News

08:51 AM
Connect Directly
Facebook
Google+
Twitter
RSS
E-Mail
50%
50%

Insurers Begin to Show Effects of Financial Crisis

As the crisis evolves, the fate of variable annuities programs ought to be of interest because it may deliver some important lessons about the uses and limitations of risk modeling. It may be that these instruments will work over the long haul, but it also appears that they could be more risky than anticipated.

In the world of securities trading, where merely thinking a thing can make it so, Harry Reid's injudicious comments aren't helping. On Wednesday, seeking to underscore the urgency of voting to pass the bailout bill, the Senate Majority Leader said he had learned that an insurance carrier "with a name that everyone knows" was on the verge of bankruptcy. In the wake of is comments, MetLife, Prudential and The Hartford issued defensive statements about their companies' financial strength, while their stock prices continued to drop.Things may not be anywhere near as bad as Reid suggested - no major insurer has gone bankrupt since Wednesday - but they aren't good. "Investors have painted their latest bull's-eye on the backs of insurers," quips a Wall Street Journal piece that notes that The Hartford's stock "fell 32 percent Thursday alone and is down 70 percent this year."

In terms of stock value, insurers are undoubtedly suffering from the misconceptions arising from AIG's collapse. If that collapse demonstrated anything it was the contrast between the financial soundness of insurance operations relative to banks and securities: the parts of AIG acting as insurance companies, duly regulated, remained healthy as the credit default swapping holding company came a cropper. But these are niceties that tend to escape the notice of the general public. The impression remains that, along with major banks and securities companies, a major insurer was felled by the crisis.

That doesn't mean the insurance industries crisis-related problems aren't serious. Its most obvious exposure is as an institutional investor whose holding are suddenly worth significantly less than previously. And as the Journal article notes, some insurers lend securities in exchange for collateral they invest and can find themselves at a loss if the value of the investments decline. Insurers are also exposed as marketers of variable annuities. This is particularly the case where those annuities are sold with a guaranteed that they will pay out no lower than a stipulated threshold.

As with insurers' institutional investments, variable annuities success or failure depends on insurers' bets on investments to which customers annuities are tied. Insurers have invested heavily in highly complex risk modeling technology that generates a highly sophisticated view of the probability of investment performance. The problem is that probability is just probability.

Reflecting on this potential area of exposure for insurers I called a major life insurer at the beginning of the week to ask, in essence, whether the possibility of major economic downturns were adequately factored into the models powering variable annuities. And even if they were, could annuities business fail to take a hit from such events, if only in the short term?

My contact was unusually reserved in his response and failed to give a satisfactory answer. He said that none of his company's annuities made guarantees as extravagant as those of some competitors, which was true enough, and he implied that this would not be an area of exposure for the company, which I suspect may turn out to be less than entirely accurate.

As the crisis evolves, the fate of variable annuities programs ought to be of interest because it may deliver some important lessons about the limitations of risk modeling. It may be that these instruments will work over the long haul, but it also appears that they could be more risky than anticipated. In the end, risk modeling relies on assumptions about the future based on the past. But predictions are only of probability, and nobody can predict the future. I am reminded of Bertrand Russell's example of the turkey whose assumptions about the farmer were based on his being fed every day. Then came Thanksgiving.

Having emerged to meet the Baby Boomer retirement market during sunny financial times, do variable annuities have excessive optimism built into them? If that is the case, it will be interesting to see what marketers of these products do to address that problem as the retirement market booms and competition intensifies.As the crisis evolves, the fate of variable annuities programs ought to be of interest because it may deliver some important lessons about the uses and limitations of risk modeling. It may be that these instruments will work over the long haul, but it also appears that they could be more risky than anticipated.

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio

Comment  | 
Print  | 
More Insights
Register for Insurance & Technology Newsletters
White Papers
Current Issue
Slideshows
Video