Insurance companies these days are collapsing in droves. Yet Nostradamus himself would have a hard time predicting the next to go belly-up. For mere consumers, anxious about policies they've bought to fund retirement or to support their families after they die, divining an insurance company's well-being is well-nigh impossible.
The problem: Insurers are allowed to carry most of their investments at cost. A bond bought for $1,000 is booked at par even though it may get only $500 in the market. While Executive Life Insurance Co. listed $10 billion in assets at the end of 1990, much of that was junk bonds, and the market value was less. In April, regulators seized Executive Life and its affiliates. The biggest insurance failure ever, it stranded thousands of policyholders.
So let's rip away insurers' accounting fiction that assets never vary in price. Let's compel them to mark their assets to present market values. The industry should be required to mark to market--say, once a quarter--and send the results to policyholders, who would have a better idea of what they've bought. Potential buyers should get those results from salespeople.
THINKING TWICE. With that knowledge, clients of Executive Life and First Capital Life Insurance Co., another recent insurance failure, could have tracked the plummeting bonds that backed their policies--and compared them with those of sturdier rivals (chart). With market pricing, insurers would think twice about risky investments. Mutual funds--long-term vehicles like life insurance--already mark to market. If the thrifts had followed those principles, their debacle could have been contained. Asks Harold D. Skipper, director of Georgia State University's Center for Risk Management & Insurance Research: "Why insulate people from bad news?"
Consumers can't turn to regulators for help. The data state insurance departments provide are skimpy. Worse, regulators are often too lax and understaffed to detect ailing insurers until it's too late. California officials should have seized Executive Life long ago. Congress may beef up insurance oversight by imposing federal standards. But history's sad lesson is that regulatory zeal ebbs with the political tides.
Another insolvency spotter to view warily is A. M. Best Co., whose ratings books are available in local libraries. The books' information is often a year old, and Best can be overly lenient. Until recently, Executive Life carried Best's second-highest rating, which is well within the safety zone. Best defends its approach as sound and blames Executive Life's demise on sudden and unforeseen public panic that caused a flood of policy redemptions.
In practical terms, marking to market is not as hard as it seems. Bonds, which make up more than half of the average insurance investment portfolio, are easy to value because most are publicly traded. Insurance providers already tally bonds' market value at yearend for state regulators. On balance sheets, they have long market-priced their stocks, foreclosed mortgages, and defaulted bonds.
Valuing the rest of the portfolio will be harder, but not impossible. Consider private placements, direct investments in companies that do not trade in public markets. The Securities Valuation Office of the National Association of Insurance Commissioners assigns risk ratings to thousands of private placements, on the basis of information the issuers send in. A formula could be doped out, using the agency's data base, to pin values to them, too.
Valuing real estate, whose woes have zapped insurers far worse than junk bonds, is the toughest challenge. Property values are a kaleidoscope involving such variables as location and building type. Nonetheless, requiring insurers to make yearly appraisals and compile vacancy and debt-load information could yield workable numbers.
VOLATILITY. Insurers greet the idea of marking to market like an invitation to a Russian roulette party. They argue that many of the liabilities the assets support--death benefits and annuity payouts--won't come due for a long time, so why worry about temporary fluctuations? Says Linda S. Dougherty, vice-president for accounting at Prudential Insurance Co.: "This would mislead and scare people." But the vast majority of insurers don't have to worry about spooking policyholders. Typically, they are very conservative investors with Gibraltar-like stability. The value of Pru's bonds has stayed steady for years.
A more valid industry fear is extreme market volatility, such as during the late 1970s, when interest rates shot up and bond prices sank. Then, even Pru's portfolio would take a beating. Still, there's a remedy: Mandate that insurers bolster capital to fill the gap between liabilities and diminished assets. The riskier the insurer's holdings, the more capital it should have.
Pricing to market is no theorist's pipe dream. Securities & Exchange Commission Chairman Richard C. Breeden backs it. The Financial Accounting Standards Board (FASB) may soon require insurers, banks, and other institutions to disclose market information as an appendix in filings. Anticipating this, several regional banks such as Atlanta's Suntrust Banks Inc. are preparing to make market-price asset disclosures. The FASB next will examine applying market values to the balance sheets. Good. Caveat emptor is useless when disclosure is empty.