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Are insurers fighting the wrong war?

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Life is interesting in the insurance world. For example, a recent Government Accountability Office report provides a revisionist view of who played key roles in helping the insurance industry remain stable during the 2007–2009 severe economic downturn.

Then there is the ongoing game of cat-and-mouse between the Financial Stability Oversight Council and two life insurers over whether they should be overseen by the big bad wolf — the Federal Reserve Board — in addition to state regulators. Moreover, life insurers that had subsidiary thrift operations are universally downgrading those businesses or shutting them completely in order to escape Fed regulation.

The U.S. Constitution gives everyone the right to their opinion. However, “opinion” in the U.S. appears to have been redefined by some politicians as allowing them to sabotage lawfully enacted federal laws such as the healthcare reform law and the law establishing the Federal Insurance Office.

They are doing so as a means of securing more and more campaign donations from rich people who are advocates of the Leona Helmsley principle of government (“only the little people pay taxes”) and from those who believe the sole federal role in insurance should be bailing out companies engaged in reckless behavior or who get themselves caught on the wrong side of the business cycle.

However, a recent Wall Street Journal article brings to mind the cautionary statement made by a federal banking regulator during the 1989-92 economic downturn that regulators and the regulated should stop “fighting the last war.” The article also said mutual funds now manage $545 billion in target-date funds.

For those who have a short memory, prior to the Pension Modernization Act of 2006, that piece of change was owned by the insurance industry. They were held in “default investments” — a product sold by insurers as the Guaranteed Investment Contract (GIC) component of retirement accounts.

GICs are still around, but $545 billion is a significant piece of change to lose to a prime financial services competitor for insurers. Moreover, the low interest rate environment has created enormous challenges.

Annuities, like GICs, are highly profitable and a signature investment product many consumers associate with life insurers, allowing the industry to sell other products based on their prominence in the market.

However, life insurers have had to reduce their offerings in this signature market because low interest rates have increased the risk of offering contracts that either guarantee rates of returns on these investments or offer other potentially expensive incentives to investors. Besides revising fixed and variable annuity contracts, a number of well-known insurers, based both in the U.S. and offshore, have exited the market completely.

The insurance industry is also going to have to be adroit in dealing with the Fed’s transition to higher interest rates. In a recent report, Moody’s Investors Services said that, based on the prices paid on credit default swaps used to insure debt offerings of U.S. insurers, investors are wary about the ability of insurers to deal with the transition. And there is growing momentum for tax reform that would place the tax-advantaged status that is the core of insurance products in the cross-hairs.

These proposals include capping tax-advantaged retirement accounts at the $3 million level and limiting inside buildup. Other proposals included in the administration’s 2014 budget would subject the Dividend Received Deduction (DRD) for general account dividends to the same flat proration percentage (15 percent) that applies to non-life companies under current law. Another would base the DRD for separate account dividends on the proration of reserves to total assets of the account. Another would expand the pro rata interest expense disallowance for Corporate Owned Life Insurance.

In other words, the battle against City Hall is a losing one for the life insurance industry. In a highly competitive financial services market, insurers are battling not only each other, but also banks, brokers, mutual funds, hedge funds and now money managers for the consumer’s dollar, whether they be corporations, high net worth individuals, the middle market or smaller investors.

Battling regulators is expensive, and expecting Congress to save you from competition is a losing proposition. The money could be spent more effectively on creating and marketing products that protect the industry’s turf — and expanding that turf.

For more from Arthur D. Postal, see:

International group blasts U.S. insurer regs

ING settles with 7 states on unclaimed property

Adam Smith will trump politics on Obamacare


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