New Rules For Life Insurers – “Future Generations Have To Deal With The Financial Carnage”

Yves here. Most people don’t think much about the life insurance industry, precisely because it has managed to be what financial services should be: boring and safe. Insurance is particularly prone to abuse, since customers pay money up front and submit claims (or in the case of investment products, get payouts) much later.

As Wolf Richter warns us, the insurance industry just approved new rules which will allow them to keep lower reserves, which is that industry’s analogue to bank capital. And the aim of this change is to allow insurers to engage in more speculation. Nothing like choosing to rely on the playbook that gave us the global financial crisis, now is there?

By Wolf Richter, San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.

During the off-hours on Sunday, when few people were willing to ruin whatever remained of their weekend, when even astute observers weren’t supposed to pay attention, the National Association of Insurance Commissioners approved new rules that would allow life insurance companies to lower their reserves for future claims.

Executives claimed that they could put that capital to “more productive uses,” such as blowing it on stock buybacks and acquisitions or plowing it into subprime-based CDOs or Greek sovereign debt, or whatever, to goose their paper returns—having already forgotten all about the financial crisis.

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

Others were less sanguine. Joseph Belth, Insurance Forum editor and professor emeritus of insurance at Indiana University, worried that “future generations of executives, regulators, and consumers will have to deal with the financial carnage.”

There are salient precedents. The Glass-Steagall Act, after decades of being reinterpreted and watered down—and finally gutted by Citibank’s foray into investment banking and insurance—was repealed in 1999. The business of finance boomed, banks ballooned, Wall Street printed paper profits, and bonuses skyrocketed. Less than a decade later, the financial crisis laid waste to the world economy. Before it, there was the S&L crisis, brought on by a series of challenges that culminated in the deeply troubled industry’s deregulation in the early 1980s. With disastrous consequences.

The Insurance industry had lobbied for the change for almost a decade. The existing rules used formulas that were “far too conservative,” life insurers maintained, according to the Wall Street Journal. Instead, the industry would implement a “principles-based” system that would use computer models—algos and “fat fingers” come to mind—to figure out how large the reserves would have to be; or rather, just how small they could be. Because rationalizing “lower reserves in the aggregate”—as Lawsky’s deputy Robert Easton called it—had after all been the goal of the lobbying campaign.
California Insurance Commissioner Dave Jones fretted about the “very complicated black-box models”—that their mathematics might be impenetrable for state regulators who then would not be capable of overseeing that “principles-based” system. Whether or not that was one of the underlying motivations for the industry remains to be seen.

Granted, it’s been tough for life insurers. Their investment returns have gotten hammered by the evil twins of a lumpy economy and the Fed’s Zero Interest Rate Policy. Initially classified as “exceptional,” ZIRP has now been in effect for four years, and its expiration date keeps getting kicked further into the future. It has brought down bond yields across the spectrum to where returns on all but junk are negligible, a process that has been draining the reserves of life insurers—just like it has been fleecing the Social Security trust fund and savers. So the thinking went, with lower reserve requirements, insurers could divert some capital to speculate in riskier assets that might offer a greater return. It would dope their paper profits and make Wall Street smile. For a while. We’ve seen this movie before.

But it’s not yet a done deal. The National Association of Insurance Commissioners, which is composed of state regulators, sets solvency standards that states may then adopt in regulating insurers. The idea is to come up with a common set of standards for all 50 states. However, states don’t have to follow the decision. And it’s unlikely that all of them will. Of the 56 members, 43 voted to approve this change. Regulators in California and New York voted against it. And in states where lawmakers refuse to adopt the new reserving requirements, life insurers would establish subsidiaries whose reserves would conform to the rules of that state.

While some life insurers might continue to be conservative under the new rules, others will venture out towards the thin end of the limb to chase paper profits from quarter to quarter. And they’re doing it just when the industry is staring at an unprecedented and brutal demographic reality: insured baby boomers aren’t going to live forever, and life-insurance payouts are going to jump to historic records.
The temptation is huge to tweak the math of the “black-box models”—as California Insurance Commissioner Dave Jones called it—to bury that reality until the bitter end. It took Wall Street less than a decade to explode, counting from the repeal of the Glass-Steagall Act. Home many years will it take the life-insurance industry after the new rules go into effect? One thing we know already: when it explodes, no one will be held responsible. Because everyone followed the rules.

Every country in the Eurozone has its own set of big fat lies that politicians and eurocrats have served up to make the euro and subsequent bailouts or austerity measures less unappetizing. Like in 1999: “Can Germany be held liable for the debts of other countries? A very clear No!” said the CDU, the party of Chancellor Angela Merkel. Read…. Ten Big Fat Lies To Keep The Euro Dream Alive.

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