A Stable Financial Shelter for Tough Times

A small article on an inside page of the February 26,
2008 Wall Street journal read “FDIC Readies for a Risenin Bank Failures.” Hmm. Looks like the FDIC knewnwhat was coming. Here’s the lead from a Sunday, Julyn13, 2008 NPR report (www.npr.org):nnnFederal regulators seized IndyMac
Bank Friday, one of the nation's largestnlenders, because of questions about itsnviability.

The bank is now being run by thenFederal Deposit Insurance Corporationn(FDIC). The bank is the largest mortgagenlender to fail during the housing crisis andnis one of the biggest banks to collapse i

U.S. history.

John Reich, director of the Federal
Office of Thrift Supervision, said Fridaynthat IndyMac "failed due to a liquidityncrisis," that is, it ran out of money. ThenOTS said it transferred IndyMac'snoperations to the Federal Deposit
Insurance Corp. because it did not think
IndyMac could meet its depositors'ndemands.

The purpose of the FDIC isnto insure the savings ofndepositors, and the agency’snactions were typical for such annintervention: The governmentnstepped in on Friday, and by
Monday, the bank’s customersnwere being served, ATMs werenworking, and debit cards andnchecks were honored. Butnregulators also acknowledge that more banks are likelynto fail.

As the housing crisis unwinds, it’s unnerving to thinknthat even your savings might not be safe. But despite thentrouble plaguing many financial institutions, guessnwhich sector appears to be holding steady? Wellmanaged,nmutual life insurance companies.

A report on the “Townsend 100” (one hundred lifeninsurance companies, comprising 85% of the industry)npublished in the July 7/14, 2008 National Underwriter,nshowed that even in the tough economic environment ofnthe past several years, the companies showed a recordn$30.4 billion in operating earnings in 2007, and a surplusngain of 6.4% over the previous year, the highestnpercentage increase since 2004.

As a specific example of financial strength in thenmidst of widespread downgrades for financialninstitutions, on July 18, 2008 Standard & Poor’snannounced it had raised credit and financial strengthnratings of the Guardian Life Insurance Company of
America from AA to AA+. S&P cited a “very strongncapital adequacy and liquidity, a stable earnings profile”nas reason for the upgrade, and added there was “limitednspeculative-grade credit risk and no exposure tonsubprime mortgages.”

It’s no surprise that life insurance companies remainnsolid. No financial institution – bank, brokerage house,nmortgage lender, insurance company – is free from thenpossibility of failure. But there are several characteristicsnof life insurance companies that tend to make them morencapable of surviving financial distress. Among the mostnprominent:
• Life insurance companies cannot practicenfractional banking, i.e., they cannot lend more thannthey have in deposits. In addition, they must keepnsufficient reserves to meet claims. Thesenconstraints promote conservative and prudent usenof the premiums they collect.
• Their primary business purpose – providingnmonetary benefits on the death of an insurednindividual – is supported by extensivenmathematical research. Unlike other types ofninsurance where coverage and costs may bennmanipulated through definitions of what is coverednor deductibles and waiting periods, life insurance isnbased solely on whether one is alive or dead. Thisnmakes for stable pricing, and a very low incidencenof insurance fraud.
• The mutual company model is cost-efficient.
Mutual insurance companies are owned by thenpolicyholders and rely on premiums for capital tonsupport the company, with any excess moneynretu
ed as dividends to the policyholders. Joh

Bogle, the pioneer of the Vanguard mutual funds,nacknowledged that he built his company on thenconcept of a mutual life insurance companynbecause it was a “structure designed to put thenclient in the driver’s seat. And that structure mustnlead to a strategy that is founded on deliveringnservices at the lowest reasonable cost.”

In his 2006 book Money, Bank Credit, & Economic
Cycles, Spanish economist Jesús Huerta de Sotonprovides the following assessment of life insurancencompanies relative to banks:

The institution of life insurance hasngradually and spontaneously taken shapenin the market over the last two hundrednyears. It is based on a series of technical,nactuarial, financial and juridical principlesnof business behavior which have enabled itnto perform its mission perfectly andnsurvive economic crises and recessionsnwhich other institutions, especiallynbanking, have been unable to overcome.
Therefore the high “financial death rate”nof banks, which systematically suspendn