hartford, Phoenix will all be rolled into AIG and the named changed to the United States Universal Citizens Strategic Insurance Trust - USUCKIT for short.

Mar 25 04:05 PM

[User 383024:]

Given your view about the weakness in life insurance businesses, and the fact that they are hard to sell (apparently), consider this.

An enormous portion of the book value of life insurers is an item called DAC, or deferred acquisition cost. There was a research report by Morgan Stanley (authored by Nigel Dally) about this topic, which included an analysis of how to look at their balance sheets in a burndown scenario where certain of these goodwill items (like portions of DAC) are written down to zero. In looking at, for instance, the Metlife 10K for 2008, I noted their overall DAC/VOBA for Dec 2008 is approximately $20bb. The report also says that 80% of this number is associated with the Individual segment of Metlife’s businesses. In Morgan Stanley's analysis, only a portion of this $20bb (corresponding to VA's) is written down in the burn-down scenario. This number, ultimately, is a form of good-will, and the real market value of this “good-will” or DAC should be driven by what acquirers today are willing to pay to buy closed blocks of business, which I would imagine is significantly lower than it has been historically (especially for life businesses). Based on a simplistic reading of the balance sheet, Metlife has $25bb in combined goodwill and DAC, and their book value is $23bb, so net of goodwill/DAC, they have negative book value.

Has anyone done an analysis of what the market value of these DAC items would be in today's M&A world?

PD

Mar 25 04:38 PM

[D.C.:]

Great Article. While Aflac appears to be in a good position, does anyone know why they're leading the fight on Capitol Hill for a reinstatement of the up tick rule and the fight against short sellers? Could this be a sign of where they're headed?

Mar 25 07:23 PM

[the_Bird:]

The question that's still out there is TARP. I know GNW and HIG have both applied, we were supposed to hear if they're getting $$ pretty soon. I wonder, though, if the Feds instead will instead hope that these guys can be pulled back from the brink via the Geithner plan; take the toxic assets off their books, rather than infuse more capital directly a la the first round of the bank bailouts.

When looking at the insurance companies, remember that the NAIC calculated capital/equity differently than the shareholders' equity figure that's governed by GAAP. My UNDERSTANDING (and correct me if I'm wrong) is that unrealized losses for most of the portfolio, under GAAP, flow through to the shareholder's equity calc via the comprehensive income line item (even with the impairment not being recognized as permanant). Under the NAIC methodology, it seems that losses on a lot of non-trading assets don't "count" towards the computation of capital.

It was either GNW or HIG that seemed to have a LARGE discrepancy between capital as calced by GAAP and capital as calced by the NAIC guidelines, so that they were claiming to still be "well capitalized" even though that was a complere crock if you looked at the GAAP numbers.

Mar 26 11:25 AM

[Allan Frain:]

Who says economics makes for dry reading !!


On Mar 25 04:05 PM AtTheMurph wrote:

> Don't worry, Allstate, Pru, Hartford, Phoenix will all be rolled
> into AIG and the named changed to the United States Universal Citizens
> Strategic Insurance Trust - USUCKIT for short.

Mar 26 12:14 PM

[Allan Frain:]

Excellent. As these "other shoes" fall, expect Congress and their apologist pundits to again claim again a black swan event that could never have been anticipated and can only be compensated by further market interference and printing of money.

Mar 26 12:19 PM

[Angela:]

I don't know what you guys are talking about Hartford is strong and I keep buying shares. They are being shorted and I am loving buying all the stock. I can't wait to cash out when they are $100+ again. If you guys are smart you will buy HIG NOW!!!

Mar 26 08:39 PM