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Life Health > Life Insurance

On Contagion

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If you have not been following the ongoing financial crisis in Greece, then you probably should. In a nutshell, what you’ve got is Greece’s runaway spending has put the country on course to default on its sovereign debt. It is not hard to see how this all developed, really, as Greece has some 800,000 people on government employ and no legal means of reducing it, as these jobs are constitutionally protected. Meanwhile, the larger business culture of the country has allowed for people like hairdressers to retire on a full pension in their 50s, in part because their work exposes them to what the Greeks consider to be harmful chemicals. I’m not kidding.

As part of the Eurozone, Greece can’t devalue its currency as Ecuador did back in the 90s when it nearly defaulted. So instead the country must pass deep and painful austerity cuts across the board if it is to have any chance of receiving the bucketloads of additional financial aid it needs from countries such as Germany to keep going. These cuts are what has currently embroiled the country in a nonstop wave of pretty nasty protests from government workers, students, pretty much anybody in the country. But the truth is this: Greece has to make these cuts, and even when it does, it still doesn’t look like it will be enough to prevent a default, which means that the country will have to get an extension on its sovereign debt payment, and even that is not assured.

Why does this matter to us? Greece, after all, accounts for only 2% of the Eurozone economy, so its default doesn’t seem like such a big thing, except that it raises the dreaded word of contagion. What contagion really is is the fer that once Greece defaults, not only will investors stop dropping money into it, but they will stop investing in, and may want to collect on outstanding debts on, other troubled economies in the Eurozone, namely Spain, Ireland and Belgium. Spain keeps coming up as the big concern, as its economy is much larger than Greece’s, and frankly, there is not enough money in the system to bail it out wholesale.

What powers the notion of contagion is that nobody really knows how much toxic sovereign debt is out there in the system, thanks largely to the manner in which debts of all kinds have been homogenized into a sort of financial slurry in recent years. It is not that if Greece defaults then Spain surely will…it is the fear that nobody really knows, and won’t know until it is too late. That kind of uncertainty gives the financial world many gray hairs, which is why Greece means so much right now. Financially, it strikes me as being like Archduke Franz Ferdinand – nobody thought knocking off a minor political figure would start the Great War, until it did. But in a world that watched AIG begin a global financial meltdown, memories have not gotten so short that people can look at Greece and not extrapolate some very scary worst case scenarios.

The reason why I am bringing all of this up is because here in the States, and more specifically, in the life/health industry, there has been much effort by the Financial Stability Oversight Committee as well as by industry groups to figure out to what extent insurers can be labeled systemically important. The blow-up we saw with AIG – not an insurance failure, but still – and the concerns over Eurozone contagion show that systemic risk is an issue that is not just a matter of current-year politics. The globalization of financial services has globalized toxic debt as well, and if the system is to deliver more certainty to all who use it, then systemic risk itself must be managed more effectively. And that, dear friends, is why the life insurance industry is being dragged into all of this.

As National Underwriter has already reported, Prudential would rather not make the FSOC’s list of systemically important institutions, and I can see their point. While the insurance industry carries the reputational weight for AIG’s implosion, insurance operations themselves are fairly stable and extremely unlikely to ever cause a global panic. How the industry works its capital, however, can (AIG proved that). And while the world’s capital markets utterly dwarf the total worth of the life industry, we have seen that it doesn’t take the entire system going bad to ruin things. It just takes one portion of it to drive fear into all the rest.

Right now, I am receiving unofficial comments from a number of sources that Prudential, MetLife and perhaps a few other carriers will be named as systemically important institutions by the FSOC, which opens up a whole ration of regulatory issues for the industry’s prime movers. We are already seeing this on the risk-based capital front, and to be sure, industry groups such as NAFA and the ACLI have staunchly resisted additional regulatory oversight, as evidenced by those groups’ opposition to health care reform and various elements of Dodd-Frank. Fair enough. You cannot blame the industry for looking out for its own interests, but the key here is not letting self-interest get in the way of striking that delicate balance our financial system currently needs but does not yet have. After all, too much regulation is a bad thing, constraining the market from doing what it does best: creating value. Not enough regulation allows that same market to eventually suffer from gimbal lock, as it did with AIG. And if AIG proved anything, it is that the system allowed for precisely the magnitude of failure it was supposed to prevent.

With Washington still locked in trench warfare over what to do with our own country’s debt ceiling, the future looks more troubled than certain (though it must bear noting that our own financial problems and Greece’s are so different in type and scale that they don’t merit much serious comparison). And while the biggest life insurers appear unable to escape additional financial regulation, one hopes that whatever new rules are applied are neither so strict that they dampen the success of the industry’s giants, while at the same time, not so flimsy as to impose the level of oversight such giants, by dint of their financial magnitude, deserve. It would be nice to think that the industry’s largest players could be left to their own devices, and if they blow themselves up, they blow themselves up. Unfortunately, AIG proved that this is not always the case. And just as the European community fears Greek contagion because they just don’t know how much risk they are exposed to, so too is the case here insofar as the life insurance’s systemic importance. Life insurers will argue they are not systemically important. Federal regulators will argue that they are, or at the very least, it would be smart to err on the side of caution. The question I have is, should the feds err on the side of caution, how much will it really hurt the likes of Pru and MetLife? A year from whenever companies such as those are deemed systemically important and subject to new rules, I will be very interested to compare their financial results to the days before. I remember how Marsh lost some $800 million in annual revenue overnight when they gave up contingent commissions a few years ago. Will systemic regulation impose the same kind of hurt on life insurers? Or will it be just another layer of compliance to deal with, imposing a less acute and more gradual kind of pain? We shall see.


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