BILLION-DOLLAR BANKRUPTCIES: The Potential Crisis in the Insurance Industry by Barry J. Hershey

BILLION-DOLLAR BANKRUPTCIES: The Potential Crisis in the Insurance Industry

Email this review


On paper, notes the author of this well-documented alert, single-premium tax-deferred annuities--a form of insurance designed to protect against living too long rather than dying too soon--are good deals for buyers as well as sellers. For those who purchase contracts, interest on their principal, plus interest compounded on that interest, accumulates tax free until they withdraw more than their one-time lump-sum premium or begin receiving regular income payments. The interest return cannot go below a designated rate, typically, three percent to four percent, and the legal-reserve life insurance companies that issue contracts pay overrides, the sizes of which depend on corporate investment results; during the 1974-79 period, total returns ranged between seven percent and ten percent. Further, underwriters guarantee that annuity customers can recover their principal and/or accrued interest on demand. Consequently, single-premium tax-deferred annuities represent a lucrative source of revenue for life insurance companies and the securities brokerage firms that, since the mid-1970s, have handled most of the marketing chores. But as a practical matter, reports Hershey (who heads a life company), there's more wrong than right with the trade in annuity contracts. Issuers, he charges, are borrowing short and lending long--accepting what amount to deposits from contract buyers who have the option of taking back their money at any time, while investing the take in long-term debt instruments (like bonds or mortgages). And, in an inflationary environment, there's little chance to dispose of such reserve assets at original cost on short notice. Even now, the difference between realizable market value and cost in many issuers' portfolios exceeds their capital and surplus accounts; this means that on a balance-sheet or liquidation basis, these underwriters are in default. As yet, no legal-reserve insurance company has gone bankrupt because of a ""run"" on the annuity bank; but in the absence of rigorous regulatory restraint, the chances are good that one or more could wind up in receivership. (The SEC, he notes, has been foiled in its efforts to get annuities classified as securities, so 50 state insurance commissions exercise the only government oversight.) Clients, moreover, could bear the brunt of this risky business, since there is no safety-net agency like the FDIC to recompense contract holders in the event of default, and industry guaranty associations lack sufficient assets. As possible reforms, Hershey offers a few Hobson's choices, including creation of a federal guaranty association or lender of last resort and legal limits on withdrawals. While the suggestions for safeguards are weak, the overall indictment is likely to jolt both Wall Street and Main Street.

Pub Date: Sept. 2nd, 1980
Publisher: Abt Books