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Clark Troy has worked in the financial services world since 2000, and is currently a Financial Advisor at DWM Advisors, registered investment advisor in Durham, NC. He has completed the educational and exam requirements towards a CFP® certification. He worked for years as a management consultant... More
  • Cuomo to the Rescue on Life Insurers and their "Secret Profits" 1 comment
    Jul 29, 2010 2:55 PM | about stocks: MET, PRU

    Bloomberg yesterday ran a lengthy article of Retained Asset Accounts ("RAA"), accounts in in which life insurers hold assets in their own general accounts rather than immediately paying death claims to beneficiaries of policy holders.  The insurers pay the beneficiaries interest, say, 1%, but continue to invest the money in fixed income instruments and earn spread income.  This struck our friends at Bloomberg as scandalous.  When the death benefits were being paid on American soldiers who died in combat, you've got a case of "profiting on soldiers' deaths."  Scandalous.

    Today Bloomberg reports that New York residents, at least, need fear no longer, for their intrepid Attorney General Andrew Cuomo has subpoenaed MetLife (NYSE:MET) and Prudential Financial (NYSE:PRU) in a fraud investigation of this heinous practice, which he dubbed insurers' "secret profits".

    It's worth taking a couple of steps back on this issue.  First off, on the profiteering angle.  Insurers are not "earning interest" on the money sitting in their general accounts.  They are active investors in portfolios composed of a wide array of instruments, principally fixed income.  They thereby incur a range of risks, including interest rate risk, credit risk, market risk, etc. Instead of "earning interest," they are managing portfolios and paying staffs to do so, or perhaps outsourcing the management of the money to other firms -- Deutsche Bank [DB] is the leader in this space.

    What would happen if an insurer lost money on its general account but was paying 1% interest on its RAAs.  Who would complain then? If they lost so much money that their ability to make good on the claims was impaired, then there would be a problem. But that's not what we're talking about, and insurers, ratings agencies, and regulators do monitor their balance sheets to be sure that carriers can pay claims.

    I corresponded with a friend who's an insurance broker about this article yesterday.  He noted that a key point (aside from the spread income, which insurers do like earning) of holding death benefits in RAAs rather than writing big checks was to save beneficiaries from needing to make big decisions about what to do with big chunks of money when they're emotionally vulnerable.  It's typical when someone gets a big check that "financial advisors", hedge fund salespeople, etc, come out of the woodwork offering to help the beneficiary make decisions.  They may even call the beneficiaries friends and relatives to exert influence on the bereaved.  He cited one instance in which the wife of a deceased police officer received a death benefit check and was dunned by a representative of a Policeman's Beneficial Association to put the money with a former cop... who turned out to be running a ponzi scheme.  Some months later, the money was gone, like Kaiser Soze.

    The Bloomberg article did raise some legitimate questions about RAAs.  Does holding them constitute deposit-taking by insurers?  Only banks are supposed to do that.  Funds in RAAs are not FDIC-insured, a fact which some state insurance regulators didn't even know themselves. The fact that they are not FDIC-insured does not appear to be adequately spelled out at times.  Generally speaking, it seems that disclosure around RAAs could be improved so beneficiaries and regulators would understand what's going on with them better.  The Bloomberg article may help in driving some of those discussions.

    But I don't think that's what Andrew Cuomo is on about. He's seeing this as an opportunity to ride in, strike a fine pose, and save the day.  That's what the New York AG office is designed for, after all.

    Disclosure: Index funds only

    Stocks: MET, PRU
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  • CommodFreak
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    >>Generally speaking, it seems that disclosure around RAAs could be improved so beneficiaries and regulators would understand what's going on with them better.<<
    Nice piece, Mr. Troy. To me, the lack of transparency for the beneficiary is the crux of the issue... The insurers often don't clearly explain these RAAs to the beneficiaries, who are often in a state of duress by the very nature of the situation. Or just plain dumfounded. The insurers deserve criticism for not being more upfront to the beneficiaries in the options they have for dispersal of the funds, whether lump-sum or doled out via the RAA. Don't bury it in the small print.
    30 Jul 2010, 04:17 PM Reply Like
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