Thursday, March 12, 2009

A Massive Coming Problem - Insurance Companies

I haven't talked about this topic on this blog, but have had many conversations with many people about the coming insurance crises. The problem is many fold. For one the accounting is mostly mark to historical cost. What that means is that if you buy a bond at par (at 100) and it goes to 70 you still mark it at par. As a result the insurance companies have not been in the spotlight since it isn't screamingly clear that they have issues. This also causes the issue of the problem being bigger than it otherwise would be since it is ignored longer. You also have the issue that the insurers are regulated at the state level, not the federal level. As a result, there is no set designated way for the federal government to bailout the insurers, unlike the banks. Thanks goes to Pete.

The tumbling financial markets are dragging down the life-insurance industry, an important cog in the U.S. economy, as mounting losses weaken the companies' capital and erode investor confidence.


Some of the hardest-hit companies are century-old names that insure the lives of millions of Americans. Shares of Hartford Financial Services Group Inc., which already received a capital injection from German insurer Allianz, are down 93% as of Wednesday's close from their 52-week high. MetLife Inc. and Prudential Financial Inc. are both suffering as the value of their vast investment portfolios declines.


countryboy said...

I'm not sure I agree with you on this one - held-to-maturity securities are reported at amortized cost on the balance sheet. What's wrong with that? The reason you're allowed to do that is that with bonds as opposed to equities is that there is a fundamental difference between the 2 securities.

Annualy revaluing a portfolio of bonds that you intend to hold to maturity would be just madness - it ignores the whole structure of a bond, which entails repayment of your principal at maturity, regardless of price movements over the life of the bond.

You're surely not proposing we bring in mark-to-market for these sorts of situations? Equities, yeah sure; bonds, no way.

Now there may be other problems insurance companies have (and there probably are), but valuing long-term bonds at amortized cost is not one of them. If we did that, imagine all the 'profits' they could book when bond prices rise.


Anonymous said...

What, no comment on the awkward and uncomfortable Jim Cramer last night?

I expected more...

Market Seer said...

I am not proposing anything in relation to the accounting for insurance firms. I am saying the accounting hides the problems for insurance companies. Just because you decide to hold the bond to maturity doesn't mean you are going to get 100 on the dollar back. There will be alot of corporate defaults (already have been) and you will get back 80 cents, 50 cents, 20 cents etc back. If you have it marked at par that will be a huge drop in value while will create holes in the balance sheets.