Are Life Insurers the Next to Go?

03/02/2009 1:00 pm EST

Focus: MARKETS

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says life insurers are losing money because of risky investments, and continuing bad money could make them vulnerable.

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.

Life insurers Hartford Financial Services (NYSE: HIG), Principal Financial Group (NYSE: PFG), Lincoln National (NYSE: LNC), 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. 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.)

What are the chances this doomsday scenario will play out? 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.

It starts with 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.

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.

As a sign that the problems for insurers are getting more serious, regulators are loosening accounting standards to try to help them out.

Though industry supporters acknowledge there could be serious trouble if the economy and the markets sink low enough, they cite several reasons a doomsday scenario isn't realistic:

  • First, life insurers typically have very little money invested in stocks or risky mortgage-backed securities. Most of it is in bonds—and in a broadly diversified portfolio of high-grade corporate or government bonds at that.
  • Next, outright bankruptcies are unlikely, says Sterne Agee analyst John Nadel, because life insurance companies aren't required to make payouts right away.
  • Nadel also doubts a run on the insurance companies will occur, because they charge hefty fees for cashing out accounts. And unlike Bear Stearns and Lehman Bros., insurers did not borrow huge amounts of money to make investments.

The points above may be reasons to feel more secure. But if the economy and the markets continue to tumble hard, the companies won't be safe.

Ultimately—in the meltdown scenario—it might be Uncle Sam that would be asked, once again, to save the day.

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