Life insurance as a bet on lower surpluses or insolvency.
Even if the banks are rescued by the state, the life insurers may have to pay for it with their own insolvency. At the very least, however, there is a threat of a reduction in surpluses and thus a lower pension provision for privately insured persons. In the portfolios of the insurers, in addition to the real toxic assets – pure bets whose total loss is imminent – there are also high-risk loans to banks, which are still regarded by the insurers as “safe fixed-interest securities”.
Lack of transparency and risk management
The hope of neoliberalism that the market will sort it out will not be disappointed in the end: Bank and insurer bankruptcies are the receipt for a naïve greed for more returns – without any regard for risks and creditworthiness. Psychics and fortune tellers, modernly called rating agencies, are booming.
Even the largest reinsurer has recognized the problem at its core:
A lack of risk management, inadequate consideration of the relationship between risk and return, and new accounting rules are an invitation to intransparency. Investments at the roulette table by insurers since 2000 were followed in 2002 by the balance sheet rule of “hidden charges” – making losses almost invisible – and allowing profits to be distributed that they did not have.
The political response in 2008 to new losses from “structured securities” in financial institutions was the de facto abolition of insolvency in the event of over-indebtedness. Obfuscation undermines investor and lender confidence.
But the financial supervisory authorities, in their traditional anticipatory obedience, will certainly keep a watchful eye on the lack of risk management. If the investments together are more than 25 % above their actual value in the balance sheet, one wants to check these valuations there first of all for sustainability.
Total default risk: Insurers’ investments in subordinated loans
In its “Special on the Financial Crisis”, the “map-Report” points to the low ratio of American junk mortgages and shares in the financial investments of life insurers: “Concern is unfounded”.
Meanwhile, the risk is in subordinated loans from insurers to banks, which offer a minimally higher interest rate compared to the conceivable risk of total default: Such investments are based on the belief that a real risk can be glossed over and that any return, no matter how high, can ultimately be safely earned: structured promissory note loans and subordinated investments were often bought by life insurers who wanted to use these “safe fixed-interest securities” to generate the return required to pay guaranteed interest and profit participation.
80 percent loss – no balance sheet truth
Now, on average, these papers are worth only 20 cents per euro of nominal value and sometimes less, but the insurers do not like to report this and do not have to, as long as the interest is paid and the papers can be held until the end and are then “presumably” redeemed by the banks at the end. However, this is not even certain of the other bank bonds to be serviced on a priority basis, which are also unsecured.
The insurers justify this hope-based accounting quite legally by saying that there is (so far) no run on their money by insurance customers and that the benefits to customers – instead of being paid from the sale of securities – can be paid from current premium income and that, in addition, the banks are being rescued. This would be just like a craftsman not getting the drain of the new bathtub tight and pointing out that you could fill up with fresh water at will.
Whether the customers accept it in the long run that their genuine fresh contribution money is paid out immediately to others and they receive shares in meanwhile nearly worthless papers for it, is questionable, works however even with snow ball systems.
Suspension of payments on subordinated loans by insurers
Now, however, it is becoming apparent that, although the banks are being rescued in general, executive salaries and dividends are being cut or suspended and – to the surprise of the insurers – the subordinated investments are also not being serviced with interest and repayments for the time being and may not be redeemed at all in the end.
The price decline of so-called hybrid bonds can be tracked daily on Bloomberg. Subordinated bonds are risk capital of the banks – for the risk that they will not pay interest and be redeemed if necessary, a little more return is promised. Others, who have also provided banks with billions in equity capital, are now being confronted by the state with the alternative of voluntarily surrendering their shares at a fraction of the billions originally paid for them, or being expropriated by laws quickly created for this purpose.
With costs to the taxpayer high despite such measures, it would be difficult to understand why insurers invested in risky subordinated bonds would be the only ones exempted from the risks they deliberately took. In the case of BayernLB, for example, Brussels has already intervened and is approving the state aid, but only on condition that subordinated loans are prohibited from being distributed.
It is precisely the rescue of the banks that is leading to the subordinated loans (which were subscribed to almost exclusively by institutional investors such as insurers) possibly becoming not only virtually unsaleable, but also quite worthless in real terms. However, if their redemption can no longer be assumed, they must also be written off immediately.
Insurance association announces benefit cuts
The reaction of the insurance industry is not to get rid of incompetent financial managers and install sound risk management; after all, to this day, even in banks, internal auditing is still unable to provide information about the exact extent of the risks in their own investments. Quite the opposite:
The insurers threaten the banks and (more or less indirectly) the state to restrict their refinancing options if the interest and redemption payments on their subordinated loans are not serviced. In addition, the old-age provision of policyholders would be reduced, which the state is just about to convert to increased capital cover with billions in tax subsidies.
It is unlikely that the state will be impressed by such threats. Perhaps one should concentrate on classic promissory note loans or better Pfandbriefe, without structures and without subordination – with a really good prospect of repayment.
CFOs with their backs to the wall
In short, although the banks are being rescued, this means that the subordinated loans made by insurers to banks in particular are by no means safe. Or precisely because they are being rescued, the interest and redemption payments on subordinated loans are not being made.
And thus the exact opposite of what the insurers claim is true. We will probably have to accept that the insured will also have to contribute to the bank bailout with lower pensions.
And because this is the case, there could also be a run on insurers that ultimately forces the sale or write-off of the securities in question – because it can no longer be assumed that they can be held until the end and then redeemed. The actuaries of the DAV are currently working out a concrete indication of how surrender values can be additionally reduced in such a case, e.g. a run on insurers in a financial crisis.
This is legally possible according to § 169 (6) VVG – and in any case already according to the regulation on the current value applicable to old contracts. It also makes the value of life insurance as loan collateral questionable.
Distrust leads to advance payment and increased use of loan collateral
The lack of transparency in the accounting rules leads to mistrust. Entrepreneurs are increasingly demanding payment in advance. Institutional investors, for example, will also have to ensure that their capital investments are secured in a way that retains their value. This trend will hardly be halted for the time being, because as a result of rating downgrades, government bonds from Italy and some other securities have also been devalued, contributing to “hidden burdens” or write-down requirements for insurers.
Where is my money still safe?
Investors will ask themselves whether they want to continue to expose themselves to the considerable risks associated with investments in life insurance policies. Nobody told these customers beforehand that numerous financial directors of the insurers would carry the money directly to the casino – the insurance savers could have done this themselves.
According to supreme court rulings, such developments can even lead to the terminability of contracts that are contractually non-cancellable in and of themselves. Which Riester or Rürup customer is happy to watch his pension being burned or accept that he will only get his money back once he, as a taxpayer, has paid a multiple to save it? However, the life insurance industry has a much bigger problem: it has gambled away the trust of its customers.
And she continues to work on it openly. Bonuses for losses instead of personnel changes, gambling addicts as financial managers, intransparency instead of depreciation and risk management. The U.S. stock market letter Heibel-Ticker writes, “My advice to you – avoid life insurance like the devil avoids holy water.”
Since all insurers are more or less similarly affected, the hope that they could save each other in a general financial crisis – via “Protektor” – is also extinguished. Those who are already invested in insurances based on collective risk bearing and collective investment will not be able to simply withdraw their money in an act of unsolidarity at the expense of those left behind.
Here, the insurers have sufficient means and possibilities to protect the customer, who has remained loyal to his insurer, from being harmed by such investors speculating selfishly against the collective. Therefore, insurers will probably survive the crisis somehow.
by Dr. Johannes Fiala and Dipl.-Math.Peter A. Schramm
by courtesy of
www.campingimpulse.de (published in CampingImpulse issue 01/2010, pages 32-33).
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About the author
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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