Stung by bad investments in high-risk "junk bonds" and real-estate mortgages, the $1.4 trillion life-insurance industry is facing hard times. With about $275 billion of their assets in mortgages and another $60 billion in junk bonds, life insurers have been experiencing escalating insolvencies the last few years as both these markets have been distressed.
The industry's mounting woes were underscored last week when New Jersey regulators seized a once blue-chip insurer, Mutual Benefit Life Insurance Co., the nation's 18th-largest with $13.5 billion in assets and 400,000 policyholders, to prevent it from becoming the largest failure ever. Bleeding from bad real-estate loans, Mutual Benefit's solvency was also threatened by a policyholder run that totaled about $1 billion in redemptions in recent weeks.
As of May 21, 16 life and health insurers had failed or been declared in hazardous operating condition this year by the National Organization of Life and Health Insurance Guaranty Associations. By comparison, 44 companies went under or were in hazardous operating condition in all of 1989, an industry record.
A study released last month by the American Council of Life Insurance revealed that the industry's delinquent mortgages reached an all-time high of 4.7 percent of all loans, surpassing the previous high of 3.9 percent in 1976. Analysts say that the industry's problem mortgages are likely to have a broader impact on insurance-company earnings as reserves are set aside to cover problem loans.
The industry's distress is prompting criticism of the system of state insurance regulation and fears about the capacity of state guaranty funds to cover policyholders fully when their insurers fail. The guaranty funds are supported by assessments of healthy insurers after an insurer goes insolvent.
With new financial pressures, insurers are scrambling to raise new capital, cutting costs through downsizing or exploring mergers in efforts to shore up their strength and in some cases to ensure survival. At the same time, some companies have been cutting back on their high-risk investments and adding more funds to reserves to deal with losses from real-estate and junk bonds.
Michael Lewis, an insurance analyst with Dean Witter Reynolds Inc., predicts a shakeout and consolidation in the 2,300-company life and health insurance industry over the next few years. But he and most other analysts do not expect a crisis on the order of the savings-and-loan debacle because, for the most part, the life-insurance industry remains profitable and better capitalized than the S&L;'s.
Still, the life-insurance industry today is facing far more risks than a decade ago. "It got crazy in the 1980s," says Terence Lennon, the chief life-insurance examiner in the New York Department of Insurance. "The consumer in the 1980s turned into a quasi-investor and that pushed companies to give higher rates." Mr. Lennon says that faced with growing competition from mutual funds, banks and savings-and-loans, insurers introduced
several new products like interest-sensitive annuities and guaranteed investment contracts, which promised higher returns than traditional life insurance offered. And to earn those high yields, insurers stepped up their investments in real estate and junk bonds.
The industry's mortgage investments, for instance, rose from just under $200 billion at the end of 1986 to about $275 billion at the end of 1990. And life insurers garnered just under one third of the $200 billion junk-bond business.
To be sure, the industry, which holds about a quarter of the nation's commercial mortgages, had long experience in the real-estate field. Historically, insurers were staid and conservative investors who eschewed speculative construction lending done by banks and typically lent money to buildings that were fully occupied or nearly so.
But in the 1980s, several life insurers relaxed their lending standards, according to executives and regulators, as many companies were swept up in the decade's real-estate fever. "There was too much money chasing too few deals," says Thomas Wheeler, the chief executive officer of Massachusetts Mutual Life Insurance Co. "I think some insurers got caught up in the euphoria of the 1980s and got trapped." Mr. Wheeler blames the deregulation of the savings-and-loans, with whom life insurers had to compete, for some of the industry's laxness.
Several big insurers have been especially hard hit by the real-estate slump and have been forced to take some painful steps to improve their condition. Travelers Corp., for instance, parent of Travelers Insurance Co., has about one third of its $43.7 billion in invested assets in mortgages, last year had a $499 million loss in the third quarter because of a reserve addition to cover problem real estate. Travelers, which also had a loss of $337 million in the second quarter of 1988 due to bad loans in the Southwest, now has about $4.6 billion in soured real-estate investments, according to analysts, and has been forced to trim its work force to reduce expenses.
Still, with the real-estate market so overbuilt, executives and analysts don't see any quick fixes in sight. "We haven't seen the bottom yet," predicts Mr. Wheeler of Massachusetts Mutual, which is still a relatively strong company. "I think the real-estate problems are going to be longer-term [for many in the industry]." Even his company, however, took the precautionary step last fall of halting new real-estate loans. Several other companies with more serious woes have done likewise.
Mutual Benefit's problems stem from bad real-estate investments, primarily in Florida and California, which were draining its capital. The insurer's seizure by state regulators means that for now the 400,000 individual policyholders cannot redeem their policies or borrow against them. Pension withdrawals are also being barred. The insurer sold almost $6 billion in group annuities and guaranteed investment contracts to hundreds of corporations. Death benefits, annuities and other claims are being paid in full.
The New Jersey regulators hope to separate the insurer's healthy investments from its bad ones, a restructuring plan often used in the banking world, dubbed "good bank, bad bank." The Prudential Insurance Co. of America and Metropolitan Life Insurance Co. have pledged to back the future obligations of Mutual Benefit, permitting it to write new policies.
The Mutual Benefit situation is also raising red flags about the ability of the current system of state regulation to detect and control problems before they become serious. It will likely fuel tighter state controls on high-risk investments. About ten states have enacted rules that limit the amount of junk bonds that insurers can hold in their portfolios, and the National Association of Insurance Commissioners, a private trade group which recommends model laws to the states, recently proposed some new curbs on junk holdings. Next year this group is also expected to issue proposals that if adopted by states would require insurers to set aside reserves for troubled real estate.
At the same time, Mutual Benefit's problems will probably speed up new congressional legislation to protect policyholders and strengthen insurers by setting minimum federal solvency standards for the industry. These new standards, which Rep. John Dingell, D-Mich., will introduce in Congress later this year, are designed to supplement existing state regulations. Their thrust is to develop common rules dealing with capital levels, investment restrictions, international insurance, company ties to affiliates and other items which all states will have to implement. In addition, the bill would extend criminal penalties to executives who are responsible for their companies' failing through bad management.
State regulation varies widely in quality, and some critics in Congress are worried that the National Association of Insurance Commissioners, which can only suggest model laws to states, lacks the clout to be an effective regulatory body. According to a recent General Accounting Office report, since 1980 only one of a dozen NAIC model laws was adopted by more than half the states.
Mutual Benefit's brush with failure also has highlighted weaknesses in the state guaranty funds that are designed to pay claims of policyholders when an insurer fails. New Jersey, for example, did not have such a fund until Gov. James Florio hastily signed one into law last week. The funds have been criticized because insurers are assessed only after a company fails, which can lead to delays in paying claimants.
More worrisome to some critics is that the funds have never had to cover large insurance failures like the recent California case of Executive Life Insurance Co., which collapsed due to heavy losses in its junk-bond portfolio. The California insurance commissioner is trying to find another insurer to rescue the company and take over much of its business, and right now most benefit claims and retiree payments are being made. But many state guaranty funds don't provide coverage for guaranteed investment contracts. During the 1980s such contracts soared in popularity; insurers sold about $200 billion of them to pension funds. First Executive had a total of $3.1 billion outstanding in such contracts.
In addition, some critics have called the guaranty funds taxpayer bailouts in disguise because many states allow insurers to deduct insolvency payments from their state taxes. In recent congressional testimony Marty Leary, the research director of the Southern Finance Project, noted that assessments of insurers to cover life and health insolvencies have soared from just under $4 million in 1980 to $164 million in 1989. Mr. Leary called for reform of the guaranty fund system so that taxpayers don't have to keep picking up the industry's tab.
Peter H. Stone, a reporter for Legal Times, has written extensively about the insurance and banking industries.