Major Changes Ahead for the Insurance Industry?

BY AARON STEIN

Welcome back. I hope everyone had a great Thanksgiving. This post will not be about the New York auto or home insurance coverage that we usually cover. This time I will be highlighting some larger trends that in some cases have already come to affect other industries but may now be coming to an insurance policy near you.

One such new area is that the 'capital markets' are starting to make eyes at the insurance industry. When I say capital markets, I'm talking about monies raised by the giant investment firms like Merrill Lynch or Goldman Sachs. Up until now, insurance companies raised the money needed to back their insurance products by selling stock, and collecting premiums and investing them. But now these super-sized financial companies have become experts at raising literally billions of dollars quite quickly and efficiently, in their constant efforts to find investments to sell to their clients.

Traditionally, these financial companies would raise money for other companies by underwriting offers of their stocks and bonds. So if General Motors wanted to raise a billion dollars to invest in a new vehicle product line, for example, they could have Merrill agree to make good faith efforts to sell enough shares of GM stock (remember that stock represents an ownership interest) or GM could offer corporate bonds (debt that has to be repaid, but does not give up any ownership) for a similar amount. They would have to weigh the plusses and minuses of each.

Now, however, with the advent of things like hedge funds, and giant pension funds and even major individual investors looking to put their money to work, enough capital can be raised to start whole new companies and industries. The capital markets were a major force behind the growth of sub-prime mortgages over the past several years, as investors chased higher yields which could only be had by coming up with the many strange variations of mortgages, and in many cases giving them to people who, it turns out, couldn't afford them and are now facing serious financial problems.

These companies could end up having a huge impact on major insurance coverages such as catastrophe insurance. For instance, billions could be quickly raised to offer reinsurance (the kind of insurance that insurance companies buy for themselves against major events like hurricanes) except that instead of insurance companies buying their reinsurance from traditional markets like Lloyds, or SwissRe, they might look for better deals from the capital markets.

Competition is generally good in that it reduces costs. For instance, it would help us here on Long Island right now if insurance carriers could lower their cost of reinsurance for windstorms and hurricanes. That's what is causing all the disruption in the insurance market for waterfront homes these days. On the other hand, the capital market's tendency to use overly aggressive sales pitches, and only shoot for short term profit as opposed to long term viability, can make for quite a mess. Right now we are going through a mortgage and real estate crisis that was made much worse by predatory lending practices and speculation, fostered by these 'capital markets' chasing down an extra per cent or two of interest on their money through sub-prime mortgages.

The one thing about insurance that is different from almost any other kind of product, is that you can have catastrophic, once-in-a-lifetime events like Katrina or the four hurricanes in 3 weeks that hit Florida a couple of years back. These require careful long-term planning and an industry with plenty of real money behind it. I'm not sure I want to see insurance get the same kind of treatment as the mortgage industry has gotten this year as a result of reckless short term practices over the past couple of years.

Next up, will the next Presidential election bring a total change to our health insurance system? As always, you can contact us through our web site at http://www.nyinsurancewithservice.com/