The Consumer's Perspective on the Insurance Crisis

By Dean, Mary Katherine; Rattiner, Jeffrey H. | Journal of Accountancy, August 1992 | Go to article overview

The Consumer's Perspective on the Insurance Crisis


Dean, Mary Katherine, Rattiner, Jeffrey H., Journal of Accountancy


Fears of another savings and loan crisis and a shortage of objective advice have left consumers confused, nervous and distrustful of the insurance industry. In 1991, state regulators seized six major insurance companies: Executive Life, Executive Life of New York, Fidelity Bankers Life, First Capital Life, Monarch Life and Mutual Benefit Life. Other household names such as Aetna, Kemper, John Hancock and Travelers had their ratings downgraded. (See the sidebar on pages 66-67 for an explanation of insurance ratings.)

The insurance industry shake-up has clients asking questions:

* What happened? Isn't insurance supposed to be among the safest investments?

* My company is in trouble. Will I be paid? If so, how much and when?

* Which insurance company is next? Answering these and other questions helps clients cope with the current crisis. Providing an objective second opinion also may prevent future problems. This article should help practitioners answer client questions and describe the expanded role CPAs can take in insurance due diligence.

INSURANCE: SOLID AS A ROCK?

The image of the insurance industry as rock solid never has been based on fact; insurance is a business like any other. An insurance policy's viability depends on the management and financial stability of the company issuing it. No agency like the Federal Deposit Insurance Corp. exists for the insurance industry. Consumers' only protection is state insurance funds, which have many limitations. Until 1991, many populous states--California and New Jersey among them--did not even have life, health or disability insurance funds. Since the onset of the current insurance crisis, changes have been rapid. All states now have insurance guarantee funds, and the District of Columbia is adopting legislation,

Life insurance and annuity payments are supported primarily by the underlying investments issuing companies make. For most companies, corporate bonds represent the largest holding. For example, the 1991 edition of Best's Insurance Reports LifeHealth shows corporate bonds constitute 36.8% of assets for U.S. life insurance companies. While highly rated corporate bonds are a fairly secure investment, they are not as secure as Treasury bills (100% guaranteed by the federal government) or certificates of deposit (guaranteed up to $100,000 by the FDIC).

In the late 1970s and early 1980s, competition, inflation and new insurance products (such as universal life) were incentives for companies to outperform competitors with higher returns and lower premiums that could be achieved only with more speculative investments. A February 1990 report by a U.S. House of Representatives oversight panel said troubled insurance company balance sheets were camouflaged with "false reports" and "complex reinsurance" agreements. (A policy is reinsured when an insurance company transfers all or part of its exposure under the policy to another company.)

WILL POLICYHOLDERS OF INSOLVENT COMPANIES BE PAID?

When an insurance company becomes insolvent, there generally are five sources of funds to pay policyholders:

* Other insurance companies. Baldwin United often is cited as an example of how the insurance industry can "take care of its own." Baldwin United was a large insurance company that failed in the early 1980s; its brokers and salespeople contributed $167 million and the insurance industry $62 million to pay policyholders. Despite this there still are questions whether all Baldwin United policyholders were fully compensated, even after state insurance funds stepped in.

* Liquidation of assets or sale of a company, or both. In November 1991 an investor group headed by Altus Finance, a subsidiary of Credit Lyonnais, was selected on the recommendation of California Insurance Commissioner John Garamendi to acquire Executive Life. Altus Finance will pay $3.25 billion for most of Executive Life's junk bond portfolio. …

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