By now, pretty much everybody is familiar with the struggles of AIG. Yet, other insurance companies didn't generally suffer from the same kinds of problems: AIG's troubles came mostly from poorly priced credit-default swaps. Life insurance companies that don't play games with derivatives seemed to be okay. But as an article in the Wall Street Journal today reports, the recession is straining the pure vanilla life insurance business as well.
Insurance companies work by collecting periodic fees, pooling them and eventually paying out promised sums once some event occurs. For simple life insurance that event is death. When they acquire those pools of funds, they don't just leave them in a saving account -- they invest them. Given how badly investment portfolios have done in this recession, it isn't surprising that their portfolios are feeling the pain -- especially since those portfolios contained real estate-related assets. In fact, the Journal reports that up to 29% of their investments were real estate-related.
Insurance companies responded, according to WSJ:
Seeking to replenish capital depleted by souring real-estate investments, many insurers have cut back on sales and raised prices on life insurance, much as banks have reduced lending and raised fees to customers to rebuild their cash cushions.
The insurers, under pressure to fill a $9 billion hole in their balance sheets, also are taking a tougher line on risk factors such as high blood pressure and obesity, in effect another way to boost prices, industry executives and advisers say.
Those actions, along with general recessionary spending pressures consumers feel, led to this (from WSJ):
That's the worst 6-month drop in almost 70 years, according to the Journal.
This raises some interesting questions about life insurance companies. I have always found it counterintuitive that insurance companies would be for-profit. It seems that a good insurance company is able to provide a very safe investment resulting in the payout you expected. But so long as executives have an incentive to create higher profits, they might make riskier investments with the portfolio.
Now, in this case, these real estate-related investments weren't perceived as risky. Yet, these insurance companies must not have done very deep due diligence to understand all of what they were buying. Why wouldn't that due diligence have taken place? Of course, they wanted to save money on costs and to increase profit. Such risks are fine for most for-profit companies to take -- they can roll the dice at their own risk. But when you're playing with funds that are intended to provide a guaranteed payout, then greater prudence should be used.
I'll be curious to see how insurance companies respond. Obviously, increasing fees and excluding more risk categories isn't working very well -- a 23% decline in sales probably wasn't their goal. Unfortunately, I fear that once the economy recovers, they will largely return to their old investment strategies and lax due diligence. Profit still matters.