Executives at AIG, the world's largest insurance provider, are bracing for a fall off in property and casualty (P&C) and life insurance business in the fourth quarter. In the third quarter, premiums were up slightly versus the previous year. But people close to AIG say that after the firm nearly went bankrupt (and was eventually rescued by the federal government) on September 15, there have been some declines in new premiums as well as renewals, and some clients have even cancelled their life insurance contracts. That's because clients who carried AIG insurance began to worry about whether AIG would have enough cash to continue to guarantee payment on their policies, they say.
They shouldn't worry too much: Insurance companies are, of course, required to hold reserves to cover the policies they write and, by law, third-party creditors 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. Those guarantees top out at around $300,000 per P&C insurance policy, 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.
“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 the New York State Insurance Department. State insurance regulators can also take a number of actions to prevent an insurer from failing.
The Protectors
State insurance regulators require companies to submit independently audited financial statements and to execute their own on-site examinations every three years. Additionally, insurance companies must maintain risk-based capital levels that are calculated according to the amount of premium they write and the types of insurance they offer. “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,” 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, at least in New York, 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 safeguards in place, insurance firms do fail. The number of insurance company insolvencies varies from zero to 10 annually, according to regulators. If a company can't meet its risk-based capital minimum, the regulators may seek to step in and take over its assets via court petition. 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.
In the case of shortfalls, 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 licensed insurance companies in each state are required to fund it — it's almost like an emergency fund that firms contribute to for clients. 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 — but again, only up to certain limits.
Mike Zovistoski, a certified financial advisor at UHY Advisors in Albany, N.Y., 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 policyholders. 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 policyholders 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. “A big concern for both MetLife 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.
There's no question it's gotten very tough for insurance companies: 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 that 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.”