Will you outlive your life insurance company?
Until quite recently, the question was rhetorical. Little in lifewas as secure, stable, and enduring as the insurance industry.
Today, however, the field shows signsof weakness.Throughout the industry,increased competition and soured assets have narrowed profit margins.Some firms have even been squeezedout of business. Like thrifts and commercial banks, insurance companies areexperiencing a shakeout thatwould have been unthinkablejust a few years ago.
In 1981 not a single insurance company went out ofbusiness. Between 1983 and1988, 89 insurers folded; in1989, 36 more became insolvent. Most of those were relatively small, but the largestfirms haven't fared much better. In 1990, First Executivetook a $859 million write-downof its junk bond portfolio, andEquitable posted a loss in excess of $90 million for the firstnine months of the year. Andthe situation might get awhole lot worse: A report recently issued by IDS, a subsidiary of American Express,warns that as many as 20 ofthe nation's 100 largest life insurance companies might not survive asevere economic downturn.
Unfortunately, insurance guaranteelaws provide an inadequate safety net tocushion a fall. Although 45 states haveenacted such legislation, which protectspolicyholders if their insurer folds, theprotection is limited to a ceiling of$500,000, hardly enough to cover thedemands of a family business.
The industry's troubles have a particularly strong impact on family busi-ness owners, who depend on insurance companies to fund stock repurchaseagreements, wealth-transfer plans, andestate-tax liquidity needs.
In the past, a business owner could select an insurer, then stick with thechoice for the long term. Today, such ahands-off approach could have disastrous consequences. To protect themselves, executives face the extra burden of keeping closer tabs on the fieldthan ever before. Indeed, consumersnow need to research their financial institutions---banks, thrifts, insurance carriers--as rigorously as those institutions examine persons applying forloans and insurance.
Monitoring the industry's members-in terms of both short-term performanceand long-term survival--begins bychecking the credit rating agencies' reports (see "A guide to credit-rating services," below). Outfits such as A.M.Best, Moody's, Standard and Poor's, andDuff and Phelps analyze the finances ofhundreds ofinsurers and passjudgmenton the firms' financial health.Within the past year, for example, Moody's Investors Service downgraded EquitableLbfe Assurance because of thefinn's underlying weaknesses.
Credit-rating agencies provide a good overview of a corporation's financial condition,but they aren't the onlysources worth consulting.For more detailed information,business owner sshouldask their accountants to investigate six key indicies thatmeasure an insurer's abilityto meet its projected returns.
First, a general rule ofthumb for evaluating an insurer's financial strength involves its level of capital andsurplus, the amount of moneyabove the reserves it's mandated.by law to set aside. Insurers with assets of $1 billion to $1O billion shouldhave capital and surplusequal to 5 percent to 10 percent of total assets, Firmswith assets in excess of S10billion should have capitaland surplus of 3 percent to7 percent of total assets.Moreover, capital and surplus should grow by at least5 percent annually.
Second, an insurer's mortality experience-the pricing of products based on average life expectancies--should earn a "most favorable" or"very favorable" rating from a creditrating service. A poorer rating suggeststhat an insurer has made incorrect assumptions about mortality averages,which can narrow its profit margin,forcing the company either to increase its policy charges or reduce its surplus.
Third, examine the quality of an insurer's investment portfolio. Be cautiousif a rating agency such asStandard and Poor's orMoody's reports that acompany keeps more than1O percent of its assets inJunk bonds or nonperforming real estate loans. Riskyinvestments may generatehigh yields, but they alsocan plummet in a flash.
Fourth, check the yields of a company's investments. Most insurers guarantee yields ofno more than 5.5 percentbut often pay twice that amount. Today,those high-end yields are depressed,and policyholders who thought they'dreceive a 13 percent return throughoutthe life of their policy are hopping mad. Make sure your insurer is offering acredible rate. And beware of a companythat projects a higher rate than the rateit's earning on its own investments.
Fifth, track your carrier's expenseratio.The expense of administering policies is difficult to evaluate since Insurers sometimes hide these charges inother areas of the business. Credit services should show that during a five-year period, annual expenses should average no more than 5 percent ofpremium income plus policy reserves.
Sixth, check the number of individuals who let their policies lapse at a specific carrier. When the so-called lapserate is low (10 percent or less), a company can price its products quite competitively because it has a good chanceof recovering its initial investmentthrough continuing premiums paid bypolicy holders.
These measurements of an insurance company's financial prowess are relatively easy to determine with the help of credit- rating agencies. If the indicators are moving in the wrong direction, it's time to find a new carrier. And with economic conditions changing so rapidly, that possibility is greater than ever.
Finally, don't make the mistake of placing more emphasis on the policy than the Insurance company. Look for the healthiest carrier, and then get the policy that best suits your needs. Don't blindly place all of your insurance eggs in one basket; diversifying your policies among several insurers is the safest hedge against an uncertain economy.
Mike Cohn is president oftheCohn Financial Group, aPhoenix-based Frm that im-plements transfer strategies forfamily businesses nationwide.
To determine whether your in-surance company is,really fit, review its credit ratings reports. Askyour agent for reports from A.W.Best, Standard and Poor's,Moody's, and Duff and Phelps,which all rate the claims-payingability of life insurance companles.
A.M. Best Company annuallyexamines and rates about 1,400life and health insurance companies. The firm's historical data oninsurers is useful for comparativeanalysis. It rates a variety of important factors and gathers finan-cial information based on thecompanies'annual reports. Individual company reports cost $l5.(Ambest Road,Oldwick,N.J.08858; 201-439-2200.)
Standard & Poor's InsuranceRating Services rates 135 lifeinsurers based on an in-depth analysis of carriers' projectedclaims-paying ability. Rather thancomputing ratios based on annualstatements (A.M. Best's method),S&P examines unpublished historical data, corporate projections,and management's battle plans.Individual company reports cost$25. (25 Broadway, New York,N.Y. 10004; 212-208-8000.)
Moody's Investors Servicerates the financial condition of 60life insurance companies. The rat-ings, similar to its bond-ratingsystem, are accompanied by athorough review of an insurer's financials. Detailed company reports cost $1,050 annually; summaries cost $125 per year. (99Church Street, New York, N.Y.10007; 212-553-1658.)
Duff & Phelps rates the claims-paying ability of life insurers. Itpublishes in-depth reports on 70insurers. D&P provides cus-tomized individual company reports for varying fees. (55 E. Monroe Street, Chicago, 111. 60603;312-263-2610.)
National Association ofInsurance Commissionerssells the IRIS Ratio Reports, whichtracks companies that have fallenoutside its own five measures ofrisk. The fee is $50. (120 W. 12thStreet, Suite 1100, Kansas City,M0.64015;816-842-3600.)
The American BarAssociation publishes the ABAPrimer: Life Insurance Products,Illustrations, and Due Dilligence(researched by M. FinancialGroup), which costs $34.95 plus$3.95 for shipping. (750 N.Lakeshore Drive, Chicago, III.60611; 312-988-5571.)