The Risk of Insolvency: Lessons from History

Life insurance insolvency's don’t occur every day, but they happen often enough to be troubling. Insolvency is bad news for policyholders – in the best case, it’s an inconvenience, and in the worst, it’s a source of serious financial harm. Insurance buyers who are familiar with recent industry history will think carefully before choosing a carrier.

Over the past 15 years, many kinds of life insurers have failed – large companies as well as small, stock companies as well as mutuals. Some of the failures resulted from imprudent investments, others from inadequate pricing. A number involved questionable transactions between parent companies and their insurance subsidiaries. But at bottom, all can be traced to the same root cause: the pursuit of short-term business growth at the expense of long-term financial strength.

The best way for insurance buyers to protect themselves against insolvency risk is to pick an insurer like MassMutual that will not fall into this trap. At all times, Mass Mutual strives to make the right decisions today so that – decades hence – we can still keep out promises to policyholders.

Too many junk bonds

Executive Life was one of a series of companies that failed in the early 1990s. In the preceding decade, many insurers has competed for customers’ savings by promising exceptional returns. Variable insurance products, guaranteed investment contracts and variable annuities came to the fore. In their drive to provide high returns, some companies took on excessive investment risk. Then investment markets tumbles, the companies proved vulnerable.

Executive Life was widely admired as a new type of insurance company. It introduced retirement annuities in 1975, and its annuity business grew strongly in the mid-eighties. But to support this business, the company relied very heavily on high-yield – or junk – bonds, which came to constitute nearly two-thirds of its assets. As junk bond defaults mounted in 1989, Executive Life’s investment portfolio began to shrink.

With the company’s results deteriorating, many customers surrendered policies and withdrew funds. In 1991, regulators in California and New York took the company’s two major divisions under conservatorship. To prevent further runs on assets, policyholders were barred from surrendering their policies.

A French group formed Aurora National to take over the California company in 1991, but policyholders has to wait more than a decade for the ensuing legal wrangles to be resolved. In 1999, California’s insurance commissioner filed suit alleging that the French buyers had lied to state regulators in order to gain access to Executive Life’s junk bond portfolio, which had soared in value after the takeover. In 2003, following a guilty plea, members of the French group agreed to pay $770.5 million – much of which was distributed to former Executive Life policyholders.

Crumbling real estate investments

It was the collapse of the commercial real estate market that proved the nemesis for New Jersey-based Mutual Benefit Life. In 1990 the company had total insurance in force of $123.9 billion. That same year, some $272 million of its mortgage loans were either delinquent or in the process of foreclosure.

News of the company’s real estate woes provoked a flight on the part of creditors and vendors, as well as policyholders. Shortly before New Jersey’s Department of Banking and Insurance stepped in to take control in 1991, Mutual Benefit Life experienced nearly $1 billion in surrenders. When the state took over in 1991, the company had some $14 billion in assets and $14,8 billion in liabilities.

The state rehabilitation plan assures that most of the company’s 700,000 insureds and annuiants would receive at least 5% in compounded interest over a 7-year period. Those who cashed in their policies sooner would suffer a penalty. During these years, recovery in the real estate market contributed to a favorable outcome for policyholders. In 1998, the state-directed rehabilitation ended when SunAmerica bought Mutual Benefit Life. Customers could cash out their policies beginning in 1999 but had to wait until 2003 to get the largest possible payment.

A parent’s misdeeds

Monarch Life grew rapidly in the 1980s after introducing its single-premium variable life policy. Then the stock market crash of 1987, combined with 1988 changes the tax laws, took the wind out of the company’s sails. Late in 1990, Monarch Life sold $3 billion of its single-premium life insurance business to subsidiaries of Merrill Lynch.

Weak performance of real estate investment dealt the company a final blow. Monarch Life’s parent company, Monarch Capital, had a high concentration of commercial New England properties in its investment portfolio. In 1991, overbuilding and a recession caused a $521 million loss. A series of transactions between Monarch Life and its parent had left the insurer vulnerable to the parent company’s losses.

The rehabilitation process at Monarch Life extended over several years, starting with temporary receivership in 1991. The company stopped writing new life insurance and annuities during 1992 and new disability insurance in 1993. When its final condition again became unsound, it was placed back in receivership in 1994.

In the late 1980’s, rapid business growth put a strain on Confederation’s capital position. At the same time, the company’s mortgage portfolio was not performing as expected. In 1994, after a strategic alliance with another insurer failed to materialize, Canadian regulators seized the company’s operations. On the same day, U.S. branch operations were taken over by Michigan’s insurance commissioner. A number of insurers were chosen to take over various components of Confederation Life’s business.

Excessive growth

Active in Canada (its home) as well as the U.K. and the U.S., Confederation Life was a leading provider of life and health insurance, as well as of annuities and pension products. In 1993, it had total insurance in force of $132 billion and assets of $19 billion.

At the U.S. company, assets were sufficient to cover approximately 90% of the $6 billion in liabilities. The relatively small shortfall made it possible to liquidate the company in an orderly fashion. Nonetheless, as late as 1996, a freeze on policy surrenders was still in place. In fact, injunctions had been obtained in both the U.S. and Canada that forbade insurance professionals from interfering with Confederation Life policies – i.e., by trying to sell new coverage to policyholders.

Underwater premiums

In more recent years, life insurers have had fewer problems with underwater investments. In fact, according to Fitch Ratings the more serious problem today may actually be underwater premiums:

"In recent years, the industry has demonstrated a tendency to complete more on product price structure. While this is not a bad concept on its face, the industry’s recent track record points towards a propensity to underprice and overstructure…The key danger is that as investors shift focus to topline performance, management will feel greater pressure to grow."

The history of Oklahoma-based Mid-Continent Life illustrates the risks of both underpricing and overstructuring. he company’s business focused almost exclusively on a single product known as Extra Life. This was designed to provide a lifetime level death benefit at very low cost by combining a whole life policy with a diminishing term rider.

But the company had promised lower premium costs that it could actually deliver. Oklahoma’s insurance commissioner placed Mid-Continent in receiver in 1997, when its reserves lagged its expected claims by approximately $160 million. At the time, the company had 175,000 policyholders and about $13 billion of insurance in force.

In 2000, American Fidelity Assurance assumed 138,000 policies from Mid-Continent with the announced intention of freezing coverages and premiums for 17 years.

Avoiding trouble

Insurance buyers can take some clear lessons from these examples. Even large and well-respected companies may try to grow by promising more than they can reliably deliver. Such companies should be avoided. The better choice is an insurer that focuses relentlessly on long-term financial strength. This kind of coverage is well worth a few extra dollars in premiums.

Mass Mutual has been creating and delivering value since before the Civil War. A powerful measure of long-term value and satisfaction is that nearly 80,000 of Massachusetts Mutual Life Insurance Company’s (MassMutual’s) policyholders in 2004 had been with the company more than 50 years. Clients stay with Mass Mutual because they’ve been treated right.

In contrast to the insurers above that took on excessive investment risk, Mass Mutual maintains a sound fundamental investment philosophy. A safeguard is prudent diversification in all managed portfolios.

A key benchmark of capital adequacy is company’s risk-adjusted capital ratio (RACR), which is the ratio of the company’s actual surplus to the required surplus. Moody’s Investors Service uses this ratio to gauge financial strength.

Not surprisingly, by all generally accepted criteria – including asset/liability management, asset quality, and liquidity – Mass Mutual is judged to be among the strongest and safest insurance providers in the nation. Our reputation for financial stability is confirmed by financial strength ratings (which are subject to change) that are among the best in any industry. These ratings for Massachusetts Mutual Life Insurance Company, C.M. Life Insurance Company, and MML Bay State Life Insurance Company were the following as of March 1, 2005:

• A.M. Best Company: A++ (Superior)
• Moody’s Investors Service, Inc.: Aa1 (Excellent)
• Standard & Poor’s Corp.: AAA (Extremely Strong)
• Fitch Ratings: AAA (Exceptionally Strong)

Sources

Best’s Insurance Reports – Life/Health, 1991, 1995, 1997 Editions, A.M. Best Company, Oldwick, NJ 08858

Executive Life:
Lloyd’s List International, March 12, 1994, p.10
American Financial Services, April 2004 Newsletter, Issue Four, Volume Five
Business Insurance, February 15, 2002, “Aurora settles fraud charges as ELIC trial moves forward,” by Joanne Wojcik

Mutual Benefit Life:
The Journal of Commerce, January 19, 1993
Regulation, The Cato Review of Business and Government: “Policyholder Runs, Life Insurance Company Failures, and Insurance Regulation,” by Scott Harrington
IBL Troubled Company Reporter, July 21, 1998

Monarch Life:
Business Week, June 17, 1991, p. 88, “As Insurance Failures Go, This One Could be Worse”
GAO Report to the Ranking Minority Member, Committee on Commerce, House of Representatives, Insurance Regulation: Observation on the Receivership of Monarch Life Insurance Company, March 1995

Confederation Life:
Journal of Financial Planning, August 1996, pp. 18-19, Peter C. Katt, “When Company Insolvency and Regulators Leave You Empty Handed”
BestWire, March 5, 1997 “Phoenix Home Life Chosen for Confederation Bailout”

Mid-Continent Life:
Insurance Journal, August 25, 2000
Katt & Company, AAII Journal – July 2001, “Misleading Promises: Beware of Agents Bearing Guarantees”
Best Wire, December 1, 1998, “Oklahoma Files Motion Against Florida Progress”
Best Wire, June 16, 1999, “Oklahoma Commissioner Mulls Ideas for Savings Mid-Continent”
Best Wire, June 16, 2000, “American Fidelity to Assume Mid-Continent Policies”
Best Wire, September 29, 2000 “American Fidelity Awarded Mid-Continent’s Business”