What is happening to the life industry?

The crisis in the life industry began long before anyone could understand the trouble it was getting in by selling variable life insurance products.

About a decade ago, very savvy consumers began looking for quick returns on their investments and discovered what they thought was a relatively easy way to do it.

They decided to opt out of purchasing whole life insurance policies (provide both death benefits and investment accounts) and began purchasing term life insurance policies (provide death benefit only with no investment component).

Their decision was based on the assumption that they were better investors of the money freed up by purchasing only term life policies than were the old fashioned, conservative life companies.

This change in insurance buying can be directly related to the dizzying success of the stock market, the Internet boom and the growing desire of the masses to get rich quick.

The life industry not wanting to lose out on this lucrative business then responded to the needs of these "sophisticated life buyers" by selling variable life insurance.

Basically variable life insurance means a policyholder pays premiums to his insurers with the right to tell his insurer where he wants his premiums invested i.e. in which stocks or bonds ( very similar to the mutual fund concept).

The idea caught on almost immediately so much so that by the end of 2000, more than 40% of all life insurance premiums were paid into variable life policies. Not bad for an old fashioned industry everyone thought.

But as we all know all good things must eventually come to an end.

But no one could have predicted just how harsh the end would be for variable life policies in a very short period of time.

It was at the peak of the life industry that many large insurance companies saw this industry as the wave of the future because of how well it had performed.

They wanted in because they sensed untapped opportunity that was theirs for the taking. In addition, many erroneously believed getting into the life industry was a "safe" way to diversify their portfolios.

Their entrance into this industry gave it the capital boost it needed to catapult the sale of variable life policies. For a while everyone was making money.

However, since 9-11, Enron, and the resultant downturn in the economy, the life industry has proven to be a very risky business to be in because its results are largely contingent upon the equities market.

The decline in the stock market has revealed in a big way just how vulnerable the life industry is to the stock market. Never before had any analyst, underwriter or senior executive realised just how "co-dependent" the life industry and the equities market really were.

Many life companies have been left holding the bag with several of the high profile bankruptcies such as WorldCom, Kmart, Global Crossing, etc.

Because of these bankruptcies, the bond portfolios of life insurance companies have been largely devalued.

It is widely accepted that the life industry will generally perform poorly in market downturns.

However what no one anticipated was the loss of value of these companies as a result of investing in companies that were considered to be financially stable.

Now life companies don't know where to invest their portfolios because if financially credible companies can't be trusted then who can?

Two of the largest life insurance companies in the world, Equitable Life in Britain and Swiss Re are in critical condition.

Metropolitan Life and Prudential became public companies so they could sell more variable policies and now they are both trying to come up with new products to regain the confidence of buyers who lost their shirts on policies they purchased from them. Bermuda has also not been spared from the crisis in the life industry. Recently, Annuity and Life Re, the first life reinsurer to set up on the island, was downgraded by the rating agency Fitch, causing Annuity's stock to tumble.

This was exactly at the time it needed to preserve share value because selling shares is one of the quickest ways to rejuvenate capital.

A short time later, the CEO announced his retirement as the company began fighting for its very survival.

Unfortunately, Annuity's mission statement is based on variable life products and until consumer confidence is restored in the value of buying annuities again, Annuity and companies with the same philosophy will find themselves hard hit in the market.

Many experts in the industry say now is the worst time to pull out of variable life policies because the market is so cheap making it the best time for savvy investors to buy in.

But I would say only if you have the time to wait out this very different bear market.

Just as a matter of interest, Annuity and Life Re was not singled out for its poor performance, Fitch downgraded 42% of all the life insurance companies it tracks signifying its concern of how risky annuities to life company's bottom lines.

Standard & Poor's also lowered its outlook for the life industry to negative because it is concerned about the strain on companies' capital as a result of: increased losses on credit instruments, decreased value in equity holdings, increased reserve requirements for guaranteed minimum death-benefit products and growth in fixed-annuity products. S&P's major concern for the life industry is the strain on capital resulting from the declining equities market.

The real problem right now is where do life insurance companies invest the large premiums they take in from policyholders in order for them to make adequate returns to be able to diversify their risks?

And, what do they do to help restore the confidence of many investors who have been severely burnt by the decline in the stock market?

Or is it just time they went back to boring old traditional whole life insurance products because at least then they were safe?

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Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffycwbda.bm