Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, July 8, 1990 TAG: 9007180389
SECTION: HORIZON PAGE: D-1 EDITION: METRO
SOURCE: Albert B. Crenshaw the Washington Post
DATELINE: LENGTH: Long
It was called a "guaranteed investment contract," and it obligated the company to pay investors a specified yield over a certain period, much like a certificate of deposit. Other companies offered these contracts, but Equitable decided to go them one better. It would allow investors to lock in double-digit returns for as long as 10 years.
The plan worked like a charm. Investors flocked to Equitable's GICs. But as overall interest rates turned down, Equitable discovered to its horror that it was paying out more to its investors than it was earning on their money. Millions of dollars were flowing out the door and would continue to flow out until the contracts expired.
After taking a painful financial beating - losses amounted to as much as $200 million to $250 million each year from 1982 to 1989 - Equitable hopes it has weathered the storm.
But its comeuppance and other calamities in the insurance industry have set alarm bells ringing on Capitol Hill and elsewhere. Policy makers and policyholders alike are being forced to ask: Is the insurance industry another savings and loan crisis waiting to happen?
There are reasons to worry, a congressional subcommittee has concluded. Insurers, like S&Ls, have been hard pressed by competing financial services firms seeking to siphon off consumer dollars. They have had to face rapidly changing economic conditions that have made many insurance risks harder to predict. Striving for profits, many insurance companies have moved into new and different lines of business and new and riskier forms of investment - just as thrifts did 10 years ago.
In addition, cases of reckless, incompetent management and even downright fraud have been discovered in the aftermath of several big insurance failures.
For its part, Equitable's move into GICs appeared to make sense at the time. With its traditional life insurance business slowing down and inflation-conscious customers hungry for investments that promised steady high returns, Equitable's top brass had been looking for something that would put the nation's third-largest life insurer back on track. But it overreached.
Today, Equitable is a much-chastened company. Its top management has been replaced, executive perks like a fleet of 12 limousines have been swept away and it is "refocusing" on its core insurance business as the old GICs "roll off the books." The company's chairman, Richard Jenrette, has vowed to lop $100 million in costs in 100 days, beginning in May.
Equitable's story shows how even a big, experienced, apparently sound insurer can quickly find itself in trouble as it seeks growth and profit in today's rapidly changing financial world.
A study completed earlier this year by IDS Life Insurance Co. concluded that in a severe economic downturn or a sharp decline in investment, "there is a significant risk that one-fifth of today's major life insurers will become insolvent."
"The parallels between the present situation in the insurance industry and the early stages of the savings and loan debacle are both obvious and deeply disturbing," Chairman John Dingell, D-Mich., of the House Energy and Commerce Committee observed earlier this year following a series of hearings by his oversight subcommittee.
Should the insurance industry go the way of the thrifts, the consequences would be at least as severe, and perhaps for the average citizen more so.
Americans depend on insurance companies today not only for traditional coverages like business liability, home, auto and life insurance, but also for annuities, mutual funds and other investment operations.
The potential exposure from mass insolvencies stretches the imagination. Even small collapses have ruinous potential, as in the case this year of a California businessman whose health insurer failed. While he was shopping for a new policy, he suffered a serious heart attack. His medical expenses ruined his business and forced him into bankruptcy.
A growing number of people depend on insurers for their pensions. It has become common practice for corporations seeking to cut costs and obtain extra cash to terminate their traditional pension plans. The pension benefits, which are government-insured, are replaced by annuities purchased from private insurers, for which there is no federal insurance.
In fact, no federal promise stands behind insurance. Instead, there are state guaranty funds, supported by assessments levied against insurers. But while the industry is fond of saying "we bury our own dead," not all states have these funds, and critics fear that many of those that do would be quickly overwhelmed if insolvency became widespread.
The likelihood of such a catastrophe is hotly debated. To understand the arguments, however, one must first understand something of how insurance works.
As Dingell's panel noted, insurance is very simple in concept and in certain ways works much the same as a bank or savings and loan. The insurance company takes in money - premiums - and agrees to give it back plus an additional amount, if and when some specified event occurs. The company, like a bank or S&L, bets that it can invest those premiums and not only make good on its promises to policyholders but also turn a profit in the bargain.
A few companies, such as Geico Inc. in Washington, make money on their underwriting. That is, they take in more in premiums than they pay out in claims and expenses. Most insurers, though, depend entirely on their investments for any profit.
As the panel noted, "The simplicity of the insurance concept is matched by extreme complexity in its implementation."
One unifying theme among critics and much of the industry is that regulation, which is handled exclusively by the states, is not effective enough.
Many state insurance departments examine companies "domiciled" in their states less than every three years, and many have limited resources.
If you own or are thinking of buying an annuity or insurance policy, especially one that you expect to have a claim against far into the future, financial planners suggest checking the insurance company's standing with one of several rating services that evaluate claims-paying ability.
The best known of these is A.M. Best Co., which rates the largest number of companies, but Standard & Poor's Corp., Moody's Investors Services Inc. and Duff & Phelps Inc. also have extensive ratings.
The ratings are a sometimes confusing collection of codes, but financial planners and other insurance experts advise sticking to the top few categories, companies rated A+ or A by Best, for example. Lists of ratings and explanations are often available at insurance agents' offices and in many cases at public libraries.
***CORRECTION***
Published correction ran on July 18, 1990
Clarification
An article titled "A calamity waiting to happen" in the July 8 Horizon section cited a guaranteed investment contract by the Equitable Life Assurance Society of the United States as an example of an insurance industry problem. The Equitable organization named has no connection with Equitable Life of Iowa, an Equitable Life Insurance Companies affiliate, which has an office in Roanoke.
Memo: CORRECTION