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 Rise
in Bank Failures.” Hmm. Looks like the FDIC knew
what was coming. Here’s the lead from a Sunday, July
13, 2008 NPR report ( www.npr.org ):

Federal regulators seized IndyMac
Bank Friday, one of the nation's largestlenders, because of questions about its
viability.

The bank is now being run by the
Federal Deposit Insurance Corporation
(FDIC). The bank is the largest mortgage
lender to fail during the housing crisis and
is one of the biggest banks to collapse in
U.S. history.

John Reich, director of the Federal
Office of Thrift Supervision, said Friday
that IndyMac "failed due to a liquidity
crisis," that is, it ran out of money. The
OTS said it transferred IndyMac's
operations to the Federal Deposit
Insurance Corp. because it did not think
IndyMac could meet its depositors'
demands.

The purpose of the FDIC is
to insure the savings of
depositors, and the agency’s
actions were typical for such an
intervention : The government
stepped in on Friday, and by
Monday, the bank’s customers
were being served, ATMs were
working, and debit cards and
checks were honored. But
regulators also acknowledge that more banks are likely
to fail.

As the housing crisis unwinds, it’s unnerving to think
that even your savings might not be safe. But despite the
trouble plaguing many financial institutions, guess
which sector appears to be holding steady? Wellmanaged,
mutual life insurance companies.

A report on the “Townsend 100” (one hundred life
insurance companies, comprising 85% of the industry)
published in the July 7/14, 2008 National Underwriter,
showed that even in the tough economic environment of
the past several years, the companies showed a record
$30.4 billion in operating earnings in 2007, and a surplus
gain of 6.4% over the previous year, the highest
percentage increase since 2004.

As a specific example of financial strength in the
midst of widespread downgrades for financial
institutions, on July 18, 2008 Standard & Poor’s
announced it had raised credit and financial strength
ratings of the Guardian Life Insurance Company of
America from AA to AA+. S&P cited a “very strong
capital adequacy and liquidity, a stable earnings profile”
as reason for the upgrade, and added there was “limited
speculative-grade credit risk and no exposure to
subprime mortgages.”

It’s no surprise that life insurance companies remain
solid. No financial institution – bank, brokerage house,
mortgage lender, insurance company – is free from the
possibility of failure. But there are several characteristics
of life insurance companies that tend to make them more
capable of surviving financial distress. Among the most
prominent:

• Life insurance companies cannot practice
fractional banking, i.e., they cannot lend more than
they have in deposits. In addition, they must keep
sufficient reserves to meet claims. These
constraints promote conservative and prudent use
of the premiums they collect.

• Their primary business purpose – providing
monetary benefits on the death of an insured
individual – is supported by extensive
mathematical research. Unlike other types of
insurance where coverage and costs may be

manipulated through definitions of what is covered
or deductibles and waiting periods, life insurance is
based solely on whether one is alive or dead. This
makes for stable pricing, and a very low incidence
of insurance fraud.

• The mutual company model is cost-efficient.
Mutual insurance companies are owned by the
policyholders and rely on premiums for capital to
support the company, with any excess money
returned as dividends to the policyholders. John
Bogle, the pioneer of the Vanguard mutual funds,
acknowledged that he built his company on the
concept of a mutual life insurance company
because it was a “structure designed to put the
client in the driver’s seat. And that structure must
lead to a strategy that is founded on delivering
services at the lowest reasonable cost.”

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

The institution of life insurance has
gradually and spontaneously taken shape
in the market over the last two hundred
years. It is based on a series of technical,
actuarial, financial and juridical principles
of business behavior which have enabled it
to perform its mission perfectly and
survive economic crises and recessions
which other institutions, especially
banking, have been unable to overcome.
Therefore the high “financial death rate”
of banks, which systematically suspend