Legislation - insurance

Because the industry was built in a climate of legislation, regula­tion, and business plans designed for a stable economy with a 3.62 percent average prime rate, its performance was less than satisfactory in the volatile 1970s and 1980s. In fact, in the early 1980s, the Federal Trade Commission's report on life insurance cost disclosure stated that effective price competition did not exist in the life insurance business and that rates of return were not what they could be. The government was complaining about low rates of return! In a turnabout, after the blizzard of failures in the 1990s, the government forced through legislation that requires the general accounts of insurance companies to be invested in safe portfolios that will have low rates of return.

The government-mandated portfolios of long-term bonds and mortgages, which insurance companies accumulated during the long period of relatively low interest rates, did look bad in the period from 1979 through 1983. The rates of return looked espe­cially low when compared with the money-market rates that were available in the early 1980s, for example, 12.78 percent in 1980, 16.82 percent in 1981, and 12.23 percent in 1982. But, then, all long-term, interest-sensitive investment vehicles, such as whole life in­surance policies, look bad in an economy in which the interest rate is increasing.

The Tax Reform Act of 1984 created a niche market for single-premium life that would pay the high current interest rates of the day. Then legislation in 1988 limited the amount of money that could be put into this type of policy to earn The high interest rates and consequently snuffed out the product. The insurance industry in those days went for higher interest rates as consumers cried, "Higher than the rest... why take less?" Aggressive companies like Executive Life pushed the junk bond mania beyond the limits and failed. Consumers learned from these failures, and the pen­dulum swung back. The next cry, heard in the 1990s, was "Rated best... I won't take less"

Insurance company rating services sprang into prominence. Standard & Poor's (standardandpoors.com), Moody's (moodys. com), Duff and Phelps (which joined with Fitch Financial) (dcrco.com), Weiss (weissratings.com), and A. M. Best (ambest. com) all blessed or damned insurance companies with their ABCs and created the public demand for "AAA." Meanwhile the supply of AAA-rated companies decreased to a handful.

Of course, we all criticized the government and state insur­ance commissioners for not correcting the problems sooner and preventing insurance company failures. Now the insurance com­missioners of the various states are responding through their cen­tral organization, the National Association of Insurance Commis­sioners (naic.org). They tell the insurance companies how much surplus (assets in excess of liabilities) the companies need to be considered financially sound. They call this measure the risk-based capital ratio.

Thus if an insurance company has assets the commissioners define as risky, the company needs to have more surplus than if it has assets the commissioners deem to be safe, such as short-term government bonds. So what do you think the insurance com­panies are doing? They are managing their general account in­vestments to get high grades from the commissioners because they know that you, the public, want that now. You and the regulators are getting what you have asked for, squeaky clean general ac­counts that are earning what you would expect from a low-risk, low-return type of investment. The returns in the general account type of product are often so low that they are close to the mini­mum contract guarantee. It is entirely possible that the day will come when your company skips its dividend in your whole life policy, or says it will pay only the minimum interest guaranteed in your universal life contract.