Life Insurance Systemic Risk

[Aberhound]

National Post published an article in todays Financial Post section which may be viewed online by subscribers. The title and author are set out below and my summary to help you find the original. It is worth the read.

 

I looked up the state guarantee associations and it appears true that other insurance companies in the same business have agreed to make up the shortfall up to a limit. It looks to me that it is another ''pay as you go" scheme which creates the systemic risk. Here is a link showing the state guarantees are mostly limited to $100,000 when the policies are cashed in. Well at least there is a limit on the risk. I wonder if this is why Fairfax is not in the life insurance business? If so we have another reason to be grateful for Prem's foresight.

 

Here are my musings on the implications. Japanese insurance companies had problems in the last decade after their crisis because the fall of interest rates made it impossible for the insurance companies to pay the amounts they had agreed to pay. So even if there were no Ponzi scheme the current policies of low short and long term rates causes problems in the pension, life insurance and annuity industries which no longer can earn sufficient income to pay the contracted amounts. As usual in economics when you try to fix something you mess up something else. Since we are likely to have low rates for a long time and since the crisis has decimated the investment portfolios of the affected companies it would be prudent to cash in permanent life insurance policies which are worth more that the insured limit. This is similar to how you never want more than the deposit insurance limit deposited in one bank except this is worse because banks only have to pay small deposit insurance premium and they don't have to cover shortfalls after the fact except to pay for any increases in the deposit insurance premiums. If you hold any companies in the US life insurance or annuity businesses you better check the systemic exposure.

 

http://www.nolhga.com/policyholderinfo/main.cfm/location/questions#one

 

4 Mar 2009 National Post

BY ANDREW ROSS SORKIN The New York Times

Rush to cash AIG policies could bring down sector

 

(my summary of a portion of the article so I don't breach copyright)

 

AIG in US 375 million life insurance policies worth US$19-trillion of face value.

 

If policyholders 'run on bank' by cashing in AIG policies could lead to failure of US life insurance companies.

 

If AIG fails to pay the State guarantee funds require other life insurance companies to pay in fund to cover the shortfall maybe bankrupting them too.