Search Results for “life insurance”

Avoid Indexed Life Insurance Products

Posted on 8 July 2015 by David Merkel

Everyone reading should know that I am an actuary, as well as a quant and a financial analyst. ?Math is my friend.

Math is not the friend of many of my readers, so I usually don’t bother them with the math. ?Tonight’s post will be no different. ?It stems from my time of creating investment strategies for what was at that time a leading indexed annuity seller.

What is the return that you get from an indexed annuity? ?It is the return from index options, subject to a certain minimum return over a 7-15 year period. Now, on average, what is the return you get from buying any fairly priced option? ?You get the return on T-bills plus zero to a slight negative percentage. ?So, if the option premiums paid are cumulatively greater than the guaranteed minimum return, the product should return more than the minimum on average — but likely not much more on average.

Why is that? ?Options are a zero sum game, and usually there is no inherent advantage to the buyer or seller. ?There are some exceptions to this rule, but it favors at-the money option sellers, never buyers.?Buying options is what happens with?indexed annuity products.

Now, over any short amount of time, like 5-10 years, you can get very different results than the likely average. ?That doesn’t affect my point. ?With games of chance, some get get good outcomes, and other get bad outcomes.

Now, the indexed product sellers will tell potential buyers that they will never lose money if the market goes down. ?True enough. ? What they don’t tell you is that over the long haul, you will most likely earn more investing in one of Vanguard’s S&P 500 funds or even their Balanced Index Fund. ?You may even earn more investing in their high yield fund, or even their bond market index fund.

In exchange for eliminating all negative volatility, you end up getting very modest interest credits, while still being exposed to the credit risk of the insurance company. ?In an insolvency, your policy will be affected. ?The state guaranty funds will likely protect you if your policy is underneath the coverage limits, but still it is a bother.

Add to that the illiquidity of the product. ?Yes, you can cash it in at any time, do 1035 exchanges, etc., but before the end of the surrender charge period you will pay a fee that compensates the insurance company for the amortized value of the large commission that they paid the agent that sold you the policy. ?For most people, the surrender charge psychologically locks them in.

Thus I say it is better to be disciplined, and buy and hold a volatile investment with low fees over time, rather than own an indexed annuity that will tend to lock you in, and deliver lower returns on average. ?That’s all, aside from the postscript.

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Postscript

How does an insurance company make a profit on an indexed annuity? ?They take the proceeds of the sale, pay the agent, and use the rest to invest. ?About 90% of the money will be invested in a bond that will cover the minimum guarantee. ?The remainder will buy option premiums — the amount of money that gets applied to that is close to the credit spread on the bonds less the insurance company’s fees to pay the costs of the company and?a charge for profit. Not a lot is typically left in a low yield environment like this. ?The company tries to buy the most attractive options that they can on a limited budget. ?Inexpensive options typically imply that most will finish out of the money, and/or when they do finish in-the-money, the rewards won’t be that large.

What Life Insurance to Buy?

Posted on 25 January 201425 January 2014 by David Merkel

Another letter from one of my readers:

Hello 🙂

I am reaching out to you because you are among the “Got To Guys” in your industry

I am doing an “expert” and “common man” round up on my blog and I think a lot of people including me will benefit from your expert advice

?I will publish a detailed post in about 10 days and will obviously mention your blog along with a link back to your website. I will also be adding a custom infographic related to the topic of discussion and reach out to journalists when I am ready with my post.

I just need few minutes of your time to answer TWO questions mentioned below:

?If you can tell me:

“If you had to buy life insurance at current age, which policy would you buy? and which company will be your choice?”

I appreciate your time and it will be a favor if you reply back.

There are only two reasons to buy life insurance. You can:

Protect your loved ones after your death.
You can scam the taxman.

If you are young, the first reason predominates.? In order to do that, long-dated term insurance will do the trick.? Insure yourself for 20-30 years, and over that time, build your assets so that at the end of the life insurance policy, your heirs will not need the insurance.? And neither will you, should you survive.? That is what has happened to me.? I have no life insurance — instead, I have assets.? Should I die, my family will survive without my wife having to go to work, intelligent lady that she is.

(She doesn’t have a financial bone in her body, she is a princess, as her father was well-off.? She has lived with me long enough to absorb my prejudices, and grasp that there are no easy pickings in markets, so avoid those with get rich quick ideas.)

If you are old and wealthy, the second impulse is important.? How do you send money to heirs, away from the taxman?? Life insurance in the US is outside of the estate.? A large insurance policy can take assets that would be taxable to an estate, and move them outside of the estate.

As an aside: estate taxes are stupid.? The intelligent wealthy don’t pay them, or pay little of them.? The wealthy have a phalanx of helpers who they hire to reduce their estate (and other) taxes.? It would be far better to tax everyone as traders, and capture income taxes when they are really earned.

As to your second question: what insurance company to buy from?? If your policy is small, it doesn’t matter.? If your company fails, the state guaranty association will pick up the remainder.? If your policy is large, buy from the highest quality companies, you don’t want to deal with the guaranty associations after a default.

On Credit Quality in Life Insurance

Posted on 17 August 201318 August 2013 by David Merkel

When I was 20+ years younger the new chief actuary of a subsidiary I was in came and told me his tale of woe.? At a prior company he had worked for, the company had terminated the defined benefit pension plan, and went to a low-credit quality insurer to purchase annuities to match the terminated benefits.

His complaint was that he had no say in the matter.? With ordinary debt agreements, the debtor has no right to assign his debt to another debtor, without the assent of the creditor.

In the same way, those that buy policies from insurance companies run the risk that their policies could be sold to a weaker insurance company.

20+ years ago, my friend said there was a simple solution, and I agree with it.? When a financial company takes over the liabilities of another financial company, those who have lent to the original company should have the right to receive their assets back at full value, with no deductions for surrender charges, etc.

This is basic.? Debtors should not be able to assign debts to another party, without the assent of the creditor.

I have seen the same thing recently in this article, as aggressive life insurers buy up policies of less aggressive life insurers.? Those insured should have a way out, as the creditworthiness of the insurer has gone down.

I am arguing that life insurers should not be able to sell their liabilities without the insured having an option to cash out at full value.? I realize that this would limit valuations among life insurers, but so what?? The basics of what is fair in debtor/creditor relations should prevail.? Big insurance companies should not have a different set of rules than would be common to other debtor/creditor relationships.

Using Life Insurance Products to Fund Long-Term Needs

Posted on 30 April 2013 by David Merkel

I have noted recently a number of advertisements offering risk-free investing.? When I dig into them, they are selling life insurance and annuities.? They claim high rates of return with virtually no risk.? Here are the problems:

Life insurers have come off of 3+ decades of falling interest rates, portfolio yields are high relative to what you can get in the market today.? Some insurers may show above average rates, but if enough take advantage of them, the rates will fall to market levels.
Commissions to agents are relatively high, which has two effects: 1) less investment performance goes to the insured, and more to the agent, and 2) High surrender charges.? If you ever need your money in full, you will never get it back from an insurance contract.
People have forgotten the 1970s, with rising interest rates, where many insurers were near bankruptcy, and on a market value basis, many were technically bankrupt.
Life insurers that have written a lot of variable business or a lot of indexed business have taken on a lot of hidden equity risk.? Imagine a Great Depression scenario, where equities fall 90% over 3 years, and it takes 20 years more for values to recover.? Guess what?? Virtually all of the life insurance industry dies, whereas most survived the Great Depression.
From Mutual Insurers, life insurance dividends are not guaranteed.? In a real crisis, dividend scales could drop to zero.? The insurance you thought was free regains a price.
Equity indexed products rarely return well.? When I analyzed them back in the early 2000s, T-bill yields were the result of my models.? Today, T-bill yields are so low that the returns must be better.? That said, you will have to accept low returns versus a long surrender charge.

Insurance is meant for protection, not savings.? It is also meant for scamming the tax man, especially with respect to estate taxes.

Just be wary here, I’m not naming names, because many of these parties are litigious, another sign of weakness.? But there is no “one size fits all” method for Wealth Management.? One of my clients recently complimented me because I don’t try to get all of the assets of a client.? Indeed, I want my clients to feel that they have chosen me for their purposes.? I do not want them to allocate more to me than they are comfortable allocating.

So, be aware of the limitations inherent in life insurance products.? And when you hear that something is virtually risk-free, take a step back and hold onto your wallet.? Nothing is risk-free.? Even with the guaranty funds backing the insurers, the full value of large policies is not guaranteed, much like large depositors in the banks.

The regulation of the solvency of life insurers has been better than that of banks for the last 30 years, but it hasn’t been perfect.? I was on the takeover team that tried to have AIG to take over the Equitable.? AXA overbid, and bought a bad situation just as it was about to turn.

As for AIG, some of those promoting insurance products say that AIG’s life insurance subsidiaries did not need a bailout in the crisis.? That was false, because of the securities lending agreements, and a few other things.? Most of the domestic life companies of AIG received bailout money.

The good record of life insurance lack of default over the last 30 years is the result of three things:

Falling interest rates
Better solvency regulation than banks
AIG’s life insurance subsidiaries were bailed out.

Be diversified, and don’t use just one set of entities to fund your retirement.? Using only insurers runs a lot of regulatory and taxation risk.? A future government may find clever ways to undo the clever tax avoidance that has been achieved there so far.? Spread your regulatory risk.? If you are wealthy enough, spread out your country risk, but be wary as you do so.? Who will support the rule of law better than the US?? Where will governments not tap assets under custody in a crisis?? Remember Cyprus.? It will not be the last place where assets are expropriated for the good of locals, even if locals got hurt as well.

Problems in Life Insurance

Posted on 4 December 2012 by David Merkel

I am not an FSA, but I am an actuary.? That said, I am not presently practicing inside a life insurance company, so as I write this, there may be some things that I get wrong.

There are two areas that concern me in life insurance accounting at present.? The first is that there is no good way to estimate the reserves for products that have secondary guarantees.? Yes, many actuaries can create models to try to estimate what the reserves should be.? But when you are dealing with variables that are less than predictable ? withdrawal assumptions, investment performance, etc., the results are often less good than desirable.

As a result, there have been reinsurance deals done to eliminate or reduce the formulaic reserves on secondary guarantees.? As a former boss of mine at AIG liked to say, ?I drop my deficiency reserves in the Atlantic Ocean.?? In other words, a Bermuda reinsurer with weaker reserving standards would absorb the secondary guarantee risk, even if it was another AIG subsidiary.? The same can be done through securitization and Special Purpose Vehicles.

Two articles on the topic:

But here is the more recent problem: allowing insurance companies to use their own models for reserving.? If the results of banks using the Basel Standards were bad, this has the potential to be worse.

You want all setting of reserves/accruals in financial companies to be conservative, and not manipulable by the companies, lest solvency be compromised.

When I was active in pricing, reserving, and cash flow modeling, I felt I had some of the best modeling out there, because most actuaries don?t understand complex regression models, and the components of investment return.

But I would never use my models to set the reserves.? That goes too far.

You don?t want to hand over reserving rules to one hired by the company, no matter how ethical he might be.? That way lies disaster.? There are always subtle pressures put on actuaries to be less conservative, because companies face pressure to show good earnings in the short-run.

Think of the mostly European quants, accountants and actuaries using the Basel standards.? Giving them the authority to set their own reserves for credit using internal models led to setting the reserves too low.? You want to have checks and balances.? You don?t want to have players serving as their own umpires.? So what if the statutory standards are too tight?? That just means earnings will be delayed, not eliminated.? Risk margins should be received as earned, and never capitalized.? Besides, the current crisis shows us that we never truly understand the parameters of the distribution.

Now, the rules in question are Statutory rules, affecting solvency, but not earnings, which come from GAAP.? What Statutory affects is the degree of solvency for subsidiaries, and the amount of free cash flow available to the holding company in the short-run.

This gives a lot of flexibility to management teams, and there is a lot more room to be liberal or conservative in terms of overall leverage policy.? In the short run, there could be a self-reinforcing cycle driving up the prices of life insurers as the less conservative buys the more conservative, resets their reserves, and uses the excess cash flow in the short run to acquire more companies.

Now for three quotations from this Wall Street Journal article on the topic:

Critics of the plan say they fear insurers will go overboard in their effort to placate investors who have grumbled for several years about subpar returns, draining the industry of reserves that could be needed in future financial crises. Many publicly traded life insurers are struggling to post the midteens returns on equity that shareholders want. Analysts say it is too soon to calculate how the new method will filter through to returns.

“This a significant and historic vote for the NAIC, moving forward on a substantive change in policy,” said Thomas Sullivan, a partner with PwC’s regulatory advisory business, and a former Connecticut insurance commissioner.

Once insurers can free up capital, “you could see more competitively priced products to consumers and/or improved financial flexibility for insurers,” Mr. Sullivan said.

Others are less optimistic. The move to principles-based reserving “is one of the most important developments in the history of life insurance,” said Joseph Belth, a professor emeritus of insurance at Indiana University and editor of the Insurance Forum. “Future generations of executives, regulators and consumers will have to deal with the financial carnage.”

Benjamin Lawsky, superintendent of the New York Department of Financial Services, had urged fellow regulators to vote no in a letter dispatched last week.

“The insurance industry weathered the financial crisis well precisely because of the careful reserving state regulators have historically required,” Mr. Lawsky said Sunday. “To ignore the lessons of the financial crisis and deregulate the industry, allowing them to keep less in reserves, is unwise.”

Listen to the New York Department of Insurance, which is the giant among pygmies.? They understand insurance regulation, versus most of the others states that don’t, who don’t deserve? a vote.? Listen to Joe Belth, who has fought against all manner of insurance frauds.? He deserves to be listened to as an elder statesman, unlike many others who think loosening up standards will produce some great outcome.

Principles based reserving will be less transparent than current standards.? Think of it this way.? Under the old rules, everyone was using the same algorithm.? You could ask questions about the inputs to it, and whether they were reasonable.? Under the new rules, regulators not only have to ask questions about inputs, but about the algorithms.? I can tell you from my experience, New York and the large states will be challenged trying to regulate that.? The small states?? They can’t even handle the present standards.

Now, it is not a done deal that these standards will come into existence.? Note from this article:

With the adoption of the Valuation Manual and prior approval of revisions to the Standard Valuation Law, the NAIC and Academy can present this as a package to state legislatures for consideration in early 2013. This package must be approved by 42 jurisdictions that represent states in which at least 75 percent of direct premiums are written before PBR takes effect. ?

Both New York and California are against this, and they have 18% of the market.? 8% more against, and this is dead.? Also, I know from my own forays back in 2000, when I led the effort to modernize Maryland’s life insurance investing code that it is very difficult to convince legislators to adopt new standards that they don’t understand.? I succeeded, and mainly because I was able to explain how excesses would be curbed.? With this legislation, I have no idea how you pitch it, aside from the braindead “More flexibility is good for the life insurance industry,” pitch.

I do not stand behind the American Academy of Actuaries.? I was a member of that for years, but I do not see them as promoting the good of all, but only that of the insurance/benefits industries.

Two more articles:

And to put my money where my mouth is, I am willing to testify against this legislation in state capitols as needed.? Maybe I get the fun of going back to Annapolis, but where else might I go?

On Life Insurance and Life Reinsurance

Posted on 30 July 2012 by David Merkel

I get good questions from readers.? Here’s one from this post:

Is there a reason why life reinsurance companies are better positioned then life insurers?

Don?t they face the same problems that they won?t be able to generate as they roll their portfolios into lower yielding bonds going forward (since rates have come down so much)?

Basically just wondering why you think RGA is cheap at 84% of AOCI adjusted book but not the rest of the life insurance industry at 35%-75% of tangible book?

Is it mostly due to your opinion of management?

I started to leave a reply and the normally reliable software glitched, and I lost it. Dejected, I decided to make it a post.

First, life reinsurance is much less competitive than life insurance.? Globally and in the US, the top 5 life reinsurers have ~80% of the market share.? Life insurance is far more fragmented, and has a decent slug of mutual insurers who don’t have an explicit profit motive.? (Note: many of the large mutuals are exceedingly well run, which makes the competition even stiffer.

Second, life reinsurance is mostly mortality exposure-based, versus life insurers which are mostly investment spread based.? The law of large numbers favors the life reinsurers over the insurers.? Low interest rates will not affect reinsurers as much as insurers.? Hint to those who analyze life insurers and reinsurers: look in the statutory statements, which have a lot more data than the GAAP statements for odd reserves that indicate a significant chance of losses if interest rates continue to remain low.

Third, life insurers have weaknesses in reserving practices for variable products with secondary guarantees.? There is no good way to calculate what a proper reserve should be.? The implied options are odd, and have no natural hedges.

That’s why I only own one life insurance company; one that has simple products.? Aside from low interest rates, valuations are low at life insurers because of lack of certainty over reserves.

So, much as I like RGA management, they are not the main reason why I like the company.? RGA executes well, and has an excellent reputation in its industry.

Here’s another question that I received via e-mail:

Prices of financial services stocks are too cheap for me to resist these days. ?I see companies like Citigroup as being just given away by Mr. Market.

?Within insurance, my equity exposure is limited to AIG, which I consider to be well managed, misunderstood, and priced attractively enough to continue holding. ?Over the past month other insurers have started to grab my attention (HIG, MFC, MET, PRU). ?HIG stands out as being the least sensitive to the possibility of a decade of financial repression. ?Do you have any favorites that you would care to share? ?This topic could make for a timely blog posting.

I responded:

Value trap.? Focus on sustainable ROEs that will validate book value.? The accounting of AIG is a quagmire, even after their disposals.

There is a further difficulty with life insurers at present.? The GAAP accounting standards do not fairly reserve for secondary guarantees on insurance and annuity policies; truth, as a life actuary and a financial analyst, the options offered are so complex and long-dated, that I?m not sure there is a way to value them.? Over the last 10-20 years, we knew that this could be an issue, but we are now seeing the issue creep in as stock performance ebbs.

But if you disagree, consider PNX, it has all of the issues, and then some.? Be sure to get the Statutory books of the companies you buy here, because that drives dividend payments to the indebted holding company.

And one more e-mail:

Hi David,?? I have enjoyed reading your blog for many years (even before GGG recommended it)

I have two questions for you about insurance companies in general — I know you are very busy, I am just hoping you can point me to some websites where I can do my own homework.

(1) If I want to check the financials of a number of mutual insurance companies, is there a consolidated source??? Do I need to pull the annual statements of each one and are the different state accounting rules comparable?

(2) As I understand it (and I am quite new to this so I may have this wrong) — mutual insurance companies use “statutory accounting”, which is different from US GAAP.??? Is there a website or library book that explains the differences between these two methods????? Does statutory accounting differ from state to state?

Again, I am sure you are very busy and I will have to do my own research / homework.? You seem to be more knowledgeable than most about insurance accounting, and I am hoping you can point me to some documentation that will help me gain a better understanding.

My response:

1a)? Consolidated source: https://eapps.naic.org/insData/ , but most companies will send it to you if you ask.? Haven?t been turned down yet, aside from Berkshire Hathaway? and I?m working on that.

1b) Generally, you have to pull each one.? Some companies will do a combined set of schedules for their investments.? When I got AIG 3 years ago, there were 60+ books?

1c) There are slight differences by state, but most of the time you can neglect that.

2a) Mutual companies use statutory accounting, but so do stock companies for the state?s analysis of insurance subsidiary solvency.? And, though stock companies use GAAP for reporting to shareholders, many mutual companies will have an internal pseudo-GAAP basis for analyzing long-term profitability, and for management bonuses, yeh.? Statutory accounting is in some ways more critical than GAAP even for stock companies, because that determines how much cash can be distributed to the holding company, which is crucial if the holding company needs to make interest payments, or wants to make dividend payments.? This is one reason why actuaries often price products by calculating marginal distributable earnings.

2b) I have attached what I think is a short primer on GAAP vs Stat accounting.? This is a big topic, and the NAIC sells all manner of resources at high prices with all of the gory details.? This should give you a good start.? I general, the volunteers from the actuarial societies put out some good summary stuff, but you have to hunt for it.

Keep fighting the good fight.? Bloggers are the conscience of Wall Street and DC?

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Life insurance is tough because there is uncertainty on claim payment on timing, and uncertainty of investment earnings.? The latter is usually more serious, because the law of large numbers does not help.? Add in the valuation issues, and now you know why a life actuary primarily invests in P&C insurance companies, life reinsurers, and simple life companies.

Full disclosure: long RGA

Two Reasons for Life Insurance

Posted on 10 January 201210 January 2012 by David Merkel

A reader wrote to me:

I periodically read your blog and it seems like you have a strong grasp of the insurance industry. ?As well, given your background as a life actuary I imagine you might have some valuable insights on whole-life products. ?I am having a baby in the late spring and have been considering the right composition of my life insurance coverage (term vs. whole life), and have thus far had a lot of trouble making sense of the whole life math and why it is a compelling option for me. ?I have received quite a lot of data from an insurance broker with the IRR’s, cash surrender values at different periods, etc., but unfortunately can only get this data in PDF form without really understanding the assumptions behind how the cash surrender value grows, or how the dividends get calculated. ?In short, I have been unable to come to a more developed thesis than the idea that whole life is just a way to lock yourself in to a middling return while the insurance company benefits from your float and makes a spread off you, while taking insurance company credit risk for decades, with some benefit in the ability to pass down a decent amount of money tax free to one’s kids when they die. ?

How do you view whole life, do you own any yourself? ?If so, I’d love to understand your logic. ?I recently re-read part of Buffett’s 94 letter in which he states how he buys whole life policies from people about to stop paying premiums for more than the cash surrender value and can only surmise that somehow at the point he is buying them there is probably a higher IRR than in the beginning of the policy (which makes sense given the math I have seen.) ??

I am skeptical because I can’t figure out the answer, which makes me not inclined to lock myself in to a life-long financial commitment with an institution that might not be around in 70 years.

For most of my life, I have had term insurance.? It was cheap, and protected my wife against an untimely death of me when we were less-than-well-off.? At present, we are uninsured on my life because my wife has enough assets that if I die, she can fund the educations of the remaining kids, and live thereafter, with perhaps some work on her part.? She’s really bright, but who would be smart enough to hire her?

In general, I think it is smart for young people to buy 20 or 30-year term insurance.? It takes care of the period where your family is most vulnerable.? You get coverage when you are young and healthy, because you don’t know what tomorrow will bring.? Then save and invest to build up assets to meet the needs you may have when the term policy runs out.? If you still need insurance at that point, and are healthy, get underwritten again for a new policy.

There is one place where a whole life policy can make sense. Sometimes mutual insurers use a portfolio method for interest rate crediting. In an environment like this, where interest rates have fallen so much, that means they are crediting to new money the same rate that they are getting old money. That is quite a bonus, so if you can find that, it may prove to be cheaper than getting a long term insurance policy.

As for the second reason to buy life insurance, it is one of the most enduring ways to scam the taxman.? Death benefits are not taxed by the states or the federal government, and unless the person dying was the policy?s owner it is immune from estate tax.

This creates a wide number of vehicles that wealthy people use together with annuities and trusts to transfer wealth out of their estate, and into death benefit proceeds that will pass to their heirs outside their estate.

This is one reason why I believe the estate tax has to go. It does not accomplish its stated ends. The wealthy find all manner of clever ways to escape it. It would be far better to eliminate the ability to shelter income from taxation while they are living. Besides, the government needs the money now.

Closing Points

?First, don’t worry about the credit risk, within limits, the state guarantee funds stand behind the insurance companies. For most people that should be enough.

Second, as for Buffett buying life policies, this is done only when an investor buys a policy from someone who is expected to live less long than the actuarial tables would’ve predicted at the time of policy issuance. The policy is more valuable than the cash surrender value; the investor attempts to make money off the difference.

This is a controversial area, and I am generally against the practice. It should not be legal; it endangers the tax favored status of life insurance, because it allows people without an insurable interest to benefit from the proceeds of life policy. That said, the market would go away if insurers were willing to deal more favorably with those who have impaired lives, and want to cash out their insurance policy.

Third, I have run into really advanced methods for scamming the taxman that involve asset-backed securities, trusts, and what else? Life insurance. In general, I think the U.S. Treasury should use their anti-abuse rules in order to invalidate these transactions, because they lack true economic purpose. That is, even if they are structured in such a way as to give the appearance of economic purpose, there is no reason that a businessman in his right mind would structure the business in that way, except to avoid taxes.

Finally, remember that the agent has a different motive than you. He wants to earn a commission. Commissions are low, and prices are easily comparable on term policies. There are services that will even do the comparison for you. The only way that an insurance agent will earn high commission is by selling a policy that is complex, not comparable to other policies, and builds up assets. The insurance company pays a high commission on such policies because they can earn investment returns off of the excess premiums that you pay in relative to a term policy.

Personal Finance, Part 3 — Buy The Life Insurance You Need

Posted on 6 November 2007 by David Merkel

Sorry that my posts have become more terse and less frequent.? A large part of that was recent computer troubles, which have largely been rectified.? I highly recommend the program and advice on this webpage if your computer is running slow.? Beyond that, I have had internet outages (thank you Verizon), and my efforts at obtaining long-term investors for my strategies have eaten up a lot of time.

Tonight’s post deals with life insurance.? My main advice: buy what you need, not what someone wants to sell you.? What most people need is protection for their loved ones from untimely death, which can be satisfied by term insurance.? Now, some wealthy people with complex estate planning needs can benefit more from other forms of life insurance, but that’s not common.? Also, people who aren’t so healthy can benefit from permanent insurance through an agent, because that may be the only way that they can obtain coverage on a reasonable basis.

Why do I favor term insurance?? It’s cheap.? It’s cheap because it is easy to compare the features of various policies against each other to find the best price.? But what if some company that is lower quality offers the best price?? The state guaranty funds stand behind the insurance companies, and no one has failed to receive a death benefit on a timely basis as a result.? (Note: agents are not allowed to tell you this, because the states don’t want lower quality companies to gain a marketing advantage by mentioning the guaranty funds.)

Term insurance offers another advantage: re-underwriting.? If after ten years, you are still in good shape, and you still need insurance, apply for a new policy at a lower rate over the same remaining term as your old one.? If you can get one, buy it and cancel the old policy.? If your health is not so good, keep paying premiums on the old policy.

Where do you buy the insurance, then?? Google the phrase “term insurance,” and a variety of comparison services will pop up.? Try a few of them, and buy from the cheapest.? The younger you are, the longer the term you should buy for, because the far-out years are cheaper.? The older you are, stick to ten years at most.

A few final points: don’t buy policy riders; they are an expensive way to obtain insurance.? Also, don’t buy convenience insurance policies that offer token amounts of insurance; they are expensive also.? Last, don’t scrimp on the amount of coverage.? Few people are overinsured when it comes to life insurance; 5-10x your salary is pretty standard, but analyze how much your loved ones will need in your absence, and buy that much coverage.

Flavors of Insurance, Part II (Life)

Posted on 5 December 2010 by David Merkel

Life insurance probably has the most complex accounting of any of the sub-industries. Part of this comes from the complexity of the contingencies underwritten, and most of the rest from producer compensation and the length of the contracts underwritten.

Life insurance and annuities are sold, not bought. In general, people have a mental bias toward thinking that they aren’t going to die in the immediate future. Annuities are often sold to people who won’t otherwise plan for their retirement. To overcome those biases, life insurance companies pay agents handsomely to originate policies. The commission is large enough that if the company expensed it, it would lose money on a GAAP basis every time it issued a policy. That’s why policy acquisition costs are deferred, set up as an asset, and amortized in proportion to the gross profitability of the business over the life of the business.

Reserving for term policies isn’t very complex, but reserves for cash value policies are set as the expected present value of future benefits less future premiums. Small changes in interest, mortality, and lapse rates can make large changes to reserve values. Other contingencies can affect different classes of policies as well; variable and indexed contracts rely on returns of the stock and bond markets. Higher assets under management mean higher fees.

There is a second business that most life insurance companies engage in. Since the companies would not be profitable if they invested in Treasury securities, they typically invest in corporate bonds, mortgage-backed securities, and other risky forms of debt. Some also invest in commercial mortgages and real estate. When there is stress in the credit and mortgage markets, life insurance companies do poorly.

In reviewing the performance of life companies as group from March 1994 through March 2004, one can see the effect of the major drivers of profitability. Underwriting was typically profitable for companies throughout the entire decade, so that was not a differentiating factor. Most of the shifts in profitability came from investment results. The credit cycle was generally positive to the beginning of 1999, negative 1999-2002, and positive after that. The equity market supported variable life and annuity writers until the bull market peak in March 2000, punished them until March 2003, and has rewarded them since then. The only period that deviated from this description was after the bubble popped in March 2000; life companies temporarily did better as equity investors fled technology stocks for the safety of stodgy sectors like life insurance.

The outlook for life insurance is no different than the past; it is tied to the outlook for the asset markets. If the credit and equity markets do well, so will life companies.

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Bringing it to the Present

Many of the things that I wrote back in 2004 regarding life insurers have proved prescient.? Life insurers have prospered as the asset markets have prospered, and suffered during the bear markets. On average, life insurers have done better than other financials, and better than the market as a whole since 2004.

One advantage the life insurers had 1999-2003 was that they got burned on CDOs and did not get caught in the bubble.? Even with other types of structured lending, life? insurers got more conservative 2003-2005, unlike most of the rest of the financial sector.? Life insurers noticed the poor underwriting, and stayed away.

It should be noted that there are life insurers that do a lot of variable business, and those that don’t.? Those that write a lot of variable life and annuities will be more sensitive to the stock market than those that don’t write a lot of variable business.

One final squishy spot: secondary guarantees.? With Universal Life and Variable Annuities, there are secondary guarantees where the reserving is questionable.? Also true of long-dated term policies… be aware that there might be some bombs lurking there, that will manifest in severe economic scenarios.

At present, I don’t own any pure life insurers.

Against Insurance Groups [AIG]

Posted on 22 July 202122 July 2021 by David Merkel

Photo Credit: Mindy Georges || The umbrella belongs to Travelers

This is a bug in my bonnet, and I have written about this for at least 13 years, and maybe as long as 16 years, but insurance conglomerates don’t work well. After suggesting at least three times that AIG should break itself up, we are finally to the last stage of it doing so.

There is a saying in the industry “Life Insurance is sold, P&C Insurance is bought.” They are different markets, and there is no reason for shareholders to own a company that does both. But some companies diversify. Who does that benefit?

The main beneficiary is the management, as it gives them cover for underperformance. They can always blame transitory factors for underperformance of one division or another.

And much as Hank Greenberg blamed his successors for the failure of AIG, the main cause of longer-term underperformance stemmed from the purchases of SunAmerica and American General at high prices.

AIG was highly profitable in 1989 with its foreign and domestic P&C operations, and its foreign life operations. What should it have done with its profits?

It should have paid a higher dividend, bought back stock, and shrunk the company as many other successful insurers have done. Companies is mature industries should return capital to shareholders.

Big companies develop a culture, and it makes them less willing to change. That was true of AIG. Hank Greenberg should have eliminated all life companies early on, and run a domestic P&C company with high underwriting standards. Then maybe it would not have had to rely on Berkshire Hathaway to reinsure them.

Just as GE has suffered, so has AIG. Both CEOs were lionized, then despised. The main idea to take away from this is conglomerates where businesses have different sales models don’t work.