Executives at AIG, once the world’s largest insurance provider, are bracing for a fall off in P&C and life insurance business in the fourth quarter. In the third quarter, premiums were up slightly versus the previous year. But we’ve been hearing that since then, there have been some declines in new premiums, as well as renewals, and that some clients have even cancelled their life insurance policies. After the firm nearly went bankrupt (and was eventually rescued by the federal government) on September 15, clients who carried AIG insurance began to worry about whether AIG would have enough cash to continue to guarantee their policies, they say.
Policyholders shouldn’t worry too much: Insurance companies are, of course, required to hold reserves to cover the policies they write, and by law, creditors who are not policyholders can’t lay their hands on a dime of the money owed to policyholders. What’s more, in the event that an insurer does go belly up, insurance policies are guaranteed by state guaranty associations—at least, up to certain limits. Property & Casualty insurance is typically guaranteed up to $300,000, though limits are higher in California and New York, while life and health insurance policies are typically guaranteed at between $100,000 and $500,000, according to state guaranty fund associations (National Conference of Insurance Guaranty Funds and National Organization of Life and Health Insurance Guaranty Associations).
“As regulators, we make sure the assets of the insurance companies are walled off, protected from the parent company’s troubles and available to pay all your covered claims,” says Eric Dinallo, superintendent of New York State Insurance Department. State insurance regulators can also take a number of actions to prevent an insurer from failing.
That said, on Wednesday, Conseco dumped a huge number of its long-term care insurance policies into a state supervised non-profit independent trust, Senior Health Insurance Co. of Pennsylvania, according to a story in The Wall Street Journal. But that trust may need to raise rates and cut benefits to make payments to policyholders, and it doesn’t have any extra capital. If the trust goes bankrupt, policy holders would have to rely on state guaranty funds.
Protecting the Protectors
State insurance regulators require companies to submit independently audited financial statements, and also to execute their own on-site examinations every three years to verify the financial conditions of each company. In addition, insurance companies must maintain risk-based capital levels that are calculated according to the company’s size and the type of insurance it offers. “The formula considers different kinds of insurance offered and weights them. Homeowners insurance, for example is more stable than medical malpractice insurance and therefore less risky. Huge companies like Met Life or State Farm will have higher capital requirements,” says Mike Moriarty, deputy superintendent of Property and Capital Markets for New York State.
In AIG’s case, the insurance subsidiaries are healthy despite the parent company’s credit troubles. Moriarty says AIG’s insurance subsidiaries, in New York at least, have risk-based capital that exceed its minimum by 300 percent. “It may seem like a lot, but that’s average,” he explains.
Even with these restrictions in place, insurance firms do fail. The number of insurance company insolvencies varies from zero to 10 annually, according to regulators. In a case where a company can’t meet its risk-based capital minimum, the regulators may step in and take over. First, state regulators will ask the troubled company to come up with a plan within 30 to 90 days that corrects its deficiency. If that doesn’t happen, the regulator seeks a court petition to take over the company and marshall its assets. The regulators would then attempt to make the company viable through a sale or merger. “If that’s unsuccessful, then we’d liquidate the company and determine its estimated liabilities, assets and any shortfalls,” Moriarty adds.
Even then, there is another safety net that state insurance regulators can rely on. Guaranty funds are managed by the state for the benefit of policyholders. Each fund is responsible for payouts to policyholders in its own state. The money in the funds derives from the licensed insurance companies in each state—it’s almost like an emergency fund that firms contribute to for clients. (All insurance companies are required to be members of the guaranty association.) Each company’s contribution is based on the total amount of premium it has written—more premium equals greater contributions. Funds are typically managed separately according to insurance type: One fund for property and casualty, another for life. If an insurance company does go bust, and the state guaranty fund doesn’t hold enough cash, then the remaining insurance companies are essentially charged the difference, according to Moriarty.
Mike Zovistoski, a certified financial advisor at UHY Advisors in Albany, NY called both AIG and the state insurance commissioner’s office immediately after word of the insurance conglomerate’s demise. “The insurance departments are very protective of policy holders. Both AIG and New York State were incredibly reassuring about the policies,” he says.
The Great Insurance Regulatory Debate
While those funds are capable of covering a few small insurance companies that become insolvent, some argue there is nowhere near enough money in the funds to protect policy holders if several of the major insurance companies bleed dry. That’s bad news when you consider the life insurance sector’s performance in the stock market. Year-to-date, according to Google finance benchmarks, life insurance company stocks have dipped 63 percent while the property and casualty stocks have declined 50 percent. By comparison, the Dow Jones Industrial Average is down 36 percent in the same period and the S&P 500 is down 42 percent. “A big concern for both MET and the entire life [insurance] space right now is that commercial-real-estate-related losses will spike and erode capital positions,” says Credit Suisse analyst, Thomas Gallagher in a recent report.
It’s gotten very tough for insurance companies, in fact; some of them are considering converting into bank holding companies in order to get a piece of the bailout pie. That’s because the Treasury says the bailout money is for bank and financial services holding companies. And that brings to life an old debate: Should state insurance regulators hand the reigns over to the federal government?
Jack Dolan, spokesperson for the American Council of Life Insurers, a trade association representing legal reserve life insurance companies, says when his office asked the Treasury why insurance companies were not included in the bailout program, they were told the money is only for federally regulated industries. Dolan’s group is a proponent of a federally regulated insurance industry. “There’s no federal presence in Washington for insurance. That’s harmful for our industry,” he says.
But the National Association of Insurance Commissioners, the organization of state insurance regulators for all 50 states, disagrees. "Some insurance lobbyists hope to politicize and mislead policymakers by suggesting AIG's problems are a result of state insurance supervision, and could have been averted by federal oversight," Praeger says. "On the contrary, conservative state regulation ensured that while the federally regulated holding company was failing, the insurance businesses were appropriately capitalized and the interests of policyholders were placed ahead of shareholders."