Financial advisors are increasingly concerned about the financial strength of the insurance companies whose products they sell. They cite low interest rates and exposure to the stock market via product principal guarantees as grounds for their concern, according to a fall study by LIMRA.
Some 26 percent of financial advisors consider the financial strength of an insurer one of the two most important factors in choosing an insurance product in 2011, the study indicates. This compares with just 16 percent in 2008 and 2003, when LIMRA surveyed this issue in the past.
The economic slump certainly isn't helping life insurers. Stephen Irwin, A.M. Best vice president in the life/health division, says his company is considering revising its rating outlook for the life and annuity industry from stable to negative. He cites the continuing effects of ongoing historically low interest rates, volatile equity markets, global contagion and heightened sovereign credit risk, high unemployment and low consumer confidence.
“The financial strength of the life-health industry has been steady despite many macroeconomic challenges,” Irwin says. However, a failure to resolve the European debt crisis and/or descent into another recession in the U.S. could take a toll on the performance of insurers in the future, he said. The Oldwick, N.J. rating agency also reports that there is the potential for volatility due to investments in derivatives and hedging programs.
Meanwhile, an analysis of life insurers' assets and investments in 2010 reveals an industry in recovery from the credit crisis, but facing a new and longer-term set of challenges from the lowest interest rates seen since the 1950s. This is based on a study by Conning Research & Consulting of Hartford, Conn., released in November.
Actuaries contend that advisors shouldn't be spooked by the insurance industry's exposure to principal guarantees, including guaranteed lifetime withdrawal benefits. Reason: They are successful in hedging those risks, according to Frank Zhang, executive director of Ernst & Young's Insurance and Advisory Services, New York. Speaking at the annual meeting of the Society of Actuaries last October, Zhang said that insurance companies have fine-tuned dynamic hedging strategies, which incorporate the use of put options to limit downside risk.
This type of program considers a hedge ratio — the amount of put options needed to hedge against the risk of losses. Those put option hedge positions are rebalanced as market conditions change.
The dynamic hedge takes into account the amount by which an option's price will change for a corresponding change in the price of the underlying security. This is adjusted as the price of the portfolio it hedges changes. Meanwhile, the change in the price of the option is also hedged.
“Variable annuity hedge programs have performed well with efficiency ratios over 90 percent,” he says.
Nevertheless, advisors attending the Insured Retirement Institute's annual meeting last fall expressed concerns about rising variable annuity fees due to higher insurance company costs for providing guarantees. And several advisors complained that wholesalers tend to bombard them with product information, but often don't discuss product suitability or the impact of market value adjustments when clients cash out their annuities early.
On the life insurance side, the life settlement business is drying up. There is little credit available for premium financing — a big driver of sales in the past. The U.S. life settlement industry saw sales drop about 50 percent in 2010 to roughly $3.8 billion in face value, which represented the third consecutive year of declines, a recent study by Conning Research & Consulting shows.
This trend is expected to continue. As a result, it could prove harder to sell a seriously ill client's life insurance policy if cash is needed to pay medical bills. It may also be harder to attract investors to life settlements on bonds secured by life insurance death benefits.
“Capital remains skittish about returning to this asset class, and most current investors are focused on acquiring distressed portfolios rather than purchasing new policies,” said Scott Hawkins, analyst at Conning, in a statement. “Given the combination of death claims and lapses on settled policies, the $36 billion in-force life settlements barely increased over the prior year.”
Others say settlements are a lousy investment and should be avoided. Larry Swedroe, director of research for the Buckingham Family of Financial Services, St. Louis, recommends that advisors avoid the product because its maturity is long and it is illiquid. Yet, there is no liquidity premium for tying up a client's money. There is also credit risk because investors are relying on cash payments from the settlement for 20 years from a single insurance company. The yield gap between a bond index and a life insurance structured settlement narrows when the duration of the bond index is extended to match the duration of the life insurance settlement.
Life settlement income streams are often packaged into securities. But the American Council of Life Insurers (ACLI) called on the Securities and Exchange Commission (SEC) to prohibit the securitization of life settlements and supports changes to clarify the application of federal securities laws.
“Securitization of life settlements will exacerbate the (Stranger Originated Life) problem,” says Jack Dolan, ACLI spokesman. “Securitization is a very effective means of market-making and encouraging rapid expansion of a ‘product,’ in this case, life settlement contracts. Promoters will use capital generated from securitization to create larger inventories of life settlement contracts which, in turn, will fuel more securitizations and more (stranger originated life insurance).”
Alan Lavine is a contributing writer to Registered Rep., and author of some 15 books on investments and insurance. He writes a column for Dow Jones MarketWatch's “Retirement Weekly,” and is a contributing editor to Financial Advisor magazine.