An earlier version of this story included a subhead that gave the
impression that MetLife is in imminent trouble. This is not the case. As of the
end of its 2008 third quarter, MetLife had unrealized losses of $17 billion out
of a total investment portfolio of $324 billion. On Nov. 5, Moody's Investor
Services affirmed MetLife's Aa2 financial-strength rating, its second-highest
rating.
With the financial system in crisis, investors increasingly rely on
government guarantees to protect their money. Bank accounts are backed by the
Federal Deposit Insurance Corp. and its $53 billion war chest. After decades on
their own, money market funds now are backed by the U.S. Treasury. And life
insurance policies and annuities? They're backed by state guaranty associations.
There's only one hitch: The states have virtually no cash on hand and must rely
on promises to pay made by healthy life insurers.
In today's climate, that could be a major problem. Stocks of life insurers,
formerly immune to the fear and panic hitting other sectors, recently became the
market's target of choice. Shares have declined nearly 50% in the past two
months as investors have learned the extent of losses in insurers' investment
portfolios. Metropolitan Life (MET),
for one, said its debt investments declined $17 billion in the third quarter of
2008. Adding to the pressure, many insurers sold variable annuities with
guaranteed-income features, which could cost them an additional $15 billion to
support, according to a recent Fitch Ratings report.
So far the system has held up. Insurers are not banks—which can tumble in an
instant if worried depositors pull money simultaneously. Insurance companies
fail in slow motion, if only because policyholders pay expensive penalties to
cancel policies. When insurers do fail, state regulators sell off what they can
and bill the remaining life insurers operating in that state to make
policyholders whole. "The funds have been pretty good at providing a basic level
of consumer protection," says Peter G. Gallanis, president of the National
Organization of Life & Health Insurance Guaranty Assns.
But the system runs on the assumption that only small insurers are likely to
fail, and then only one at a time. Few noticed in 2007, when Benicorp Insurance
in Indiana and Texas-based Lincoln Memorial Life Insurance both flopped.
Sometimes, though, failures are far more substantial. When Executive Life
went belly-up in 1991, states couldn't raise enough to cover its obligations.
Annuity and life insurance policyholders in California recovered as little as 70
cents on the dollar or were forced to accept modified terms with alternative
providers. "I wouldn't put a tremendous amount of credence in guaranty funds,"
says Adam Sherman, president of advisory firm Firstrust Financial Resources in
Philadelphia.
It remains to be seen if the insurance market will further weaken or keep
muddling through. But if a large company does fail, certain guaranty funds may
not live up to their name. In a handful of states, a single insurer dominates
the business, writing nearly one-fifth of the total dollar value of premiums.
Even in others, guaranty funds are typically permitted to assess surviving
companies only a small amount—about 1% to 2% of premiums per year. "The funds
could become exhausted," says Donald Light, an insurance analyst at consultancy
Celent.
Insurance customers need to be more vigilant. Stop focusing only on cost and
service and start worrying about solvency. Check such agencies as Standard &
Poor's (MHP),
Fitch Ratings, Moody's (MCO),
and A.M. Best to find the highest-rated companies, and be alert for downgrades.
Then dig deeper. Find out about an insurer's exposure to real estate and
mortgages and make sure its debt holdings are investment-grade. "Everyone's
under the false assumption that it doesn't matter what company you buy from,"
says Thomas Archer, chairman of financial-services firm Archer Financial Group
in New York. "It does."
