“There’s something wrong with us, something very, very wrong with us. Something seriously wrong with us . . .”
— Bill Murray, Stripes
Based on the steady stream of bad news, you’d think Bill Murray was addressing top managers of America’s biggest insurance companies – rather than the misfits and assorted losers of his fictitious 1981 army platoon. If you don’t see the similarity, take a look at a recap of recent industry news and see if you don’t draw the same conclusion that there is something very, very wrong with the current health of the insurance industry and the culprits who made it all possible:
• The 24-stock KBW Insurance Index fell 48 percent in 2008, with MetLife down 43 percent, Prudential off 67 percent and Hartford plummeting 81 percent.
• A.M. Best Company, the primary rating agency for the insurance industry, downgraded 43 companies and issued only 14 upgrades. In the annuity sector Best issued 31 downgrades and only eight upgrades.
• AIG, one of the largest, highest rated and most respected companies in the industry pleads for, and receives, $150 billion in government funds, just to stay in business (the company is now effectively under the control of the government).
• Great icons of the industry – Hartford, Prudential, Lincoln National Corp. and Principal Financial – have been humbled to the point of restructuring in order to beg for a federal financial bailout.
• The capital and surplus (funds needed to grow the insurance company) for the industry declined by over $77 billion dollars in 2008.
• Insurance industry employment declined in 2008 as did the sales of life insurance and variable annuities, and continues to contract in 2009.
And if you thought the industry’s report card for the New Year would reveal a more promising battery of results, you’d be mistaken: the unremitting cascade of dismal reports continued akin to a Chinese water torture:
• Feb. 1: The American Council of Life Insurance argues to the National Association of Insurance Commissioners that some insurers are in such dire shape that they needed immediate relief from state policy reserve requirements.
• Feb. 5: Bloomberg.com reports “Prudential Financial Inc, the second-largest U.S. life insurer, posted its worst loss as a publicly traded firm …” Fourth-quarter losses hit $1.57 billion, compared with a profit of $871 in the year-earlier period …” Bloomberg adds that Prudential is, “Seeking to replace capital it lost on stock market slumps and bond defaults by cutting the dividend, selling a stake in a securities brokerage and applying for government aid.” Not a pretty picture.
• Feb. 6: A.M. Best Co. reports “Hartford Posts $806 Million Loss in Fourth Quarter” posting a $2.75 billion loss for the full year, compared with a $2.95 billion profit in 2007. Hartford slashes its dividend by 84 percent.
• Feb. 6: Moody’s Investor Service reduces Hartford’s long-term senior debt rating to Baa1, denoting below average credit rating. The ratings for Hartford’s property and casualty and life subsidiaries were downgraded to A1. Moody’s points out that all the ratings have negative outlooks, meaning more downgrades may follow.
• Feb. 9: “U.S. life insurers Principal Financial, Lincoln National and Genworth posted fourth-quarter losses, hurt by soured investments” reports Reuters.
I could go on and on, but I’m sure you get the point.
How Did Things Go So Very, Very Wrong?
As complex as the situation may seem, the reality is quite simple. To quote Pogo in the famous cartoon, “We have met the enemy and he is us.”
But how could this happen? Simple. Insurance companies had persevered and prospered for almost two centuries – through all the ups and downs and swings in financial cycles. And they achieved this stellar performance for one reason: they were boring to the point of tears. The consumer might expect to be surprised, excited or depressed by their investment company, but not their insurance company. Insurance companies were tried, true, and always delivered on their promises.
But then a change in direction. Out of a misguided and perceived need to compete with banks and investment firms, (and no small amount of greed and incompetence among insurance executives) insurance companies shifted from their staid, risk-aversive, long-term growth business model to a short-term, risk-aggressive approach.
As the largest insurance companies converted from the mutual insurance to stock insurance concept, the focus of management shifted from long-term policy value and security to short-term stock price. It became more important to manufacture increasing quarterly earnings than building long-term values for the company and policyholders. Short-term gratification replaced long-term stability.
Selling long-term products while seeking short-term results is not consistent or in parallel with the right thing to do. By trying to serve two masters insurance companies lost sight of the fact that their success, credibility and respect in the market was achieved by taking a long-term view of long-term consumer needs. Bowing to the gods of short-term results, insurance companies drifted away from the tried and true concept of managing the risks of others for a fee and began to actually assume the risks. Insurance companies had made an art – boring as it was – of understanding and managing risk. If the risk could be turned against them – they walked away. If the risk was not understood – they turned it down. If the risk could not be managed – they did not take it. Decades of loyalty to these principles created credibility with the consumer and resulted in solid, consistent – if not spectacular – growth and profitability.
After the companies began to list their stocks, they were soon sucked into the vortex of quarterly results. The pressure of peers in financial services and the “everyone-is-doing- it” philosophy magnified the anxiety of insurance executives and (in their mind) this justified violating the traditional principles of insurance management. The news of the day confirms the fallacy of such logic. As Chester A. Riley (William Bendix) would say in the popular 1950s TV sitcom The Life of Riley, “What a revoltin’ development this is!”
Despite the pain of these financial problems, the insurance industry may pay an even greater penalty for its missteps. This penalty comes in the form of lost credibility with the consumer. When an individual buys an insurance policy to protect against potential loss, the decision is often based on the belief in the credibility and veracity of the insurance company to meet the promises and guarantees made.
Once that bond of trust between the consumer and the insurance company has been damaged – as has begun to happen – there is, in reality, no way or reason for an insurance company to continue to exist.
What Can Be Done To Right The Wrong?
Assuming the insurance industry can extricate itself from the quicksand of financial problems it has created, the single most important challenge for the industry is to recapture the trust and confidence of the consumer that has been damaged by the head-long rush for short-term results. The recipe for this is simple – Get boring again!
Author Jim Collins writing in his business bestseller Good to Great, encapsulates that thought nicely with his comparison of the fox and the hedgehog. “The fox knows many things. But the hedgehog knows one big thing.”
By way of example, Collins notes that Walgreens, the hedgehog, generated cumulative stock returns from the end of 1975 to 2000 that exceeded the market by over fifteen times, handily beating such great companies as GE, Merck, Coca-Cola, and Intel. “It was a remarkable performance for such an anonymous – some might even say boring – company,” wrote Collins. Walgreens’ competitors never gained the advantage of the hedgehog because their efforts were scattered, diffused and inconsistent.
The insurance industry executives could learn a lesson here, too. They should recognize once again that there is not only virtue, but profit in the concept of knowing and practicing the “one big thing”: being boring when it comes to protecting and preserving an individual’s financial well being. That means being conservative, consistent, stable, and reliable.
It used to be that the most important product the insurance industry sold was, “peace of mind.” People bought insurance not for what they would get, but for what they would get to keep. If a person purchased life insurance it brought peace of mind knowing that if they died their family would get to keep their lives. If a person deposited funds in an insurance annuity, they had peace of mind knowing the insurance company would keep the funds safe till they wanted to get them back. When an individual placed their retirement funds with an insurance company they had peace of mind in knowing there would always be a steady income, no matter how long they lived.
Unfortunately, today’s generation of insurance company executives do not seem to understand or appreciate the concept of “peace of mind.” For them, the idea of peace of mind is soft and uncool. Instead, these executives have bet the future of their companies on complicated, confusing, gimmick laden, risky products that are thinly disguised as investments, not insurance. The products may be “cute,” but they lack any vestige of real creativity or innovation needed to meet modern consumer needs. It is a losing bet.
If the insurance industry is to right the self-inflicted wrongs it suffers from today, it must once again recognize that the only reason for the existence of insurance itself is to provide “peace of mind.” The irony is that providing the consumer with “peace of mind” is not all that difficult. The survival and success of the insurance industry comes down to a straightforward – boring – yet proven philosophy. Do simple things, but simply do them.