The life insurance companies that millions of Americans entrust to help protect their families or pay the bills in their golden years are caught in a downward spiral eerily similar to the one that has brought down banks and brokers.
Like Bear Stearns and Lehman Bros. (LEHMQ, news, msgs), life insurers Hartford Financial Services (HIG, news, msgs), Principal Financial Group (PFG, news, msgs), Lincoln National (LNC, news, msgs) and many others all have significant exposure to mortgage-backed securities and other risky debt instruments.
They're reporting huge losses that -- if they continued -- could trigger a meltdown.
That could wipe out shareholders, who already have suffered declines of 20% to 40% in the past week alone. Customers with annuities or insurance policies might have to turn to state insurance backstop funds and settle for only a portion of the money they were expecting.
Health, auto and property insurers are better off. But based on how far life insurance stocks have fallen, investors are worried many won't survive at all.
What are the chances this doomsday scenario will play out?
"To know that, you have to gauge how bad this market will get over the next six months, which none of us know," responds Jim Ryan, an analyst with Morningstar (MORN, news, msgs). It all comes down to how much worse things could get for the economy and for the debt instruments and stocks that life insurance companies hold.
"We're telling people to be more careful, particularly if you are going into longer-range products that involve significant upfront funding like annuities," says Bob Hunter, the director of insurance for the Consumer Federation of America. "You want to make sure that the company is actually around when you want to get the money out. I'd say there's a good likelihood some of them will go under."
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Death spiral
It's easy to imagine a spiral that takes many insurers out or at least has them asking for help from the federal government.It starts with those serious market losses. Life insurance companies rely on investments in bonds and stocks to meet cash-flow needs years from now. But because of exposure to dubious debt securities backed by shaky subprime and commercial real-estate loans, they're now piling up investment losses big time.
In early February, for example, Hartford Financial reported a loss of $806 million, or $2.71 per share for the previous quarter, including a $610 million realized loss on investments. Lincoln National reported a $1.98-per-share loss, including a realized loss on investments of $238 million after taxes.
This isn't the end of it. Analysts at Morgan Stanley (MS, news, msgs), for example, estimate Lincoln National is sitting on $7.6 billion more in unrealized losses in its $58 billion investment portfolio. Many other companies have significant unrealized losses, too.
These big losses create two problems for life insurance companies. First, they have to reserve more capital against payments they promise by selling annuities and life insurance policies.
More importantly, the erosion of their capital bases has ratings agencies downgrading their debt. If that continues, big corporate customers and individuals might consider them too risky and pull business -- sparking a "run on the bank" at insurers.
"Over the course of 2009, we expect signs of a flight to quality on the part of annuity buyers," Wachovia analyst John Hall wrote in a recent research note. He thinks that's already playing out at Lincoln National.
All of this, then, brings another cycle of downgrades in credit ratings -- a kind of vote on how likely a company is to pay back its debt. Taken to extremes, investment losses that spark ratings downgrades -- combined with stock price declines -- would make it virtually impossible for insurers to raise capital. It would also be tough to roll over debt coming due over the next two years.
Poof. There would go your life insurance companies.
This scenario inched closer to reality in recent weeks as insurers announced big fourth-quarter losses. The news had debt-rating agencies such as Fitch Ratings, Moody's Investors Service and Standard & Poor's Ratings Services cutting their ratings for Hartford, Principal Financial, Prudential Financial (PRU, news, msgs) and Genworth Financial (GNW, news, msgs), citing "surging investment losses and weakening earnings capacity."
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Some help from regulators
As a sign that the problems for insurers are getting more serious, regulators are loosening accounting standards to try to help them out.In the past few weeks, insurance regulators in Connecticut, Iowa and Ohio have eased accounting standards for life insurers like Hartford and Allstate (ALL, news, msgs) in an effort to help them meet standards for capital on hand.
State regulators are allowing insurers to count future tax refunds as capital on hand. They are also permitting insurers to reserve less cash against promised annuity payments. Again, this seems disconcerting, since you might expect regulators to ask for more reserves at a time when investment assets are falling.
"They are trying to grasp for other forms of capital," says Donald Thomas, an accounting analyst with Gradient Analytics. "This is a sign of stress among these companies."
The Consumer Federation of America likens the practice to doling out "lollipops at a barbershop."
Continued: Don't worry, be happy
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