INSTABILITY and unusual risk-taking virtually define the history of U.S. institutional finance of the 1980s. In reaction, the 1990s as a whole are likely to be characterized by a return to conservatism in management and regulation of such institutions, developments clearly evident in the early part of the decade.
The life insurance industry, part of an increasingly intracompetitive universe of financial institutions, has participated in both the slide toward instability of the 1980s and in the retreat toward caution of the 1990s, but in a greatly attenuated manner compared with depository institutions. The pressure on capital ratios and the increase in portfolio difficulties and in the volatility of liabilities have been less pronounced than in commercial banking and far less than among the thrifts. Insurance company failures have remained fairly isolated and have involved small percentages of numbers or assets of the universe of companies.
Nevertheless, perceived stress is high among industry management and analysts, while the general public is somewhat apprehensive. A dichotomy exists between reality and perception. One reason is the difficulty of curing quickly the portfolio problems of a long-term lender, which certainly applies to the insurance industry's commercial real estate investments. Another reason is structural stress on the industry arising from the clash between an increasingly investment-performance-oriented financial environment and the traditionally high-cost insurance distribution system. Finally and ironically, the intensive attention devoted to the finances of the industry by regulators and rating agencies itself contributes to stress.
LIFE INSURANCE EVOLUTION DURING THE 1980s
The industry more than held its own against other institutions during the high-flying 1980s, whether the measurement is asset growth, funds supplied in the capital markets, or share of the consumer dollar obtained. Thus, the industry was ahead of the commercial banks and the thrifts in net funds supplied to the capital markets in 1991, whereas it had lagged far behind a decade earlier. The ratio of premiums and annuity considerations relative to disposable personal income (DPI) actually rose from 3.24 percent in 1980 to 5.07 percent in 1990, a post-World War II high. In addition, the number of insurance companies (over 2,100 in 1991) was larger than a decade earlier, although down somewhat from the 1988 peak.(1)
This record reflects major changes in response to the market pressures of the 1980s. The key components of the adaptation were a sharply rising share of accumulation (as against protection) products on the sales side, and a corresponding diversification into specialized-product matching on the investment side.
In the course of the major inflation of the late 1970s and early 1980s, traditional whole-life policies turned out to be costly to the insured. Long investment maturities did not permit escalation of policyholder crediting rates in line with that of interest rates. Besides, spreads between earnings rates on investments and crediting rates were high as long as life insurance was sold primarily as a protection device.
Faced with a sharp turn toward term insurance and with policy loan drains and liquidity squeezes, the industry developed a class of policies that provides for the flowthrough of current investment results to the policyholder inside an insurance wrapper. They frequently permit investment choice on the part of the insured and flexibility as to premium input while maintaining mortality protection. Depending on their specific characteristics, these policies go under such names as variable life, universal life and variable/universal life. These policies now represent about one-third of all life insurance in force.
Even more crucial in maintaining the flow of funds to the industry was the increased emphasis on pension and annuity business. The industry widened its role in 401-K (employee savings) plans while holding its shares in the individual retirement (IRA) and small-business (Keogh) pension plan markets. …