Wolf Richter: New Rules For Life Insurers – “Future Generations Have To Deal With The Financial Carnage”

Yves here. Most people don’t think much about the life insurance industry, precisely because it has managed to be what financial services should be: boring and safe. Insurance is particularly prone to abuse, since customers pay money up front and submit claims (or in the case of investment products, get payouts) much later.
As Wolf Richter warns us, the insurance industry just approved new rules which will allow them to keep lower reserves, which is that industry’s analogue to bank capital. And the aim of this change is to allow insurers to engage in more speculation. Nothing like choosing to rely on the playbook that gave us the global financial crisis, now is there?

By Wolf Richter, San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.

During the off-hours on Sunday, when few people were willing to ruin whatever remained of their weekend, when even astute observers weren’t supposed to pay attention, the National Association of Insurance Commissioners approved new rules that would allow life insurance companies to lower their reserves for future claims.

Executives claimed that they could put that capital to “more productive uses,” such as blowing it on stock buybacks and acquisitions or plowing it into subprime-based CDOs or Greek sovereign debt, or whatever, to goose their paper returns—having already forgotten all about the financial crisis.

“The insurance industry weathered the financial crisis well precisely because of the careful reserving state regulators have historically required,” said Benjamin Lawsky, superintendent of the New York Department of Financial Services. “To ignore the lessons of the financial crisis and deregulate the industry, allowing them to keep less in reserves, is unwise.”

Others were less sanguine. Joseph Belth, Insurance Forum editor and professor emeritus of insurance at Indiana University, worried that “future generations of executives, regulators, and consumers will have to deal with the financial carnage.”

There are salient precedents. The Glass-Steagall Act, after decades of being reinterpreted and watered down—and finally gutted by Citibank’s foray into investment banking and insurance—was repealed in 1999. The business of finance boomed, banks ballooned, Wall Street printed paper profits, and bonuses skyrocketed. Less than a decade later, the financial crisis laid waste to the world economy. Before it, there was the S&L crisis, brought on by a series of challenges that culminated in the deeply troubled industry’s deregulation in the early 1980s. With disastrous consequences.

The Insurance industry had lobbied for the change for almost a decade. The existing rules used formulas that were “far too conservative,” life insurers maintained, according to the Wall Street Journal. Instead, the industry would implement a “principles-based” system that would use computer models—algos and “fat fingers” come to mind—to figure out how large the reserves would have to be; or rather, just how small they could be. Because rationalizing “lower reserves in the aggregate”—as Lawsky’s deputy Robert Easton called it—had after all been the goal of the lobbying campaign.

California Insurance Commissioner Dave Jones fretted about the “very complicated black-box models”—that their mathematics might be impenetrable for state regulators who then would not be capable of overseeing that “principles-based” system. Whether or not that was one of the underlying motivations for the industry remains to be seen.

Granted, it’s been tough for life insurers. Their investment returns have gotten hammered by the evil twins of a lumpy economy and the Fed’s Zero Interest Rate Policy. Initially classified as “exceptional,” ZIRP has now been in effect for four years, and its expiration date keeps getting kicked further into the future. It has brought down bond yields across the spectrum to where returns on all but junk are negligible, a process that has been draining the reserves of life insurers—just like it has been fleecing the Social Security trust fund and savers. So the thinking went, with lower reserve requirements, insurers could divert some capital to speculate in riskier assets that might offer a greater return. It would dope their paper profits and make Wall Street smile. For a while. We’ve seen this movie before.

But it’s not yet a done deal. The National Association of Insurance Commissioners, which is composed of state regulators, sets solvency standards that states may then adopt in regulating insurers. The idea is to come up with a common set of standards for all 50 states. However, states don’t have to follow the decision. And it’s unlikely that all of them will. Of the 56 members, 43 voted to approve this change. Regulators in California and New York voted against it. And in states where lawmakers refuse to adopt the new reserving requirements, life insurers would establish subsidiaries whose reserves would conform to the rules of that state.

While some life insurers might continue to be conservative under the new rules, others will venture out towards the thin end of the limb to chase paper profits from quarter to quarter. And they’re doing it just when the industry is staring at an unprecedented and brutal demographic reality: insured baby boomers aren’t going to live forever, and life-insurance payouts are going to jump to historic records.

The temptation is huge to tweak the math of the “black-box models”—as California Insurance Commissioner Dave Jones called it—to bury that reality until the bitter end. It took Wall Street less than a decade to explode, counting from the repeal of the Glass-Steagall Act. Home many years will it take the life-insurance industry after the new rules go into effect? One thing we know already: when it explodes, no one will be held responsible. Because everyone followed the rules.

Every country in the Eurozone has its own set of big fat lies that politicians and eurocrats have served up to make the euro and subsequent bailouts or austerity measures less unappetizing. Like in 1999: “Can Germany be held liable for the debts of other countries? A very clear No!” said the CDU, the party of Chancellor Angela Merkel. Read…. Ten Big Fat Lies To Keep The Euro Dream Alive.

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  1. Gerard Pierce

    There is something missing in this whole narrative. The last time I paid any attention (a lot of years ago) Insurance companies were happy with a highly safe 4% return.

    Currently, I would assume, (until someone tells me I haven’t a clue) that they would be able to get this kind of return in short term corporate finance and they wouldn’t have to bet the farm to get it.

    If they suddenly need a higher return, what has changed? Have they lost their collective shirts over the last 5 years? Has someone changed the compensation structure for insurers in the last few years? Has Goldman figured out some way to convince insurance company execs that handing over the money will get them 72 virgins in the afterlife?

    Somehow it reminds me of Trudeau’s cartoon book: “But the Pension Fund Was Just Sitting There “

    1. Yves Smith Post author

      Um, investment returns are one of the big components of life insurance returns. The other is underwriting profit.

      ZIPR squeezes insurers’ returns, big time. See here for an example:


      In the next few years, millions of savers are in for a surprise that could cost them tens of thousands of dollars now—or hundreds of thousands later.

      The reason: Universal-life insurance policies bought years ago when interest rates were high will face cancellation if policyholders don’t pay more.

      If interest rates stay low, many policyholders will face the unhappy choice of kicking in more money, accepting a lower death benefit or walking away, possibly sacrificing years of premiums they already paid.

      Many people are “sitting on a ticking time bomb,” says Kenneth Himmler, president of Integrated Asset Management, an advisory firm in Los Angeles. About 70% of the new clients whose insurance coverage he reviews are facing higher out-of-pocket costs because policies aren’t generating enough interest income to pay costs, he says.

      1. John F. Opie

        Here in Germany you can either get pure risk life insurance or risk+capital gains growth life insurance. The former pays you zilch back, but costs less because it only pays out in case of death or invalidity.

        The risk+capital gains growth life insurance sells itself as a great investment instrument because of historically high growth rates in the past. Well, lots and lots of Germans are finding that while the promises of strong returns were made, they don’t have to be kept, and while the insurance companies by law are not allowed to show negative returns, it is an extremely safe bet that is the case.

        Of course, there is no real recourse for the insurance holder than to cancel the policy, with all the attendent penalties and fines. The insurance companies contine to double-down on riskier and riskier investments because they have to state current returns on their prospectus, which in Germany is a legal and binding document (i.e. if someone lies in their prospectus, it’s a criminal offense and you can take them to court, which makes for some mind-numbingly dull prospectus filled with caveats and weasel words), and are hoping and praying for the economy and interest rates to recover.

        Of course, they are joining their real estate investment funds brethren, as well as pretty much everyone else. Wishful thinking at its best…

      2. Lyle

        Of course this does show the value of buying term insurance and investing outside the insurance policy. Then you only care if the insurance company is ok while paying the premiums. Also at that level the state guarantee funds come in up to some sum. Universal life has always been a bad deal by combining 2 things, just like if one could find a mutual whole life policy today it would be a bad deal. (Now I have 2 one that is 40 years old, the other 30 by this time the premiums flow right to cash value, and one is paid up in 3 years also)

        1. LucyLulu

          Agreed +2. Universal life policies are good deals for insurers, not policyholders, who would fare better with term policies and investing their own savings.

          Insurers have made dramatic changes to the new policies they offer to address the problem of low interest rates going forward. Its meeting the obligations of policies that are already in effect that pose problems.

  2. fresno dan

    “As Wolf Richter warns us, the insurance industry just approved new rules which will allow them to keep lower reserves, which is that industry’s analogue to bank capital”

    When I look up the insurance commissioners I get this:

    That is, these are state officials. Now, I would agree that 99.99 percent of government regulators at both the state and Federal level are defacto employees of the industries they are suppose to “regulate” but it seems inexact to say it was the insurance companies that did this – it is much worse, it is governemnt regulators who did this.

    “As state regulators, we take insurance company solvency very seriously. It is vital that consumers get the benefit of the promises made by their insurers,” said Kevin M. McCarty, NAIC President and Florida Insurance Commissioner.”

    It seems to me its not the number of laws or regulators, its whether the laws are good and the regulators are honest.
    I find it astounding that after the collapse of the financial system, people think that “black boxes” and “flexibility” are a good thing in handling money when there is overwhelming evidence that finance guys actually don’t know what they are doing (other than getting themselves the maximum bonuses possible).

    1. Patccmoi

      Well, that’s always how it works. The industry (whatever it is) lobbies the government until their regulators relax the rules against them (I say against them, but really most of the time these rules are allowing an industry not to self-destruct in the long term by seeking short term benefits).

      Sadly these relaxed regulations tend to all turn into a massive mess a decade down the road…

  3. Nonanon

    So, buy stock in life ins co until bubble swells, then short the world? It couldn’t repeat itself, could it.

    How much was lost in this last crisis, $7T?

  4. Bam_Man

    ZIRP will eventually destroy the entire P&C and life insurance industries.
    Policy premiums will continue to escalate to the point of unaffordability for the vast majority.
    Whatever premiums they continue to collect will be subject to loss in high-risk asset classes. No happy ending here for anyone. I suppose that eventually P&C and life insurance will wind up being another government subsidized/backstopped/provided service as their business model is clearly finished.

    1. LucyLulu

      How would ZIRP destroy P&C insurers. They don’t offer policyholders returns on investments at a future date. As far as the consumer is concerned, at the end of the policy period, premium is gone and so is coverage.

      Insurance — an industry that generates more profits by providing their customers with less. What could possibly go wrong?

  5. Peter Pan

    I just sent off a message to my state’s insurance commissioner stating my disapproval for this valuation reform. I also asked whether he voted to approve the reform and whether this will become effective for the state.

    1. Peter Pan

      Here is the email response to my questions:

      Hello ,

      Commissioner Kreidler did vote on December 2 to adopt the revised NAIC Valuation Manual. The vote was 43 for, 8 against, and 2 abstained. The Valuation Manual is used in conjunction with the Standard Valuation Law which NAIC revised earlier.

      The Valuation Manual does not apply in Washington until the Standard Valuation Law is adopted by the Washington Legislature AND the law and manual are adopted by 42 states representing 75% of life insurance premium in this country. Three states have enough premium volume, that if they acted together, could block final implementation.

      Because of major structural differences between the banking and insurance industries, it is not safe to assume that a regulatory concept that worked/did not work in one industry will have the same outcome in the other industry. At this point, we believe that the Valuation Manual may be beneficial in the insurance industry and we will be preparing a legislative proposal to adopt the Standard Valuation Law. That legislative proposal most likely will not be introduced until 2014.

      I hope this information helps. Please let me know if you need anything else.

      Stephanie Marquis
      Public Affairs
      Washington state Office of the Insurance Commissioner

  6. Susan the other

    Life insurance companies should offer a full refund and call it good. If they prolong their increasing red ink they will soon be insolvent. They probably are already if they are as sleazy as the banks. Instead of letting them go on like this, the commissioners should demand that they fold. Getting a pre-death payout would be cool. Get to spend it!

  7. LucyLulu

    My understanding is that the new proposal requires the approval of 42 states before going through, that is, votes by the 42 state legislatures where 75% of premium is written. Reserve requirements have been set by state regulators under the umbrella of standards passed back in 2000. These standards have been widely criticized by industry workers and revisions debated ever since.

    Again, it is my understanding, that it isn’t that lower reserves are being sought, but reserves that more accurately reflect anticipated payouts. Since 2000, industry claims that some reserves have proven too low, and some too high, as there is no built-in flexibility among different products. For example, term life with long-term premium guarantees would require 150% expected mortality rates for reserves to begin to be drawn down. In effect, pricing of term policies is structured such that pricing of universal life policies can be reduced.

    The new standards would use more complex actuarial models to establish reserve requirements. Anybody who knows much about actuarial work knows that it involves using math with complex multi-variable matrices and passing seven rigorous exams, usually after several years experience in the field. Actuaries are the ultimate geeks with IQ’s well into the genius category, IME. They are also well-paid and at least at one point, had the lowest suicide rate of all professions. Will state insurance regulators be able to attract people who are up to the task of being able to understand more complex financial numbers manipulations? Apparently, the American Academy of Actuaries has expressed similar concerns, as well as a proposed solution.


    IME, as a corporate wife for over 20 years (and being told by the CEO of one of the largest global reinsurers that I had a better grasp of the industry than most who worked in the industry…… well yeah, I’d been forced to sit through enough business dinners, and after a few years of sitting mute and studying my silverware), state insurance regulators have not been subject to corruption and done an admirable job thus far of keeping the industry on the straight and narrow path. Threatening a company to report a violation to state regulators often suffices, and complaints, as Yves has noted, produce results. The insurance industry has a deep respect for state regulators. May that continue.

    Muddying the picture further, IMHO, is the funding of these same reserves. During the mid-2000’s, mortgage securities were popular vehicles. Fortunately, the industry had shifted back to letters of credit by the time the bubble burst. Still, that is oversimplifying the case, as offshore captives are typically funded to enter into the LOC’s, with benefits ceded back to the insurer. Insurers will retain initial risk and cede the rest to reinsurers. Nothing is simple or straightforward. What is considered “safe” when funding reserves? How “safe” did the funding have to be under the old standards? Using MBS was not what I would call safe. What are the new standards for funding reserves? This is just as important, if not more, as any required percentage. It isn’t clear.

    Details in the WSJ are scant. They provide no basis for their claim that reserve requirements are being lowered overall, nor specifics on how funding requirements have changed. Per American Academy of Actuaries, whose interests lie towards public policy, the new standards are a welcome improvement. S&P has claimed the new standards which “requires insurers to establish heightened statutory reserves for certain universal life insurance policies with secondary guarantees (SGUL)” will challenge insurers.” I’m unconvinced that the new standards are imposing additional risk rather than shoring up some of the underfunded life products.



  8. LucyLulu

    I tried and can’t find a source to verify, but if memory serves me correctly, reserves were required to be invested in AAA rated funds. That would explain the move out of MBS in 2007. Because, at least on the P&C side (no experience with life and health), reserve requirements don’t impose an undue burden, e.g. 4% of anticipated future claims would be a typical number I heard thrown around, this seems a reasonable requirement. Reinsurance would be used to protect against catastrophic loss rates that would threaten the company’s solvency.

  9. dirtbagger

    Let me think this through. Insurance companies want reserve requirements lowered so as to be better aligned with perceived risk. If the insurance companies believe risk has been overstated for the last decade, then it follows that insurance premium rates have also been excessive over the same period. I want a rebate!

  10. Ep3

    It’s gonna be the same thing as last time yves. Just another investor bubble. Sure, for awhile tons of money will be made, everyone will brag to their friends about how they know someone that they invested only $1000 in a policy and it grew to multimillions and that any idiot could do it.
    Or, yves, what if the deal is that the insurance companies need all this extra money to pay these baby boomers’ policies? The insurance companies can gamble and bonus out all the current profits and use the incoming new policies to fund current payouts. Until the float goes upside down. Cuz slowly over time, the ins will be less that the outs, just small amounts that can be worked around. And this would continue to build until all of a sudden a big payout is needed and it breaks the elephants back. Luckily the era of bailouts is over.

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