Why the Lifeline for the Life Insurers?

Shares in life insurers have soared higher in trading on news they may get a government bailout via TARP capital injections. Hartford Financial, Genworth Financial, Lincoln National, Prudential Financial, all have stayed steadily in the green.

But why should US taxpayer dollars, which were supposed to be used to help banks, be used to bail out insurers that are regulated by the states, which enjoy the economic benefits of their business? What next, mutual fund companies?

Why should US taxpayers bail out life insurers who routinely lobby state regulators to weaken their capital reserve requirements, and who have their policies backed by state insurance guarantee associations?

The world didn't collapse when a major life insurance company, Executive Life, folded in 1991.

A TARP bailout for the insurers is yet another controversial move by the government.

Yes, according to their industry lobby group, the life insurers own about a fifth of all corporate debt, and are the single largest owner of corporate debt in the country, so keeping insurers afloat helps defrost credit markets that have been priced for the ice age.

Yes, Americans owns lots of life insurance policies and variable annuities that the insurers sold, which are retirement investments that guarantee minimum returns regardless of stock market drops.

But despite the fact that TARP was meant to bail out bank that pose a "systemic risk" to the economy, the bailout of the life insurers is a pre-emptive rescue, none of them face bankruptcy for now. Also,  the corporate bond market is coming back, and many variable annuities are not due and owing for ten years or more.

And their bailout tosses spotlights on an important issue--the backdoor way into TARP, which is meant to rescue banks. That is, companies can try to qualify for TARP taxpayer money by buying thrifts or industrial loan companies, outfits that basically process loans and credit cards (see the column "The United States of Bailouts".)

And why should US taxpayers bail out insurers that are regulated by the states, which enjoy the economic benefits of their business? Here's what Fox News analyst Jim Farrell has to say about this:

Policy Problems

1. First, insurance companies are regulated by state authorities.  The state authorities have already determined that they are not willing to provide financial assistance to these insurance companies.  If the states are not willing to do so, why should the federal government?

* The life insurance sought nationwide capital relief from the National Association of Insurance Commissioners (the life insurance companies wanted to hold fewer assets as a reserve against policy claims than provided for under state laws).  The NAIC declined to give the insurance companies this blanket relief.

2. Second, the states where these entities are headquartered receive tremendous financial benefits from these entities.  Why should some states reap the benefits, but the costs be shared by all federal taxpayers?

* According to testimony on March 17, 2009 to the Senate Banking Committee by The Illinois Director of Insurance (Michael T. McRaith) on behalf of the National Association of Insurance Commissioners "States derive $17.5 billion in taxes and fees from insurers, with approximately eight percent (8%) used to support regulation and the remainder supporting State general funds."

3. Third, the Illinois Director of Insurance recently assured Congress that it was "unlikely" that any insurance company was "too big to fail"

* In his March 17, 2009 testimony to the Senate Banking Committee, Director McRaith stated:

- "Given that the US has the world's most vibrant and competitive insurance marketplace, it is unlikely that any one insurer is "too big to fail." If an insurer were to fail, regardless of size, State-based guaranty funds would protect existing policyholders and pay claims.

McRaith continued: "As history demonstrates, competition and capacity allow other insurers to fill marketplace voids left by the failed insurer. States also operate residual markets to cover those unable to obtain an offer of insurance in the conventional market. Therefore, even a major insurer failure, while traumatic in terms of job displacement and, perhaps, for shareholders, will generally not impose systemic risk."

4. Fourth, some states (and in at least one case clouded by a potential conflict of interest) have relaxed the reserve requirements for select insurance companies.  This means that these insurance regulators made it more likely that, in the event of a failure, the insurance company would not have sufficient funds to honor existing policy-holder claims.

Why should all taxpayers pay for decisions made by individual state regulators (especially if they had the potential of being clouded by a conflict of interest)?

*Hartford Financial Services Group, an insurer that is apparently asking for a federal handout, got almost $1 billion in reserve relief from a state regulator who is a former executive at the company, according to Bloomberg.

Hartford, which lost $2.75 billion last year, got the relief from a state regulator who is a former executive at the company, Bloomberg says.

Connecticut Insurance Commissioner Thomas Sullivan rebuffed a Feb. 10 request by the Consumer Federation of America and the Center for Economic Justice to recuse himself from matters involving his former employer, Bloomberg reports.

He approved a change in accounting standards that reduces the amount of money Hartford must hold for customer obligations by about $987 million. The insurer announced the action in a regulatory filing today, Bloomberg says.

* In addition, NewYork's insurance director Eric Dinallo gave MetLife--another federal bailout requester--a reserve benefit of about $1.8 billion.

MetLife Inc., the biggest U.S. life insurer, said in December the change would give the firm a benefit of about $1.8 billion. Regulators in Iowa and Ohio have signaled they may provide relief, Bloomberg says.

5. Fifth, just as the FDIC provided guarantees for bank accounts and thus obviated the need of the federal government to provide TARP funds to failing smaller financial institutions (and these institutions were allowed to fail), state guarantee programs and state-mandated insurance reserve requirements provide similar assurance that policyholders will be generally protected.

- Insurers have their policies backed by state insurance guarantee associations.

- The total amount of money available every year to pay policyholders in states' insurance guaranty funds is $8.8 billion, according to the National Organization of Life & Health Insurance Guaranty Associations.

- No state's insurance guaranty fund has ever been wiped out.

- In addition, the world did not end when a multi-billion dollar insurance company failed in California in 1991.

When Executive Life Insurance Company failed in 1991, 277,320 of the approximately 299,967 policies (85%) were 100% covered, with the remaining 15% of policyholders receiving between 79% and 89% of their policy's value.

6. Sixth, the root of the problem is variable insurance products sold by these companies that contained a guaranteed return provision. Meaning, they sold annuities that guaranteed a minimum return to investors. But why bail out companies who sold a risky product and also investors who knowingly took this risk?

* Investors in these products knew (or should have known) that: (1) annuities are not life insurance - they are contracts between the purchaser of the annuity and the issuing insurance company; (2) annuities are not insured by the FDIC or any federal government agency; and (3) like mutual funds, these products carried a risk that they may decrease in value or even lose all value.

* The Dow Jones Industrial Average is down about 45% since its peak in October 2007, and most mutual funds have experienced similar declines.  The federal government is not bailing out mutual funds to "make whole" investors in these vehicles because the investors took the risk that their value may go either up or down.

7. Seventh, in order to qualify for TARP funds, insurance companies bought banks or thrifts.  These insurance companies are now looking to leverage a "small" purchase to a large TARP handout.

* Hartford Financial Services Group Inc. infused $20 million into a troubled Florida thrift (Federal Trust Corp.) to qualify for TARP funds.  Hartford wants to use this $20 million investment to get access to $1.1 billion to $3.4 billion through TARP.

* This will allow the insurance company to remain largely outside of federal oversight, but still get federal funds.

* Both Morgan Stanley and Goldman Sachs fully transitioned to bank holding companies to get access to TARP funds. So did American Express, CIT Group (see blog "The United States of Bailouts.")