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Life Health > Life Insurance

Too Big To Be Unconventional?

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Not long ago, a Nobel Prize winner told a Congressional hearing that financial giants should stick to conventional products.

This raises a lot of questions. What impact would such a government restriction have on product competition? On product innovation? On consumers? On distributors? More on that later.

NU‘s report on the hearing, by Senior Editor Allison Bell, indicates that Columbia University economist Joseph Stiglitz made this suggestion in written testimony to the Joint Economic Committee in April 2009.

“Being too big to fail creates perverse incentives for excessive risk taking,” Stiglitz had said. “The taxpayer bears the loss, while the bondholders, shareholders, and managers get the reward.”

Stiglitz said giant banks should be “forced” to return to the “boring business of doing conventional banking,” and that too-big-to-fail insurance companies should be “limited” to selling “conventional insurance products, with well defined actuarial risks.”

Like it or not, insurance professionals have a stake in this issue.

For as long as I can remember, insurance advisors have wanted and needed new products–conventional and innovative; simple and complex.

Career agents rely on their carriers to provide both types and to allow outside brokering for products not available in-house. Independent agents and brokers expect their primary carriers to offer both types, but they routinely go wherever they must to locate a product to fit a unique customer’s need.

If the too-big carriers can only offer conventional products, the restriction will definitely affect the flow of all that business–and competition.

The nature of the impact will depend on the definition of “conventional” products. Stiglitz said a newly-formed Financial Products Safety Commission should identify which financial products are “safe enough” to be held or issued by the too-bigs, but who knows what definition it would use?

The impact will also depend on how closely the too-bigs adhere to conventional boundaries. This can be tricky, given that products often move from being innovative or off-the-beaten-path to conventional.

Consider: In the 1970s, universal life was new, innovative, even controversial. But by the 1980s and 1990s, it had gone mainstream. In many respects, it has become as conventional as whole life. However, now that carriers are also offering lifetime death guarantees with universal life, the product is once again perceived as “hot”–and too risky for some carriers.

How to classify universal life, then? Conventional or innovative? Safe or risky?

What about the UL newcomer, indexed universal life?

What about variable UL or group variable UL?

Then there are all those look-at-me annuities with lifetime income benefit guarantees and lifetime withdrawal benefit guarantees. Hmm…let’s see, annuities plus guarantees…sounds pretty conventional. But in this down economy, those annuity guarantees are looking pretty risky. In fact, some carriers are dropping them, just like the ULs with secondary guarantees.

So, should the too-bigs just leave those risky retail products alone?

It might be that Stiglitz meant to limit the restriction to more esoteric products sold at the institutional level, such as credit default swaps, derivatives and structured deals. After all, those products are in the eye of today’s financial hurricane.

But even here, the issues are not clear cut. As readers know, swaps have been around for a decade, and the business community did not view them as particularly risky or unconventional for most of that time. After all, the chance of default was viewed as minimal. Now, in retrospect, it is known that it was the use of swaps that rendered them risky and unconventional in more recent times (when investors started using them for betting on certain financial difficulties).

If the too-bigs are barred from offering swaps and similar products, what impact might this have on institutions that used the swaps for the intended–and pretty tame–purpose (to hedge against default)? And what curtailment in business operations would result from that?

Similar questions would arise if the Stiglitz proposal is applied to retail insurance products for consumers. If the too-bigs can only offer conventional versions of such products, what impact would that have on public access to innovative designs?

In his written remarks, Stiglitz predicted that “plenty of other institutions” would fill the role left vacant by the product restrictions on the too-bigs. That’s hard to say. It could be that the “others” will lack the resources, talent, or desire to do this. It could be that everyone stays on the conventional side of the fence. Where would risk-bearing innovation be then?


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