That’s the question I woke up with this morning. Sad, isn’t it.
The Wall Street Journal reported this week that Treasury will soon announce that it will use TARP funds to invest in life insurers, or at least those who snuck under the federal regulatory umbrella by buying a bank of some sort. The argument for the bailout is a version of the “No more Lehmans” theory: the failure of a large financial institution could have ripple effects on other financial markets and institutions that could cause systemic damage. For a bank, the ripple effect is primarily caused by two things: (a) defaulting on liabilities hurts bank creditors, and (b) defaulting on trades (primarily derivatives) hurts bank counterparties, if they aren’t sufficiently collateralized (think AIG).
My thought this morning was that life insurance policies are long-term liabilities that are already guaranteed by state guarantee funds, so we don’t have to worry about (a), and hopefully most life insurers were not doing (b) – large, one-sided bets on credit risk like AIG. So why not just let them fail and let the states take over their subsidiaries? But then I checked the facts, and it turns out that the limits on state guarantee fund payouts are pretty low. So the scenario is this: you hear bad things about your life insurer, you decide to redeem your policy (usually at a significant loss to yourself), turning it into a short-term liability, and then the insurer has to start dumping assets into a lousy market, pushing the prices of everything further down and hurting everyone holding those assets. Would this really cause a systemic crisis worse than we’ve already got? I don’t know, but no one in Washington wants to take that risk.
Ultimately, though, this goes back to the question of whether this is a liquidity crisis or a solvency crisis. If it’s a liquidity crisis – in which case you would expect to see lots of people redeeming their policies already – then there are better ways to prevent a run on the life insurers. For one thing, if the insurers really do have good assets to cover their expected payouts, the government could just boost the limits on the state guarantees, charge the insurers a premium for the guarantee (insurers already pay a premium for the backstop they get from the states), and pocket the money. Alternatively, the government could act as a reinsurer, taking on some of the payout risk in exchange for a corresponding proportion of the assets and premiums. Using TARP money might work, but since it just adds a few billion dollars to the insurer’s capital (without guaranteeing anything), it’s not a surefire solution.
If it’s a solvency crisis, though, we have to ask whether a few billion dollars of TARP money is enough. The Hartford estimates it is eligible for $1-3 billion of money. (I picked them because they are discussed in the WSJ story, not because I know anything else about them.) It also has $288 billion of assets. How do their assets compare with the assets of, say, a bank? In principle, insurance companies are more closely regulated, and their investment mix (in terms of bond ratings) is constrained. But it’s also true that insurers – especially the large ones – were investing in more sophisticated products in an attempt to earn higher yields. (For details, see pp. 156-76 of the Hartford’s latest 10-K.) And we know that you could lose a lot of money investing in AAA-rated assets. If this does turn out to be a solvency crisis, then this could be the first page of a long story.
The Baseline Scenario 
I vote for increasing the guarantees to a reasonable level, perhaps a half million for a life. Not enough to satisfy everyone, but enough to be solvent, for most. Other things are trickier. Should a person lose everything because his or her umbrella policy is worthless? Or because the long term care policy is no longer solvent?
I vote for “no more bail out.” I vote for “moral hazard.” And I vote for Nancy Reagan’s “Just Say No.”
While we moved into weird world long ago, we’ve got to be getting back to the real world. And that path doesn’t lead us through bailing out life, fire, auto, home, flood, and/or tax-cheating Insurance.
When historians look back and write about The Rise and The Fall of America, this period or maybe the goofier one which should be coming up – when the Feds start bailing out grocery stores, gas stations and maid service firms (lawyers don’t need a bail-out they’re too busy) – will be the moment that America really started to fall apart.
Where is the outrage?
Does it come once Social Security is declared insolvent or once medicare is deemed on life support? Is that the moment when people will step up and say we want our country back, we want our government back?
It’s really too back that Obama wasn’t elected before Bill Clinton and G W Bush, he would have had a real shot at cleaning things up. But as it is, with the team he has and the job they are currently doing, he’s just here to make sure Elvis has left the building and then turn out the lights.
To make a difference, Obama needs to clean house, eliminate the Wall St – Washington connection.
Has anyone seen a number aggregating the CDS exposure in the insurance industry? I’m assuming it’s a meltdown magnitude and that’s the dirty little secret behind Geithner’s ask from Congress for additional authority.
It’s a game of musical chairs that doesn’t have many chairs to go around. The big banks of course get first dibs on the chairs. They all know precisely when the music stops and make sure all their other banking buddies have their seats pre-saved as well. Not many chairs left after that, so it turns into quite a scrap fight.
People are now looking for real resources (true capital) to plug in the holes for all the years of fake capital generation. There are just not enough resources to go around. Print all the money you want but it’s going to mean less and less after each successive bailout.
Since we have limited resources for bailouts, we better do a good job of picking the companies/industries that have the best chance of boosting our real GDP/productivity in the coming years. Is the the criteria being used? Doubtful.
The odds of a run on life insurance companies is probably greater than we think, due to the use of life insurance policies as a retirement savings vehicle in Asia. There was a run on AIA (AIG subsidiary) in Hong Kong in September 2008 that was under reported here; the run was forestalled when the Hong Kong government seized AIA’s in-country accounts.
So much for confidence in the latest “rally”.
So now your average Joe’s assets consist of a house that’s worth less than the mortgage on it, a 401(k) plan fully invested in a company that’s about to go under and a life insurance policy with a company that’s not solvent. Tell him the free market is the best system in the world.
With the insurers the question as to the valuation of the assets is further clouded by the liability side of the balance sheet. The fall in rates must have substantially increased the PV of many of those liabitites
I can see where a life insurance company might legitimately invest in credit derivatives to manage the credit risk associated with its major holdings. But that would not comprise a large portion of its overall portfolio, since the main objective of that portfolio would be to match its assets and liabilities. So I don’t really understand how a life insurance company could come to have enough CDS exposure for it to pose a solvency issue for the company or a systemic risk.
They could have plenty of problems with ABS and CDO investments, however. But we won’t really know what the TARP funds are used to offset or what they were trying to avoid. It doesn’t make a whole lot of sense to me for the Treasury to just give money to any financial institution that can demonstrate that it made poor investments. If they are actually trying to avoid a run on that institution (as opposed to masking its insolvency), how can they demonstrate that they have actually “made progress” in quelling that fear if your average American can’t even identify what the problem is precisely.
the problems with assets at life insurers aren’t limited to ‘sophisticated products’. sure, this happened, but even without this there would be two serious issues brought on by the downturn itself.
look at the basic cycle of life insurance for the average customer:
— person X buys term life insurance with a premium fixed for several years, pays in for 30 years, accumulating a balance until they retire,
— then, person turns that balance into a ‘variable annuity’, receiving a fixed yearly payment until they die.
in the first stage, the contract has a fixed premium based on approx 10 year interest rates set at origination. so if 10 year interest rates go down, person can cash out the policy and go elsewhere to get a better rate. (same as mortgage prepayment risk — this is why insurers generally didn’t buy MBS — they already had mortgage prepayment type risk.)
as you know, 10 year interest rates are way down. so you would expect policyholders to be ‘refinancing’.
now in the second stage, insurers pay out a fixed amount yearly until the holder’s death. there is no ‘prepayment’ type risk because the holder can’t redeem the policy. however, this payment was set based on prevailing interest rates at the time the annuity was purchased. so the insurer is short a long term treasury bond. generally insurers hedge this risk in a number of ways, but one of them is by purchasing real property, the assumption being that property values and rents will be inflation invariant. well, we know that story.
note that given the macro shift we have been through it is difficult to see how insurers wouldn’t be squeezed. they were required to hedge during the bubble, and required to pay prevailing market prices for their hedges.
take that story, which isn’t good, and overlay the fact that ins cos did get involved in some fancy stuff — and you can see why there is a problem.
I’m a financial planner and did some research into this topic for some clients who are using a life insurance policy as their primary estate planning vehicle.
So far I have not seen evidence of “runs” on life insurers. However, their balance sheets are somewhat obscured by actuarial rules and general lack of transparency about asset and liability valuation. Also, the extreme competition in the years prior to this market crisis led them to take increasing amount of risk. They are similar to the banks in both these ways. Couple this lack of transparency with significant credit exposure, market exposure, and headline risk – and the risk of runs on life insurers is not that far fetched. Even if a given life insurer is solvent, this is hard to be certain about, so runs on other insurers could spark runs on solvent insurers and create a liquidity crisis as you describe.
I think an important take-away is that the state guarantee funds are NOT funded. In fact, the failure of a major insurer will create significant capital demands on other insurers in the state. Nor have state guarantee funds ever been tested by a big insurer failure, much less several failures. So the insurance on insurers is questionable, and payout in the event of failure is often well below surrender value for any sizable contract. (At some point the media will pick up on this and you will see changes in behavior at the policyholder level.) If you are worried about your life insurer, exiting can make sense. For policyholders who remain insurable, you could expect to see a “flight to quality” as they move their policies over to stable insurers, of which there are still a handful.
My clients were using their life insurance to achieve legacy goals, which are subordinate to the goal of financial security. However, many policyholders are depending on life insurers for their financial security – whether using annuities for retirement income or life insurance for dependents. They are likely to be more nervous…
Thanks for that comment. I suspected that these guaranteed annuities might be part of the problem, but I didn’t know how big a problem they were. The problem, as you say, is that insurers are allowed to sell annuities, as well as guaranteed payout products, with effective interest rates that are higher than they can lock in using Treasuries. Yes, they try to hedge themselves all sorts of ways, but there is no perfect hedge – otherwise you’d have a money-making machine.
I admit, I was shocked to see how low the limits offered by state guarantee funds are. I suppose one strategy would be to spread your life insurance across multiple carriers, but this is a lot harder than with FDIC-insured deposits. For example, even with term insurance, if you bought into a 20-year level term policy at the age of 30 and you are now 45, there is no way you can get the same insurance at the same premium by switching carriers.
To see a ‘live’ example of how quickly you can lose billions investing in AAA rated assets, check out Calculated Risk’s post on the portfolios of the two huge credit unions (assets $57 billion) seized three weeks ago by the government.
Much of the life insurers’ portfolios are likely to look very similar.
If we TRUST that Treasury knows what they are doing and the perceived risk is comparable to the consequences of large bank failures, then they have to do the insurance company bailouts to remain consistent in their bailout policy.
If a run on the insurers is the major concern, then setting up a guarantee system similar to the FDIC (FIIC) would seem to be in order. Since this has not been proposed as far as I know, it may be inferred that the risks lie elsewhere.
One other consideration is that this could be a scheme to funnel more money through the backdoor to banks. I don’t know how this would work, but it is worth thinking about.
Thank you James, I was wondering what you thought.
And I agree with the idea that FDIC type insurance for policy holders would be a way to not funnel money to “friends of the Fed”
The shame is on the makers of this incredible misuse of money, all justified by already “IN FORCE” scare tactics.
There will be no more Lehman’s because Goldman isn’t betting big on any other company to go down, but if they do, i would bet that that company would go down, and then have another “AIG” saved to pay off the bet. IT IS TOO OBVIOUS.
It takes this kind of fear to set in stone a good smokescreen for ANOTHER misuse of money…and we as taxpayers will be paying interest on this money that was misdirected either forever, or until the US Government is officially insolvent in the eyes of the world.
It is rather silly to be citing laws at this time, but what jursidiction does the federal government have over insurance companies? As you point out in your post, these are institutions regulated on a state level, not on the federal level. Indeed, insurance companies have bent over backwards to stop any federal regulation of their business in the past. The activities of these companies is also very opaque and they don’t report much of their activities because that’s the way the state laws are written and they have been able to make a lot of money under the radar. So what if Hartford or some other major insurer went? How would that be a systemic risk?
This move by the government also raises questions about Obama’s happy talk about the economy. How can one arm of the federal government talk about green chutes when another arm is putting together plans to bailout insurance companies from unexpected loss?
I vote for
1. No more bailout
2. Get all the bailout money back
3. Start prosecuting all bank executives immediately. Jail them, since they are clearly a flight risk.
the biggest job of the Obama admin, is to keep all of us and the world believing that the ongoing “bailouts” are necessary and also creating the saving grace of keeping our country from defaulting on the treasuries…i really wonder if press releases and “happy talk green chutes” is powerful enough to stop the bleeding from all the big money giveaways that have taken place to keep banks open, that should have been taken over then “reprivatized”–congress has the power to do this and there was no need for TARP if instead, the power was granted case by case, to take over insolvent holding companies….
To pass a law now to do so, only legitimizes what was done with AIG, and the lobby for TARP and the 180degree turn to “infuse” instead of the words used in the lobby for the TARP….very complicated, very dark.
I see over at Bloomberg this from the FDIC:
“The Washington-based FDIC insures deposits at 8,305 institutions with $13.9 trillion in assets. The 252 lenders on the FDIC’s “problem list” had assets of $159 billion at the end of the fourth quarter, about 1.1 percent of total assets, an increase from the $116 billion at the end of the third quarter, the agency said on Feb. 26.”
Why can we just clean up all of America’s small/medium banks at a price of $160 billion and then clean up any weaken in the “good” big banks and let the other toxic big banks pound dirt?
you got my vote.
Click to access z1.pdf
page 117 you might find it useful to see how much money the agents to the US Treasury, 12 private federal reserve banks are making during this long awaited fabulous “bailout” time for their history….12 private banks rebate all profit but their “EXPENSES” on the money that that flows from the US Treasury…this is BOOM time for these private entities!
It may be time to reconsider Andrew Jackson’s presidency and his actions, as far as what role these private entities play in “helping” our country.
OK, I know, I have said enough, and all I will say about this. I just hope our country will survive what is happened. Thank you.
It is a solvency crisis.
I don’t recall any recent large die-offs in the North American human biomass.
Never chase yield, no matter what your dinner party guests are boasting about. Just say no. Grabbing pennies in front of a steamroller is a fool’s gambit.
Hey as long as I get my 3% cut of the bailout I’m happy:
http://iloveclosing.com/2009/04/10/why-i-won%e2%80%99t-get-out-of-bed-for-less-than-3-commission/
The Closer
that makes sense. it’s by design. when you lock in a premium, it’s a constant premium. your death risk goes up. so the ins cos make money on you for the first part of the term and lose money for the last part of the term.
yup — exactly.
one other thing to note: life insurance and life annuities go hand in hand. why? because they hedge each other with respect to changes in the death rate.
if the death rate goes up, insurance policies pay out but annuities stop paying out, and vice versa.
that’s assuming a change in death rate independent of age, etc. (doomsday for ins cos is a plague that affects only the young insured.)
so that’s why ins cos need to sell annuities.
funny, i followed the link and the last page was p.116.
Maybe of interest is the Congressional Oversight Panel’s report which came out recently. Interesting website includes a video with Professor Warren (I believe from the institution up the river a/k/a the little red schoolhouse).
http://cop.senate.gov/reports/library/report-040709-cop.cfm
Professor Warren is noble and has extreme courage to face her task with the honesty and determination that she illustrates…but generally, i think the 20trillion dollar gorilla is a monsterous force with which to reckon because it is sitting on (lurking over, or whatever metaphor can illustrate the deadly power of the stakeholders that benefit from the gorilla) most of our elected officials.
Something important to note about life insurance policies – life insurers generally benefit (substantially) from unanticipated inflation. Why?
For annuities, it’s obvious. For term it’s less obvious, but no less true. Let’s say I have 500k in life insurance on a 20 year term policy, and at the young age of 30 I pay only 500 dollars a year. If I were 50, I might pay a lot more to buy the policy – maybe 2000 dollars a year. In the beginning of the policy, the life insurer earns the most expected profit (because dollars are most valuable and chance of death is low). Toward the end of the policy, inflation has decreased the value of the premium, but it has had a much larger effect on the expected payout because the chance of death later in the term is much higher.
Insurers bank on this, which is one of the reason that a bout of deflation would destroy them. It would mean that their liabilities increase as the policy nears its end (precisely when chance of death is highest).
Jim,
Do you, your family and your close relatives have life insurance?
Never felt more alive!
i think this bail out is one of gov efforts to bring investor’s confidence back. I hope it’s gonna work.
Wouldn’t inflation devalue the insurance company’s assets? If I hold a massive amount of Treasuries paying 3% and inflation goes to 10%, I think I have a problem. My liabilities may be reduced to the extent that a fixed payout obligation is worth less, but since my assets should be larger than my liabilities, I would have thought the impact would be net negative.
Also, in an inflationary environment wouldn’t the value of my product to the customer decline, impairing my ability to get new customers?
that’s why insurers own real (rental) property — presumably a 10% inflation rate would apply to rents as well, so they would probably take no more than a temporary hit.
large scale asset price crashes are killer.
Hartford has $288 billion of assets?? not any more they don’t… much of the is CRE…. they’re really broke, just like the banks.
Hi Q,
I didn’t understand the logic behind this:
“10 year interest rates are way down. so you would expect policyholders to be ‘refinancing’.”
The way, I think about this is to compare life insurance with taking out a mortgage.
When I borrow from the bank to buy a house, I want to pay the lowest interest rate possible. Therefore when interest rate drops I want to refinance.
However, when I buy life insurance, it is almost like I am lending to the insurance company every month with my insurance premium. The insurance company promises to pay me back some time down the road. The amount is calculated base on the prevailing interest rate at the time I enter into the life insurance. The higher the interest rate, the more I expect the insurance company to pay me back some time down the road.
So from my perspective, I would want to lend to the insurance company at the highest rate possible right? If interest rate drops I should be happy that I’ve locked in at a higher rate right?
Anyway, I don’t know anything about life insurance. What is wrong with my logic?
Thanks,
Ben
Paris,
You hit the nail on the head. I’m wondering however, if a person in the US dies and hes worth “negative”, is there some sort of negative assets death rebate, that is opposite of the death tax? Interesting….:-). They really are a riot, aren’t they?
AA
Theres several problems with that though:
1. They probably didn’t break any laws, unless “stupid and greedy” are now illegal.
2. There’s not enough prison space.
3 You would also have to jail the vast majority of your politicians and senior gov officials.
AA
Not only does the US Congress have the power to take over insolvent banks….it’s also THE LAW. They are actually obligated to take over insolvent banks. This nonsense that Geithner is doing, while amusing, is clearly a bailout of his pals, and not anything that resembles what US policy is under THE LAWS encated after the last melt-down back in the 1980’s (S&L disaster).
LOOK IT UP – it’s the law.
AA
Well, in fact, they could do exactly that. And probably will at some point. You see, the reality of “bailout nation”, is that the ruling elites must FIRST get all their money out by transferring the crud to the taxpayers. Then, and only then, the bank crashes. It requires the “sheeple” to remain passive until the theft is complete….and it’s working so far.
AA
Do you, your family and your close relatives have life insurance?
It doesn’t matter.
People need to apparently re-learn that insurance carries counterparty risk. It’s not like our grandparents didn’t warn us about this.
Awwwww. It’s really tragic when the entire house of cards comes crashing to the ground in your lifetime. Oh well…..It could’nt go on forever. It just makes me want to sing…..and dance…..just like those passengers on the main deck of a sinking Titanic. As the ship went under, the band played on.
AA
Oh so righteous you are!
Now tell that to your friends and family that do own life insurance! You’ll be the life of the party!
Hahah!
I think the following saying is completely wrong:
“He Who Dies With The Most Toys Wins”
I think it should be:
“He who dies with he most unpaid debt wins!”
Clearly that means the person has successfully consumed more than what he earned in his time and got away with it!
Paris,
You unfortunately, like so many people, do no understand that the US has not had a “free market” system for a long long time.
We have a “mixed” economy, with the government providing moral hazards upon moral hazards and unintended consequences galore. We have a Federal Reserve System that has debased the dollar to the tune of 95% and through the banks confiscated more of American’s wealth than can ever be measured.
This is not a failure of the free market as so many socialist/communists would have you believe. This is a failure of the “mixed” economy with the government and more importantly the FED at the center of it all.
I did the calculation for the value of the assets as of 2/23/09. I used the information in the chart (part of the calculated risk posting) and moody’s default rate.
My calculation suggestion the asset own by US Central is still worth more than 90 cents for every dollar of the original asset price.
Can someone else double check the calculation and report back?
Naw, logic is irrelevant!!!
qazw and Jim will gladly sacrifice their first born if they can take revenge on those stupid greedy bankers!
Yummm…, sweet sweet revenge. You could almost taste it. Almost damn it…
You think Phoenix Rising from Ashes is tragic? I am disappointed!
I personally think everything will be better because of this crisis. Much of the imbalance will be corrected. The system as whole will be more robust and resilient. Changes for the better is already happening every where I look!
Hahahah!
Darn, the above is from me. I hit submit too soon. But you could probably can tell from my “Hahahah!”
Hey adios,
You are kind to inform here!
The usual excuse for not taking over the bank holding companies is lack of authority, and since i am not a lawyer, it is hard for me to figure, but i do know that if you take something in front of Congress, like the 2-3 weeks of lobby for TARP was a big effort, Congress can do whatever they want. So, that is why it seemed so criminal to do the other.
Why cant US citizens make a legal case against the government? Like a class action suit?
Big life insurers are just as insolvent as the big banks. The change to mark to market is a big win for both groups. I would be amused to see what the credit loss part of MtM is for both groups. The big life insurers are a critical component of the economic crisis. I agree that this is just a prologue to the the coming fallout of the big life insurers. The life insurers, like most others investing massive amounts of money, got greedy and went for higher yield in MBS and similar financial instruments. Also, I agree with previous posts that the increased competition in the life insurance sector caused too many variable annuity guarantees that would be too big of a liability for any company to absorb if there were any moderate decline in asset values. The doomsday scenario that we currently face was definitely not baked into the life insurers projected risk/return scenarios when determining variable annuity offerings. What a disaster! But thank heavens they got under the TARP (which was obvious for a long time) and all of the other surreptitious government bailout programs. Where does this end?
117 on the pdf, not the document.
Another consideration with insurance companies is that they sometimes provide the ‘safe’ investment option in 401(k) plans. This is the ‘guaranteed investement contract’, fixed interest rate investment option that was/is touted as the place to be for people with low risk tolerance, for money that cannot be risked in the short term, and for those who, actuarially speaking, no longer need to run the risks associated with stocks.
Though called ‘guaranteed investment contracts’, there really is no ‘G’ in GIC, other than the supposed solvency of a large and putatively conservative firm (and ‘supposed’ and ‘putatively’ haven’t been working out so well lately, unfortunately).
I don’t think ‘stupid’ has anything to do with it. These are almost all smart people in the sense that they know how the game is played and they’ve pulled down their millions, and nobody is asking them to return any of it. As far as the shareholders interest goes, the banks also know how that game goes, and the Obama administration is playing it’s part and propping things up. The taxpayers get the shaft, of course, but that’s what taxpayers are for.
True, Bear Stearns and Lehman didn’t work out so well for some of the elite, but the Feds seem to be playing there part much better now…
With that said, it would appear that the whole push to ‘finally get legeslative authority to unwind the too big to fail institutions’as bernake and then all the rest in Washington have pushed, this is just a cover up to justify not doing that in the first place…why cant the public know this and do something about this corruption?
In addition to the ‘moral hazards’ that you refer to (which is also called ‘lemon socialism’ – ‘Heads’ corporate America wins, ‘Tails’ taxpayers lose), we are also a mixed economy in the sense that the Federal government spends in excess of half a trillion dollars a year on defense, an amount equal to defense spending by the rest of the world combined. This is part ‘permanent stimulus package’ (defense spending pulled us out the Great Depression, let’s just keep this going), part consumption of excess production, and part funding mechanism for research and development (which corporations, having an horizon of only three months, can’t really justify due to the long time frame for return on investment – if there is one).
This last is perhaps the most obvious. The digital computer, originally called such because it was used to compute artillery trajectories, was invented on a government research grant. The internet, originally called DARPAnet (Defense Advanced Research Projects Agency), was too.
In any event, all major modern economies have been/are structured with government playing this role, whether the country called itself capitalist, socialist or communist.
It’s been awhile since I worked in the insurance industry, but I think in the old days there were fixed annuities and variable annuities. Fixed annuities, obviously enough, had a ‘fixed’ or constant payout. Variable annuities were based on specific securities and the payout changed with the performance of those securities.
Then, fairly recently, somebody got the bright idea of guaranteeing a variable annuity, i.e. there is a limit below which the payout can not fall. Given the way markets have performed lately, some insurers are taking a bath on these guaranteed variable annuities, which are guaranteed by no one other than the company that sells them.
I understand the importance of innovation in computer software, automobiles and medicine, but whenever I hear about innovation in finance it seems like somebody gets hurt. The unusual thing about this example is that the innovator is getting hurt (although the purchaser of the innovation isn’t out of the woods yet, either).