Is My Life Insurance Policy Safe From a Stock Market Collapse?

With all of the recent news of the U.S.’s downgraded debt and the ensuing stock market roller coaster, one has to at least wonder about the stability of their life insurance company and policy. After all, the insurance company needs to make dividend payments on permanent life insurance policies and guarantee it has the funds available to pay out all claims as needed.

No one in the financial markets has a working crystal ball to forecast and guarantee the safety of your life insurance policy, but a little bit of knowledge about life insurance companies, along with the positive and negative effects from the stock market downturn can make a substantial difference in feelings of safety bout your life insurance policy.

Volatile Markets

The stock market collapse in 2009 undermined the value of equity and bond investments, while permanent life insurance policies made a very short list of financial assets that preserved value. Some investors are starting to realize the attractiveness of life insurance as one part of a portfolio diversification strategy.

Based on life insurance companies’ stability during the 2009 market downturn, some experts are pushing for life insurance to become its own asset class. when discussing portfolio diversification with your financial planner, don’t be surprised if he or she adds permanent life insurance to the list along with stocks, bonds and fixed annuities.

Policy Guarantees

Many permanent life insurance policies have a guaranteed minimum return for cash value growth, usually slightly higher than the return on bonds.. It may help soothe your nerves to check your insurance company’s credit ratings with each of the four major credit rating agencies: Moody’s Investor Service, Standard & Poor’s, A.M. Best and Fitch Ratings. Many life insurance companies list their credit ratings from each agency on their website.

Public libraries usually carry updated publications from these agencies. If your insurance company has been downgraded, check for news releases and decide whether your specific insurer is heading toward financial trouble, or whether the life insurance industry in general has experienced a downgrade. Many insurance companies did in fact receive downgrades because of their investments in mortgage-related securities.

Life Insurance Company Challenges in the Current Market

With the challenging market conditions over the last few years, life insurance companies have experienced pressure on their market valuations, with their assets losing value. This relates in large part to the amount of investments life insurance companies maintain in stocks and mortgage-backed securities. Life insurance companies tend to limit their portfolio risk by mostly avoiding RMBS, or lower quality residential mortgage backed securities and structured financial instruments that may invest in these.

However, insurance companies have significant investments in many other markets including equities and corporate bonds, which both experienced simultaneous declining valuations. The decline in government bond rates also pointed toward a substantial increase in insurers’ liability levels.

Many life insurance companies have sold annuity products, many of which include guaranteed minimums in terms of income streams paid to annuity holders. The annuity products also have other features that cost the insurance companies more money in a declining market.

Life insurers have started investing in corporate bonds because of the low return on government securities. The corporate bonds offer some returns, but come with more risk than government securities, causing life insurance companies to have pressure on both the asset side and the liability side of the balance sheet.

Hedging strategies have been a source of protection for insurance company portfolios in recent years, to limit the impact of variable annuity contract downsides. Because of increased volatility in the market, the cost of hedging strategies has eaten into the profits life insurers earn on this activity.

Insurance companies have been forced to adopt a different strategy with variable annuity products, which had included elaborate promises of minimum returns to customers buying these products. Insurers had been hoping to attract a larger percentage of the lucrative baby boomer market, and have now reacted by adjusting, or planning to adjust, variable annuity pricing and the features offered to more feasible levels. These changes will help offset the exposure to increased hedging costs.

On the Positive Side

In all of this information, there is a positive side: life insurance companies do not tend to take on much debt, and their liabilities tend to be very long-term. This means insurers have much less liquidity risk than banks or other financial institutions that rely more heavily on debt. Life insurance companies gain more stability because they do not have high levels of fixed debt to service.

Insurance Companies as Financial Stabilizers

Here is some information that might make you feel optimistic about life insurance companies’ stability: insurance companies tend to act as stabilizing forces in a volatile economy. They are major players in the global financial markets, comprising the second largest investor group worldwide after investment funds, with over $20 trillion assets managed worldwide in 2007, according to the OECD Private Pension Outlook 2008.

Life insurance companies have liabilities with a much longer holding period than investment and commercial banks, giving them the capacity to adopt investing strategies with much longer time horizons.

As life insurers stay with these strategies and resist selling off investments when markets fall, like many other types of investors do, they act as a stabilizng force in the financial system. Life insurance companies and other insurers have contributed an important stabilizing factor during the current economic crisis.


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