Financial advisers are looking more closely at the financial health of insurance carriers before they recommend life insurance policies and annuities with guarantees.
"[The financial condition] does make me more aware when selecting insurance companies for my clients," said James P. Dew, president of Dew Wealth Management of Scottsdale, Ariz., which manages $47 million. "Now I not only look at ratings and financials but I also look at their business model to see where they are putting their money."
Advisers say they got quite a scare last month when American International Group Inc. reported a $5.29 billion fourth-quarter loss on write-downs related to the credit crisis. The New York-based insurance behemoth's dismal earnings report has made advisers particularly vigilant on behalf of their clients, some say.
AIG's results included pretax losses of $11.12 billion related to Wilton, Conn.-based AIG Financial Products Corp.'s supersenior credit default swaps and $2.63 billion from other-than-temporary impairment charges in AIG's investment portfolio connected to mortgage-backed securities.
But AIG isn't alone.
Twenty of the 24 carriers in the KBW Insurance Index reported declines in fourth-quarter earnings, while 22 of 24 have seen their year-to-date share price tumble. Year-to-date as of March 19, the index was down 14.89% to 134.81.
Although advisers don't expect major insurers to go belly up on bad investments, some advisers are giving extra thought as to how they choose the carriers that provide guarantees to investors.
STAYING AFLOAT
"It is exactly events like we have happening now that make choosing an annuitization strategy risky," said Morris Armstrong, owner of Armstrong Financial Strategies, a fee-only firm based in Danbury, Conn. "You have entered into an irrevocable credit decision without the ability to change it in the future or be adequately compensated for increased credit risk."
Analysts are also predicting continuing earnings weakness this year as subprime assets deteriorate, but they are confident that the large insurers and the industry will be able to hold up.
The life insurance industry will report $2 billion to $3 billion in realized losses for the fourth quarter of 2007, according to estimates from Fitch Ratings Ltd. of New York.
Negative-ratings actions stemming from subprime losses have been limited so far.
However, Standard & Poor's of New York recently slashed its ratings on small carriers such as Scottish Re Group Ltd. and Security Benefit Life Insurance Co. The ratings firm downgraded the former to A, from A+, while it cut its rating on the latter to BB, from BB+.
S&P put both Scottish Re of Hamilton, Bermuda, and Security Benefit of Topeka, Kan., on negative-credit watch. "Those are carriers we're concerned about because of what appears to be outsized exposures in the subprime area relative to their capital position," said Rodney A. Clark, an S&P credit analyst.
Analysts warn against making broad judgments about the industry's financial strength, based on what has happened to a handful of carriers whose ratings are subject to numerous factors.
"AIG is a unique case — you have several areas of subprime exposure, adding to volatility," said Bruce Ballentine, vice president and senior credit officer at Moody's Investors Service Inc. in New York. "It's still a strong company, but we put up a caution flag because of its subprime exposure."
On the other hand, advisers aren't willing to take analysts' recommendations at face value alone. Instead, they are digging deeper before recommending a company's product, especially if it is a fixed annuity or a life insurance policy.
"I would say that our awareness and due diligence is at a heightened level," Mr. Dew said. In his firm's case, this involves scanning annual reports, tracking dividends and holding the company responsible for less-than-excellent results.
"We don't disregard [the ratings agencies'] assessment," Mr. Dew added. "But if the companies dropped their dividends or there's a ratings change, we want to know why."
Holdings in a carrier's general account are also on advisers' radar screens, as is the reinsurance that is backing their obligations.
"Insurance companies have a general ledger that usually consists of Treasuries, high-rated corporate bonds and mortgages," said David Samuels, president of Corinthian Wealth Management. The San Jose, Calif.-based firm manages $60 million.
If a company's ratings are threatened due to severe losses on their general ledger — say, from mortgages — they may have to look at tightening underwriting standards or even curtailing certain types of policies, Mr. Samuels said. They don't want to appear to have high exposure to investment risk while also being responsible for large potential losses due to lax underwriting standards.
Life insurers' Comdex rankings are a way to evaluate the carriers, Mr. Samuels added.
These rankings measure insurers' financial strength and are based on results from various ratings systems. Carriers are then ranked against one another on a scale of 1 to 100, with 100 being the highest.
RECESSION CONCERNS
But Mr. Samuels noted that carriers may "ride out" the subprime situation "without too much damage."
Although the weak earnings in and of themselves aren't a prediction of doom, advisers and analysts think that the industry could run into difficulty if the U.S. economy goes into a recession.
Values for variable-life policies could drop in a declining market, and clients would take the brunt of the impact, Mr. Samuels said. "Where the cash value is being eroded, some of these policies could lapse, leaving the client in the position of having to come up with extra money to keep the policy in force," he said.
Variable annuities would remain less attractive in this event, but if wide spreads persist, institutional investment products such as guaranteed investment contracts and funding-agreement-backed notes will be more attractive, said Laura Bazer, vice president and senior credit officer at Moody's.
A recession, along with unemployment levels at 6%, could strain mortgages, resulting in significant losses, Mr. Clark said.
"Even some of the major carriers might see some deterioration, but small companies could be impaired to the point they can't meet guarantees," he said.
Rockier times in the market may be ahead, but the industry should be able to manage, analysts said.
"It could always get worse, but currently, subprime exposure is quite manageable," said R. Andrew Davidson, an analyst with Fitch Ratings. "If the carrier had issues that concerned the public, you'd see demand taper off, but in comparison to other financial services companies, the insurers look good on a comparative basis."
E-mail Darla Mercado at [email protected].
