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Insurance firms seek silver lining after dark clouds

THE BALTIMORE SUN

The financial condition of Monarch Life Insurance Co. was inaccurately characterized in an article on the insurance industry in The Sun's Business section on July 28. Monarch Life is in receivership but remains solvent. It continues to pay claims, service policies and take new business. Its parent, Monarch Capital Corp., has filed for bankruptcy.

* The Sun regrets the errors

New York -- A bust or two may undermine the banking system, but it is a quirk in the economics of the insurance industry that disasters are often a precondition for better days.

Any optimism about insurance companies at the moment, of course, is an unusual point of view. The commercial property market, where many insurers have large investments, appears to be a black hole, and destructive runs lurk ominously in the background. Moody's Investors Service downgraded six insurers the week before last and another four Thursday. And on Wall Street, insurance company share prices have fallen across the board, led by a 15 percent decline last month in the stock of Baltimore-based USF&G; Corp.

"One finds no shortage of reasons for the dismal June performance," said Ronald Frank, an analyst with Smith Barney. Bad pricing of policies, bad weather, bad interest rate movements and bad losses all add up to very bad times.

There is reason to hope for better times ahead. Current problems already are prompting changes in consumer attitudes, policy pricing and company investment policies that are likely to be beneficial.

But because the insurance industry is comprised of very different segments, there is no single solution to the industry's problems.

Begin with life insurance. That area has prompted the greatest concern because of the recent insolvencies of Mutual Benefit Life Insurance Co. in New Jersey, Monarch Life Insurance Co. in Massachusetts and both Executive Life and First Capital in California. While not minimizing the agony caused by these dTC failures, only 2 percent to 5 percent (depending on the source) of industry assets are affected. And even that overstates the problem because the assets in question aren't valueless, just not valuable enough.

In the past, the industry has been adept at cleaning up its own calamities.

Indeed, insurers like to note that they, unlike bankers, "bury their own." Since the Depression, there hasn't been a major life insurance failure that left policyholders holding an empty bag, though in the Baldwin United case in 1983 they received a lower interest payment on their investments.

The bad news about the good record is that insurance companies have never needed a federal safety net like deposit insurance. Instead, the industry relies on a complex pool of company-financed state funds. In the past, the lack of a solid backstop may have made the companies more prudent. Now, however, it causes alarm, because many people use life insurance more like a long-term savings account.

According to statistics from the American Council of Life Insurance, more than half of the industry's premiums stem from annuities. Another large chunk of premiums comes from what is referred to in the trade as "whole life" -- insurance that not only pays off in the case of death (known in its pure form as "term life") but also accrues interest and has a redemption value.

With no safety net, jittery policyholders could go on a redemption binge, something with which the industry is poorly structured to cope. Life insurance policies are sold to last decades; insurance companies make investments to match. In a panic, companies can't quickly turn those investments into cash.

Whether runs will become endemic is questionable. Penalties for early redemptions can be 10 percent of a policy's value. In the past, that has discouraged runs and allowed life insurers to wait out market swings.

And even if runs do occur, most life insurers are far stronger than Executive Life or Mutual Benefit Life. Mutual Benefit Life, for instance, had 40 percent of its funds invested in real estate, twice the industry average, said Sean Mooney, an economist with the Insurance Information Institute. Executive Life, he added, had 70 percent of its money in "junk bonds," more than 10 times the industry average.

With these companies dead, insurers and policyholders are already beginning to value stodginess.

A broker at Prudential Securities said that until this spring, her customers' preferences for annuities meant she typically ignored offerings from affiliated Prudential Insurance -- even though the deals offered high commissions. Now, she says, Prudential's top-flight credit standing has become more important than interest rates. A Prudential Insurance spokesman confirms that inquiries for products have noticeably accelerated since Executive Life's collapse in April.

Risky investment hasn't hurt property/casualty companies as much as their inability to profitably underwrite risk. Property/casualty companies have far smaller investment portfolios than life insurers and tend to invest in short-term, easily salable securities. That is because property/casualty companies pay out money in claims soon after collecting it.

Still, property/casualty companies haven't escaped unscathed in recent years. That is primarily because prices on policies haven't kept up with payments on claims. Annual increases in premiums have trailed annual increases in claims every year since 1987, according to the Insurance Information Institute. Quarterly earnings for the industry peaked in 1988 and have slid since, according to Kidder Peabody & Co.

There are myriad cries of distress. But just as distress may make life insurance companies and clients more prudent about investments, distress typically makes property/casualty insurers more prudent about what they charge for taking risks. The second-quarter earnings report of AVEMCO, the Frederick-based insurer of small private airplanes known for its willingness to forgo business rather than do it at a loss, suggests that this may be occurring. During the second quarter, AVEMCO's business expanded -- the first time in more than four years.

"We're hopeful -- you have to be in this business," said AVEMCO's Chief Executive William Condon. "To say [the slide in pricing] is over is premature, but we have seen tremendous improvement in our ability to get business at our prices."

He added, "It doesn't mean it is completely behind us. We are very much a part of the commercial property and casualty business, and that business has had tough times, particularly aviation. But this is probably the bottom."

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