Search Results for “life insurance” – Page 2

Getting a Job in Insurance

Posted on 7 March 2018 by David Merkel

Well, I never thought I would get this question, but here it is:

Thank you for your dedication to your blog.

I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions?

Thank you for your time.

Kind regards,

There are many things to do in insurance.? Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.? Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.? Then there are the drones in customer service and claims.? Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions.

Before I begin, I want to say a few things.? FIrst, if you work in insurance, be kind to the drones and helpers.? It is the right thing to do, but beyond that, they don’t have to go beyond their job description — they know their opportunities are limited — it is only a job.? Treat them with respect and kindness, and they will go above and beyond for you.? I learned this positively first-hand, and a few of them 20-30 years older explained it to me when I noticed they weren’t helping others who were full of themselves.

Second, the insurance industry does a lot to train drones, helpers, agents, marketers, underwriters, and younger people generally, if they are willing to work at it.? There are self-study courses and exams that vary based on what part of the industry you are in.? Take the courses and exams, and your value goes up — it is not obvious how that will work, but it often pays off.

Third, it is not a growing industry, but lots of Baby Boomers are retiring, and leave openings for others.? Also, drone and helper positions often don’t pay so well at the entry level, and turnover is somewhat high.? The same is true of agents — more on that later.

Fourth, watch “The Billion Dollar Bubble,” and episodes of Banacek if you want.? The actual practices of how they did things in the ’60s and ’70s don’t matter so much, but it gets the characterization of the various occupations in insurance right.

FIfth, insurance is a little like the “Six Blind Men and the Elephant.”? Actuaries, Accountants, Administrators, Marketers, Underwriters, and Investment Managers (and Lawyers and Programmers) each have a few bits of the puzzle — the challenge is to work together effectively.? It is easier said than done.? You can read my articles on my work life to get a good idea of how that was.? I’ve written over 30 articles on the topic.? Here are most of the links:

DId I leave out the one on insurance company lawyers?? Guess not.

Sixth, it is easier to teach those with technical skills how the business works than to teach drones and helpers technical skills.? It’s kind of like how you can’t easily teach math and science to humanities and social science majors, but you can do the reverse (with higher probability).? It is worth explaining the business to computer programmers.? It is worth explaining marketing and sales to actuaries.? Accountants get better when they understand what is going on behind the line items, and maybe a touch of what the actuaries are doing (and vice-versa).

Seventh, only a few of the areas are close to global — the administrators, the underwriters, the actuaries, and the marketers — and that’s where the fights can occur, or, the most profitable collaborations can occur.

Eighth, insurance companies vary in terms of how aggressive they are, and the dynamism of positions and ethical conundrums vary in direct proportion.

So, back to your question, and I will go by job category:

Drones and helpers typically don’t need a college education, but if they show initiative, they can grow into a limited number of greater positions.
Computer programmers probably need a college degree, but if you are clever, and work at another insurance job first, you might be able to wedge your way in.? While I was an actuary, I turned down a programming job, despite no formal training in programming.
Lawyers go through the standard academic legal training, pass the bar exams, nothing that unusual about that, but finding one that truly understands insurance law well is tough.
Accountants are similar.? Academic training, pass the accounting exams, work for a major accounting firm and become a CPA — but then you have to learn the idiosyncrasies of insurance accounting, which blends uncertainty and discounting with interest.? The actuaries take care of a lot of it, but capturing and categorizing the right data is a challenge.
Actuaries have to be good with math to a high degree, a college degree is almost required, and have to understand in a broad way all of the other disciplines.? The credentialing is tough, and may take 5-10 years, with many exams, but you often get study time at work.
Agents — can you sell?? Can you do a high quality sale that actually meets the needs of the client?? That may not require college, but it does require significant intelligence in understanding people, and understanding your product.? Many agents can fob some bad policies off on some simpletons, but it comes back to bite, because the business does not last, and the marketing department either revokes your commissions, or puts you on a trouble list.? “Market conduct” is a big thing in insuring individuals.? The agents that win are the ones that serve needs, are honest, and make many sales.? Many people are looking for someone they can trust with reasonable returns, rather than the highest possible return.? One more note: there are many exams and certifications available.
Marketers — This is the province of agents that were mediocre, and wanted more reliable hours and income.? It’s like the old saw, “Those who cannot do, teach. Those who cannot teach, administrate.”? It is possible to get into the marketing area by starting at a low level helper, but it is difficult to manage agents if you don’t have their experience of rejection.? Again, there are certifications available, but nothing will train you like trying to sell insurance policies.
Underwriters — as with most of these credentials, a college degree helps, but there is a path for those without such a degree if you start at a low level as a helper, show initiative, and learn, learn, learn. Underwriters make a greater difference in coverages that are less common.? Where the law of large numbers applies, underwriters recede.? The key to being an underwriter is developing specialized expertise that allows for better risk selection.? There are certifications and exams for this, pursue them particularly if you don’t have a college degree.? Pursue them anyway — as an actuary, I received some training in underwriting.? It is intensely interesting, especially if you have a mind for analyzing the why and how of insured events.
Investment personnel — this is a separate issue and is covered in my articles in how one can get a job in finance.? That said, insurance can be an easier road into investing, if you get a helper position, and display competence.? (After all, how did I get here?)? You have to be ready to deal with fixed income, which? means your math skills have to be good.? As a bonus, you might have to deal with directly originated assets like mortgages, credit tenant leases, private placements, odd asset-backed securities, and more.? It is far more dynamic than most imagine, if you are working for an adventurous firm.? (I have only worked for adventurous firms, or at least adventurous divisions of firms.)? Getting the CFA credential is quite useful.
Administrators — the best administrators have a bit of all the skills.? They have to if they are managing the company aright.? Most of them are marketers, and? a few are actuaries, accountants,or lawyers.? Marketing has an advantage, because it is the main constraint that insurance companies face.? It is a competitive market, and those who make good sales prosper.? VIrtually all administrators are college educated, and most have done additional credentialing.? Good administrators can do project, people and data management.? it is not easy, and personally, few of the administrators I have known were truly competent.? If you have the skills, who knows?? You could be a real success.

Please understand that I have my biases, and talk to others in the field before you pursue this in depth.? Informational interviewing is wise in any job search, and helps you understand what you are really getting into, including corporate culture, which can make or break your career.? Some people thrive in ugly environments, and some die.??Some people get bored to death in squeaky-clean environments, and some thrive.

So be wise, do your research, and if you think insurance would be an interesting career, pursue it assiduously.? Then, remember me when you are at the top, and you need my clever advice. 😉

A Failure of Insurance Regulation

Posted on 17 December 2016 by David Merkel

Credit: Bloomberg || Graph of Penn Treaty’s stock price 2002-2009

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I wrote about this last in October 2009 in a piece lovingly entitled:?At Last, Death!?(speaking of the holding company, not the insurance subsidiaries). ?I’m going to quote the whole piece here, because it says most of the things that I wanted to say when I heard the most recent news about Penn Treaty, where the underlying insurance subsidiaries are finally getting liquidated. ?It will be the largest health insurer insolvency ever, and second largest overall behind Executive Life.

Alas, but all good things in the human sphere come to an end.? Penn Treaty is the biggest insurer failure since 2004.? Now, don?t cry too much.? The state guaranty funds will pick up the slack.? The banks are jealous of an industry that has so few insolvencies.? Conservative state regulation works better than federal regulation.

Or does it?? In this case, no.? The state insurance regulator allowed a reinsurance treaty to give reserve credit where no risk was passed.? The GAAP auditor flagged the treaty and did not allow credit on a GAAP basis, because no risk was passed.? No risk passed? No additional surplus; instead it is a loan.? I do not get how the state regulators in Pennsylvania could have done this.? Yes, they want companies to survive, but it is better to take losses early, than let them develop and fester.

A prior employer asked me about this company as a long idea, because it was trading at a significant discount to book.? I told him, ?Gun to the head: I would short this.? Long-term care is not an underwritable contingency.? Those insured have more knowledge over their situation than the insurance company does.?? He did nothing.? He could not see shorting a company that was less than 50% of book value.

It was not as if I did not have some trust in the management team.? I knew the CEO and the Chief Actuary from my days at Provident Mutual.? Working against that was when I called each of them, they did not return my calls.? That made me more skeptical.? It is one thing not to return the call of a buyside analyst, but another thing not to return the call of one who was once a friend.

Aside from Penn Treaty, the only other company that I can think of as being at risk in the long term care arena is Genworth.? Be wary there.? What is worse is that they also underwrite mortgage insurance.? I can?t think of a worse combo: long term care and mortgage insurance.

The troubles at Penn Treaty are indicative of the future for those who fund long term care.? Be wary, because the troubles of the graying of the Baby Boomers will overwhelm those that try to provide long term care.? That includes government institutions.

Note that Genworth is down 60% since I wrote that, against a market that has less than tripled. ?If their acquirer doesn’t follow through, it too may go the way of Penn Treaty. ?(Give GE credit for kicking that “bad boy” out. ?They bring good things to “life.” 😉 )

Okay, enough snark. ?My main point this evening is that Pennsylvania should have had Penn Treaty stop writing new business by 2004 or so. ?As I wrote to a reporter at Crain’s back in 2008:

On your recent article on Penn Treaty, one little known aspect of their treaty with Imagine Re is that it doesn’t pass risk.? Their GAAP auditors objected, but the State of Pennsylvania went along, which is the opposite of how it ordinarily works.
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Now Imagine Re takes advantage of the situation and doesn’t pay, knowing that Penn Treaty is in a weak position and can’t fight back, partially because of the accounting shenanigans.
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It is my opinion that Penn Treaty has been effectively insolvent for the past four years.? I don’t have any economic interest here, but I had to investigate it as an equity analyst one year ago.? Things are playing out as I predicted then.? What I don’t get is why Pennsylvania hasn’t taken them into conservation.

Another matter was that Imagine Re was an Irish reinsurer, and they have weak reserving rules. ?That also should have been a “red flag” to Pennsylvania. ?The deal with Imagine Re was struck in late 2005, leading to upgrades from AM Best that were reversed by mid-2006.

It was as if the state of Pennsylvania did not want to take the company over for some political reason. ?Lesser companies have been taken over over far less. ?Pennsylvania itself had worked out Fidelity Mutual a number of years earlier, so it’s not as if they had never done it before.

Had they acted sooner, the losses would never have been as large. ?I remember looking through the claim tables in the statutory books for Penn Treaty because the GAAP statements weren’t filed, and concluding that the firm was insolvent back in 2005 or so. ?Insurance regulators are supposed to be more conservative than equity analysts, because they don’t want companies to go broke, harming customers, and bringing stress to the industry through the guaranty funds.

The legal troubles post-2009 probably?had a small effect on the eventual outcome — raising premiums might have lowered the eventual shortfall of $2.6 billion a little. ?But raising premiums would make some healthy folks surrender, and those on benefit are not affected. ?It would likely not have much impact. ?Maybe some expenses could have been saved if the companies had been liquidated in 2009, 2012, or 2015 — still, that would not have been much either.

Some policyholders get soaked as well, as most state guaranty funds limit covered payments to $300,000. ?About 10% of all current Penn Treaty policyholders will lose some?benefits as a result.

Regulatory Policy Recommendations

Often regulators only care that premiums not be too high for the insurance, but this is a case where the company clearly undercharged, particularly on the pre-2003 policies. ?For contingencies that are long-lived, where payments could be made for a long time, regulators need to spend time looking at premium adequacy. ?This is especially important where the company is a monoline and in a line of business that is difficult to underwrite, like long-term care.

The regulators also need to review early claim experience in those situations (unusual business in a monoline), and even look at claim files to get some idea as to whether a company is likely to go insolvent if practices continue. ?A review like that might have shut off Penn Treaty’s ability to write business early, maybe prior to 2002. ?Qualitative indicators of underpricing show up in the types of claims that arrive early, and the regulators might have been able to reduce the size of this failure.

But wave goodbye to Penn Treaty, not that it will be missed except by policyholders that don’t get full payment.

Thoughts on MetLife and AIG

Posted on 5 February 20165 February 2016 by David Merkel

In some ways, this is a boring time in insurance investing. ?A lot of companies seem cheap on a book and/or earnings basis, but they have a lot of capital to deploy as a group, so there aren’t a lot of opportunities to underwrite or invest wisely, at least in the US.

Look for a moment at two victims of the?Financial Stability Oversight Council?[FSOC]… AIG and Metlife. ?I’ve argued before that the FSOC doesn’t know what it is doing with respect to insurers or asset managers. ?Financial crises come from short liabilities that can run financing illiquid assets. ?That’s not true with insurers or asset managers.

Nonetheless AIG has Carl Icahn breathing down its neck, and AIG doesn’t want to break up the company. ?They will spin off their mortgage insurer, United Guaranty. but they won’t get a lot of help from that — valuations of mortgage insurers are deservedly poor, and the mortgage insurer is small relative to AIG.

As I have also pointed out before AIG’s reserving was liberal, and recently AIG took a $3.6 billion charge to strengthen reserves. ?Thus I am not surprised at the rating actions of Moody’s, S&P, ?and AM Best. ?Add in the aggressive plans to use $25 billion to buy back stock and pay more dividends?over the next two years, and you could see the ratings sink further, and possibly, the stock also. ?The $25 billion requires earning considerably more than what was earned over the last four years, and more than is forecast by sell-side analysts, unless AIG can find ways to release capital and excess reserves (if any) trapped in their complex holding company structure.

AIG plans to do it through?(see pp 4-5):

Reducing expenses
Improving?the Commercial P&C accident year loss ratio by 6 points
Targeted divestitures (United Guaranty, and what else gets you to $6 billion?)
Reinsurance (mostly life)
Borrowing $3-5B (maybe more after the $3.6B writedown)
Selling off some hedge fund assets to reduce capital use. (smart, hedge funds earn less than advertised, and the capital charges are high.)

Okay, this could work, but when you are done, you will have reduced the earnings capacity of the remaining company. ?Reinsurance that provides additional surplus strips future earnings out the the company, and leaves the subsidiaries inflexible. ?Trust me, I’ve worked at too many companies that did it. ?It’s a lousy way to manage a life company.

Expense reduction can always be done, but business quality can suffer. ?Improving the Commercial lines loss ratio will mean writing less business in an already overcompetitive market — can’t see how that will help much.

I don’t think the numbers add up to $25 billion, particularly not in a competitive market like we have right now. ?This is part of what I meant when I said:

…it would pay Carl Icahn and all of the others who would be interested in breaking up AIG to hire some insurance expertise. ?Insurance is a set of complex businesses, and few understand most of them, much less all of them. ?It would be easy to naively overestimate the ability to improve profitability at AIG if you don?t know the business,? the accounting, and how free cash flow emerges, if it ever does.

They might also want to have a frank talk with Standard and Poors as to how they would structure a breakup if the operating subsidiaries were to maintain all of their current ratings. ?Icahn and his friends might be surprised at how little value could initially be released, if any.

Thus I don’t see a lot of value at AIG right now. ?I see better opportunities in MetLife.

MetLife is spinning off their domestic individual life lines, which is the core business. ?I would estimate that it is worth around 15% of the whole company. ?In the process, they will be spinning off most of their ugliest liabilities as far as life insurance goes — the various living benefits and secondary guarantees that are impossible to value in a scientific way.

The main company remaining will retain some of the most stable life liabilities, the P&C operation, and the Group Insurance, Corporate Benefit Funding, and the International operations.

I look at it this way: the company they are spinning off will retain the most capital intensive businesses, with the greatest degree of reserving uncertainty. ?The main company will be relatively clean, with free cash flow being a high percentage of earnings.

I will be interested in the main company post-spin. ?At some point, I will buy some MetLife so that I can own some of that company. ?The only tough question in my mind is what the spinoff company will trade at.? Most people don’t get insurance accounting, so they will look at the earnings and think it looks cheap, but a lot of capital and cash flow will be trapped in the insurance subsidiaries.

There is no stated date for the spinoff, but if the plan is to spin of the company, a registration statement might be filed with the SEC in six months, so, you have plenty of time to think about this.

Get MET, it pays.

One Final Note

I sometimes get asked what insurance companies I own shares in. ?Here’s the current list:

Long RGA, AIZ, NWLI (note: illiquid), ENH, BRK/B, GTS, and KCLI (note: very illiquid)

Bid Out Your Personal Insurance Policies!

Posted on 31 July 2015 by David Merkel

Photo Credit: Dana || They charge more for "Arrest me red" too! — Photo Credit: Dana || They charge more for “Arrest me red” too!

This should be a relatively quick note on personal lines insurance. I’m writing this after reading the piece in this month’s Consumer Reports on Auto Insurance. ?I agree with most of it. ?For those that are short on time, my basic advice is this: bid out your auto, home, umbrella and other personal lines property & casualty insurance policies once every three years, or after every significant event that?changes your premium significantly.

Here are a few simple facts to consider:

Personal lines insurance — auto, home, umbrella, rental, etc. is a very competitive business, and the companies that offer it?all want an underwriting formula that would give them the best estimate of expected losses from each person insured.
After that, they want to know how much “wiggle room” that they would have to build in some profit. ?Where might the second place bid be? ?How likely are consumers to shop around?
Most insurers use a mix of credit scores and claim history to calculate rates. ?Together, they are effective at forecasting loss costs — more effective than either one separately.
Read my piece?On Credit Scores. ?They are very important, because they measure moral tendency. ?People with low scores tend to?have more claims than those with high scores on average. ?People with high scores tend to be more careful in life. ?This is a forward-looking aspect of a person’s underwriting profile.
It’s fair to use “credit scores” because they are positively and significantly correlated with loss costs. ?The actuaries have tested this. ?Note that it is legal in almost?all states to use credit scores, or something like them, but not all of them.
As the Consumer Reports article points out, many insurance companies take advantage of insureds that stick with them year by year, because they don’t shop around. ?Easy cure: bid out your policy every three years at minimum. ?If enough people do this, the insurance companies that overcharge loyal customers will stop doing it. ?(Note: when I was a buy side analyst analyzing insurance stocks, one company implicitly admitted to doing this, and I was insured by them. ?Guess what I did next? ?It was not to sell the stock, though eventually I did when I saw that their premium increases were no longer increasing profits.)
Also be willing to unbundle your home and auto policies — there may be a discount, or there may not as the?Consumer Reports article states. ?I’ve worked it both ways, and am unbundled at present.
If they have that much money for amusing advertising, it implies that the market isn’t that rational. ?Bid it out.
But — it is important to realize that insurers don’t all have the same formulas for underwriting, and those formulas are not static over time. ?Bidding out your insurance makes sure you benefit from changes that positively affect you.
Insurers tend to get more competitive as the surplus they have to deploy gets bigger, and vice-versa when it shrinks after a large disaster. ?If your premium goes up after a disaster, bid the policies out. ?If it drifts up slowly when there have been no significant disasters, or claims on your part, they are taking advantage of you. ?Bid it out.

Bid it out. ?Bid it out. ?Bid it out. ?What do you have to lose? ?If loyalty means something to the insurer, they will likely win the bid. ?If it doesn’t, they will likely lose. ?Either way you will win. ?If you have an agent, they will note that you are price-sensitive. ?The agent will become more of an ally, even if it doesn’t seem that way.

I went through this several times. ?Most people who have read me for a while know that I have a large family — I am going to start teaching number seven to drive now. ?I bid it out when kids came onto my policy. ?It produced a change. ?When two of my kids had accidents in short succession, my premiums rose a lot. ?They would not underwrite one kid. ?I got most of it back when I bid it out. ?Since that time, the two have been claim-free for 2.5 years. ?Guess what I am going to do next March, when I am close to the renewal where premiums would shift? ?You got it; I will bid it out.

There is one more reason to bid it out: it forces you to review your insurance needs. ?You may need more or less coverage than you currently have. You might realize that you need an umbrella policy for additional protection. ?You may decide to self-insure more by raising your deductibles. ?The exercise is a good one.

You don’t need transparency, or more regulation. ?You don’t get transparency in the pricing of many items. ?You do need to bid out your business every now and then. ?You are your own best defender in matters like this. ?Take your opportunity and bid out your policies.

Make sure that you:

Choose a range of insurers — Large companies, smaller local companies, stock/mutual, and any that favor a group you belong to, if the group is known to be filled with good risks.
Give them a standardized request for insurance, giving all of the parameters for your coverage, and data on those insured.
Tell them they get one shot, so submit their best bid now… there will be no second looks.
Some companies argue more about paying claims. ?(AIG once had a reputation that way.) ?Limit your bidders to those with a reputation for fairness. ?State insurance departments often keep lists of complaints for companies. ?Take a look in your home state. ?Talk with friends. ?Google the company name with a few choice words (cheated, claim?denied, etc.) to see complaints, realizing that complainers aren’t always right.
Limit yourself to the incumbent carrier and 4-6 others. ?Seven is more than enough, given the work involved.

So, what are you waiting for? ?Bid out your personal insurance business.

Full disclosure: long AIZ, ALL, BRK/B, TRV for myself and clients (I know the industry well)

Why Life Insurers, Defined Benefit Plans, and Endowments Invest Differently

Posted on 25 April 2015 by David Merkel

Despite the large and seemingly meaty title, this will be a short piece. ?I class these types of investors together because most of them have long investment horizons. ?From an asset-liability management standpoint, that would mean they should invest similarly. ?That may be have been true for Defined Benefit [DB] pension plans and Endowments, but that has shifted over time, and is increasingly not true. ?In some ways, the DB plans are becoming more like life insurers in the way they invest, though not totally so. ?So, why do they invest differently? ?Two reasons: internal risk management goals, and the desires of insurance?regulators to preserve industry solvency.

Let’s start with life insurers. ?Regulators don’t want insolvent companies, so they constrain companies into safe assets using risk-based capital charges. ?The riskier the investment, the more capital the insurer has to put up against it. ?After that, there is cash-flow testing which tends to push life insurers to match assets and liabilities, or at least, not have a large mismatch. ?Also, accounting rules may lead insurers to buy assets where the income will show up on their financial statements regularly.

The result of this is that life insurers don’t invest much in risk assets — maybe they invest in stocks, junk bonds, etc. up to the amount of their surplus, but not much more than that.

DB plans don’t have regulators that care about investment risks. ?They do have plan sponsors that do care about investment risk, and that level of care has increased over the past 15?years. ?Back in?the late ’90s it was in vogue for DB plans to allocate more and more to risk assets, just in time for the market to correct. ?(Note to retail investors: professionals may deride your abilities, but the abilities of many professionals are questionable also.)

Over that time, the rate used to discount DB plan liabilities became standardized and attached to long high quality bonds. ?Together with a desire to minimize plan funding risks, and thus corporate risks for the plan sponsor, that led to more investments in bonds, and less in equities and other risk assets. ?Some plans try to cash flow match expected future plan payments out to a horizon.

Finally, endowments have no regulator, and don’t have a plan sponsor?that has to make future payments. ?They are free to invest as they like, and probably have the highest degree of variation in their assets as a group. ?There is some level of constraint from the spending rules employed by the endowments, particularly since 2008-9, when a number of famous endowments came to realize that there was a liability structure behind them when they ran low on liquidity amid the crisis. [Note: long article.] ?You might think it would be smart to have the present value of 3-5?years of expenditures on hand in bonds, but that is not always the case. ?In some ways, the quick recovery taught some endowment investors the wrong lesson — that they could wait out any crisis.

That’s my quick summary. ?If you have thoughts on the matter, you can share them in the comments.

Classic: Choosing an Insurance Company?

Posted on 28 March 2014 by David Merkel

This was published in the “Ask Our Pros” column at RealMoney. ?I don’t know when, and I don’t have the actual question, but looking at my answer, I think I know what was asked.

I’ve been cheated in the past by insurance companies. ?How can I choose an insurance company that won’t cheat me?

This is a question after my own heart.? I worked in the life insurance business as an actuary for 17 years, serving in almost every area that life insurance companies have.

Life insurance agents and products have a bad reputation in the financial press.? Much of that bad reputation is deserved.? Products are often sold that pay agents well, but do not meet the needs of clients.? Agents influence the flow of information between the company and policyholder, and sometimes tell different stories to each side.

The life insurance industry has tried over the years to control the sales process better, so that only suitable products get sold.? Regulators have demanded it, industry groups want a better reputation, and individual companies have learned that writing bad business is unprofitable.? There are regulatory rules, industry conduct codes, etc.? It is difficult to root out bad apples among agents, which can flit from company to company; companies with bad records tend to get disciplined by the regulators and the courts.

Life insurance and annuities are products that are generally sold, not bought, excluding fancy tax reduction schemes used by high net worth individuals.? Typically, though, they get sold to people who will not plan for their own financial well-being, and would not save, invest, and protect their families on their own.? It is an expensive way to invest, but it is better than not investing at all.

There is a need for agent-sold financial products to help those that will not plan for themselves.? This provides a real service, though never as good as what an intelligent investor would do for himself, if he had the time to research everything out.

Disability and health insurance often get a bad rap over claims payment practices, often deservedly so.? Part of the reason for that is that people don?t want to pay the full price of these products; companies respond with lower priced products and get more hard-nosed about claims.? Part of the research that any person should do about an insurance company is their claims payment practices.? State insurance commissioners keep a record of which companies get complaints, and which do not.? Insurance fraud further pushes up costs, and makes companies scrutinize claims more.? Trial lawyers further push up costs by making medical malpractice expensive through exorbitant tort claims.

Auto and home insurance usually don?t draw the same level of complaints as the above areas.? There are some companies that try to be too sharp about claims practices; this is something to watch out for in any insurance company.? Auto insurance (or the equivalent) is mandatory; mortgage companies require home insurance.? The market is regulated, and usually highly competitive.

Another area of complaint is private mortgage insurance [PMI].? PMI benefits the lender, but is paid for by the homeowner.? The benefit to the homeowner is that he can buy a home, and not make a down payment of at least 20%.? The lenders require PMI when the ratio of the first mortgage to the appraised home value is greater than 80%.? New laws require PMI to go away when the ratio drops below 78%.? Homeowners can petition the lender when the ratio is at 80%.? (The lender will probably require a new appraisal.)

Now all this said, insurance companies have had a lower return on equity in the past 20 years than all other companies on average.? Insurance companies don?t make all that much money.? So where does the money go?? 1) Agents.? 2) Benefit payments.? 3) Home office expenses.? Investment income usually subsidizes insurance companies; they lose money on underwriting on average, and when the pricing cycle is weak, they lose substantial amounts.? Since the inception of health insurance, the insurance industry may have lost money in aggregate.

In Summary:

Plan your investment and protection needs yourself, or find a trusted advisor to help you.? Investment knowledge pays its own dividends.
Study a company?s claims paying practices before buying.
Review expense and surrender charges and other contract terms.
Choose an insurance company off its reputation, and not price only.

On National Western Life

Posted on 25 March 2014 by David Merkel

From respected reader:

Just did a quick calc based on NWLI earnings and thought I would pass onto you as I know you at least used to hold it as a double weight. ?Let me know if you think there are major holes in this theory:

From the Annual Report:

“The yield on debt security purchases to fund insurance operations rebounded somewhat to 3.53% in 2013 from 3.37% in 2012 but was still below the 4.18% yield attained in 2011.”

So, investment yields improved, but are still down. ?Their unrealized gains in securities dropped from $541 million to $146 because of this, so this part of the “hidden value” in the shares went down.

But if rates can get back up to that 4.18%, a quick calc says that would cause annual earnings on their $9 billion investment portfolio to increase $58 million. ?If 2/3’s of this is credited to annuity holders, it leaves $19.5 million before tax for shareholders. ?32% tax from 2013 gives after tax earnings increase of $13 million or $3.57 increase in earnings per share.

If we could get yields back up to 5.5% like they were a few years ago, using the same calc would give an increase in EPS of $9.38, or a 1/3 increase in earnings.

It is still a double-weight here. ?It is not as cheap as it once was, but it is still cheap. ?Financial stocks should always be valued on a combination of price-to-book and price-to-expected-earnings.

Why? ?Because accrual items in the accounting can either be aggressive, fair or conservative. ?If aggressive, earnings will be overstated, and book value understated. ?If conservative, earnings will be understated, and book value overstated. ?For the most part, the two measures balance the squishy accounting.

Now as for the disclosures in the NWLI 10K, we need to note that more than 2/3rds of the bonds that they hold are “held to maturity.” ?That’s unusual, as is their policy where they don’t buy high yield bonds. ?Held to maturity means the value of the bonds amortizes over time, but price moves don’t affect the accounting, unless default is likely. ?Thus if interest rates rise, book value will not be affected much, but earnings will rise on a GAAP basis.

NWLI has a conservative investing culture, and in the present aggressive environment that is a *good thing.* ?Adjusting for the held to maturity securities, the adjusted price-to-book is 55%, and my estimate of future earnings is one-ninth of the current price. ?It is rare to find stocks trading at a significant discount to book and a single-digit P/E.

Full disclosure: long NWLI

On Reinsurance

Posted on 31 August 20132 September 2013 by David Merkel

From a reader:

Was reading a history of AIG and it was discussing the early years. There was a line to the tune of ‘anything Hank reinsured paid off’.

You’ve written many times usually in the context of LTC, that insurers should not insure anything where the customers have a better idea of future claims than the company does. How is this rule not violated by reinsurance? Are reinsurance actuaries better, or are most deals in agreement about the risk and more about regulatory arbitrage/capital relief?

My response:

Which history are you talking about?

His response:

Fatal Risk – “They pretty much hit it perfectly. Whatever they laid off risk-wise seemed to result in claims and it was during a period where reinsurance was fairly cheap. They got the best part of the deal, by far.”

Okay, now I get it.? I’ve reviewed Fatal Risk, and have the most helpful 5-star review at Amazon.? I also have a special discussion with Roddy Boyd here.? I regard him as a friend of mine.

If insurers are supposed to be conservative, their reinsurers should be doubly so.? But AIG was a big company, and a plum to have as a client, many imagined.? But AIG would hand off underpriced risks to reinsurers, and there was a saying current when I worked at AIG 1989-92 “Never give a reinsurer an even break.”? This varies from the clubby reinsurance world pre-1980, where reinsurers and insurers would adjust terms of agreements in order to be fair, whatever that means.

AIG broke from that, and stressed the strict letter of the contract, and did not compromise.? An example from my time at AIG: a reinsurer of annuity business was caught short when Congress implemented the “DAC tax,” which was really a tax on new insurance premiums.? The reinsurer lost and asked us to compensate them.? We refused; there will always be more reinsurers.

Much reinsurance on the life side does cover regulatory arbitrage and capital relief.? With P&C, that’s not a big factor; rather it is risk reduction.

Reinsurers see more of the industry than a single insurer, that partially compensates for the reinsurer not having as much detail as the ceding insurer.? Reinsurers underwrite insurance companies and their management teams, in addition to the exposures at hand.? If an insurer gets a reputation for being too slick, reinsurers back off.

AIG may have been different because they were so big.? But even AIG had rough times with reinsurers: rescission of annuity treaties with Lincoln National in the mid-90s (costing hundreds of millions), and earnings management with General Re, on a reinsurance deal that did not pass risk, which led to the downfall of Hank Greenberg.

P&C reinsurers have other ways of mitigating risk as well, for example, requiring the company to take the first $XX million of losses, and limiting total losses covered.

So, no, reinsurers aren’t brighter than insurers, but they have to be selective, and not write business just to deploy capital.? If they are disciplined, they will turn down business when they can’t make money on underwriting, and send shareholders the excess capital.

On Long-Term Care Insurance

Posted on 3 July 2013 by David Merkel

I’ve said this before, but it bears repeating: be careful in any transaction where the other parties know the deal better than you do.? In most insurance transactions, the company knows more about the transaction than the individuals or firms seeking coverage.? There are exceptions, though, when the model for policyholder claims behavior is not well-understood.? This exists in life and annuity coverages in small ways, and in health, disability, and long-term care coverages in greater ways.

The main advantage that a potential life/disability/health insurance buyer has is that he knows the details of his health far better than the insurer does.? Underwriting standards vary across companies, and not all companies are as thorough at checking the health of the insured as the others do.

With life and annuity coverages, outside of life settlements, this risk to the insurance companies is small, because the actuaries expect the potential losses from the hidden knowledge of the insureds, and build it into pricing.? Death is a tough way to make money, and those using it to make money off insurers must pay a heavy price to do so.? When death stares you in the face, it seems kind of callous to say, “How can I make money off this for my heirs?”? Most people realize that there is something more serious going on than making money, when death is near.

But when we deal with health matters, things get more murky, particularly the older we get.? Again, insurers will attempt to determine those that have the greater probability of making significant claims, but the ability to do so is more limited, because people know when they are not well beyond when they have sought medical help in the past.

(This is one reason why Obamacare (PPACA) will end up increasing costs for most healthy people.? By attempting to cover everyone, and limiting the ratio of premiums from the sick to the healthy to a factor of three, those who are healthy will pay a lot more, or find some clever way to drop out.)

As an aside, before the modern health insurers found their footing around 1988, cumulative profits for the industry as a whole was negative.? Since then, they got better at discriminating on what groups/individuals they would cover, and those they would not.

But with long-term care insurance, the insurance industry has not made money to date. Why?? Insurers have consistently underestimated the willingness of people to file claims on their policies.? Thee is no incentive not to do so, unlike death.

Thus the insurers have been in a battle involving raising premiums on new and old business, with healthier business leaving.? The model doesn’t work, I don’t care what the largest writer Genworth thinks, when the article says:

Genworth Financial Inc., with about a 33% market share of long-term-care policies sold to individuals, said in May that it is seeking premium increases averaging more than 50% to stave off more losses in its oldest policies.

Genworth also halted sales June 1 through AARP, the older-Americans’ group with a huge pool of potential customers.

“We’ve learned a lot over the last 30 years, and we now believe we have a better ability and more knowledge” to issue policies that “provide significant financial protection to Genworth,” Genworth Chief Executive Thomas McInerney said in an interview.

The insurer started requiring blood tests and other medical screening, which the industry generally hadn’t done before. And it is charging women who apply individually more than men for the first time because women tend to live longer and require more years of care.

That brings me to this summary: don’t own companies that are deep into long term care, like Genworth.? Think of Penn Treaty, and other companies that went bankrupt as a result of long term care.? Long-term care? is not insurable; those insured have too much control over when they make claims.

As for those with long-term care policies, if they are old, keep paying on them, you will likely do well on them when you finally need to draw on the policies.? You have benefits that benefits that can no longer be purchased.? Enjoy the exclusive club you are in.

On Insurance Investing, Part 7 [Final]

Posted on 15 May 2013 by David Merkel

I wrote this piece once, and lost it, 1000 words.? Going to try again.

1) The first thing to realize is that diversification across insurance subindustries usually does not work.

Do not mix:

Life & P&C
Financial & Anything
Health & Anything

Maybe you can mix P&C, Mortgage & Title, after all Old Republic survived.? The main point is this.? Insurance is not uniform.? Coverages are sold and underwritten differently.? Generally, higher valuations will be obtained on “pure play” companies? Diversification is swamped by management inability.? These are reasons for AIG and Allstate to spin off their life operations.

2) Middle-sized companies tend to do best from a valuation standpoint: the large have nowhere to grow, and the small are always questionable on their viability.? With a few exceptions, I like sticking with focused mid-cap companies with my insurance names.

3) Be aware of total subindustry capital relative to need.? After a big disaster, those that underwrote well will have capital to deploy into a stronger underwriting environment, where capital is scarce.? But don’t make too much of it because capital has become very fluid in insurance; the barriers to entry and exit are low.? Still, it is best to be an investor after a disaster, when everyone is running scared.? When total capital is high, and companies are fat, dumb, and happy, it is time to leave.

4) It’s good to look through the Statutory statements [regulatory statements filed with state insurance regulators] of their operating insurance subsidiaries to look for odd entries.? Occasionally, you will run into problems that do not have to be reported under GAAP accounting.? (Note: they should be reported under the spirit of GAAP, but not the letter of GAAP.? I have a saying, “It is okay to violate GAAP to be more honest, but not to be less honest.”)

Here’s an example: I ran across a life company that had to post an extra statutory reserve because they would lose money if interest rates rose.? That’s a significant admission, and the company was invested far more aggressively than almost all the other life companies we were tracking.? We shorted it, and got ripped as the credit markets surged 2003-2005.? We got out with a small gain when their earnings proved inadequate as interest rates rose, and credit losses rose.? But it took a long time.

At this point, I would be looking for special reserves established for secondary guarantees established for Term and Universal Life, and Variable Life & Annuity policies.? There is no specific requirement to hold those reserves on a GAAP basis, even though there may be general principles that would encourage additional reserves or disclosures.

5) There are ways of multiplying capital across subsidiaries — Subsidiary A reinsures liabilities of subsidiary B, while Subsidiary B reinsures liabilities of subsidiary A.? This is a way to create hidden leverage, so be aware of what is being done at the subsidiary level.? Doing these sorts of things is dumb, though legal.

Reviewing leverage is a good idea as well, where it is located, and what conditions it has.? The practice of insurance subsidiaries issuing surplus notes to parent companies has become all too common, which allows subsidiaries to write more business at the risk that when a subsidiary becomes impaired, the domiciliary state takes it over, and the parent company gets little to nothing.? (Payments on surplus notes can only be made with the approval of the insurance commissioner. In insolvency surplus notes typically receive nothing.)

The thing is, it is a lot harder to produce return on assets than return on equity. Though part 6 focused on ROE, in the short run, insurance companies can improve their ROE through substituting debt for equity.? The same applies to insurance companies that write GIC Medium Term Notes.? It’s just a cheap way of making a little extra income arbitraging your subsidiary’s high claims paying ability rating.? It fascinates me that regulators have allowed the insurance industry such latitude with deposit contracts that are called annuities, but have never once been annuitized.

Another hidden source of leverage are financial reinsurance agreements.? Down in the insurance subsidiaries, companies trade away a portion of future profits for surplus today.? These are usually bad deals to enter into, but because some insurance companies have a sales culture that requires continual growth, even if the sales that don’t justify the cost of capital required to back the policies.

6) Free cash flow is difficult to determine for financials, this applies to insurers as well.? Each regulator has rules on how much can be paid in dividends to their holding company.? Typically, subsidiaries can dividend away surplus so long as they are still strongly capitalized after the dividend.? (If it is large, they may have to petition their regulator for approval)? So if you want to approximate free cash flow for an insurer, try the following:? (Income or loss outside your insurance companies for the current period) + (Distributable Income from insurance companies for the current period).? The latter figure is statutory income +/- any decrease/(increase) in capital required to maintain the remaining business with adequate financial strength, calculated separately for each subsidiary.

7) Last note: on DAC/VOBA [deferred acquisition costs, value of business acquired; they? are similar, so I will just talk about DAC].? Once I had to convince a boss that though it is an intangible, like goodwill, it is not like goodwill in that it is more rigorously tested for recoverability.? If DAC gets written down (as opposed to amortized) that means that the future sum of profits on some of the insurance business is expected to be less than the acquisition costs deferred for the business.

Now, DAC can be done conservatively, by product and class year.? The more disaggregated it is, the more conservative, generally.? A few cells getting written down is no big thing.? But DAC can be as liberal as having one cell, which means if DAC is written down, the total value of future profits from existing business has been reduced — the company is worth a lot less.? The change in value is even more than the reduction in the DAC, because in the writedown process, the discount rate on the DAC went from a positive number to zero.? All other things equal, a DAC asset is worth more the higher its discount rate.

S0 pay attention: if DAC amortization is high relative to net income before tax, it means there isn’t that much margin for adverse deviation in the DAC.? Also, all other things equal, lower levels of DAC as a fraction of net worth are better.

Close with a story: before Mony Group was bought by AXA, it was doing DAC for the company as a whole.? A value investor, seeing the discount to book value, and sensing opportunity bought a lot of Mony.? Profitability was so bad, they had to write down DAC.? Book value declined & price to book value declined as well.? The value investor agitated for a sale, and AXA stepped in, buying it for moderate premium to where it was trading.? The group I was with went long for an arbitrage trade on a cash deal.

But the value investor thought the premium wasn’t high enough and agitated for more.? Because the takeout price was 70% of book, the idea seemed plausible.? But when you factored in the DAC earning 0% and a few other items, it looked generous enough to me.? So when the price got several percent above the deal terms we sold our stake and went short as much as we could find without having to pay much interest on the borrow.? Bit-by-bit the stock price moved down until a few days before the deal would close, when the price collapsed below the deal price, and we covered.? We even arbed a little more on the long side, but the trade was over.

And the point is this: it may look cheap, but test your assumptions on the values of assets and liabilities before committing a lot of capital to a any insurance stock.? GAAP, Tax and adjusted Statutory income validate book value, so a cheap stock with a low return on equity or assets is often not cheap.