Insurance Insights

A History of Insurance Economic Resiliency

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Hot Take:

Hot Take

One of the key pieces of advice I have offered potential insurance financial professionals when considering a career in the insurance industry is a simple word: resiliency. The industry has withstood extreme economic circumstances while other industries have suffered permanent damage, job losses and closures. Has that ability for insurance survival just been uncanny, or is there more to it? We explore that anomaly in this brief tour of some insurance economic history.

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Several years ago, while attending a corporate audit committee meeting for an insurance enterprise, I was asked by the Chairman of the Board how one makes money in the insurance business. This was an astute, seasoned gentleman, a former Chairman of the Board of a major international auto manufacturer and distributor.  He was new to the insurance industry but highly skilled in running an enterprise.  It was not a dumb question but an honest one. My answer was,” Slow and steady.”  Again, not a cavalier response, just a candid one. Some may consider that a rather boring existence, but it is the primary reason for most success in business and life, even in a fast-paced and driven society.

Our insurance industry has remarkably endured quite a few seasons of economic calamity, while other industries have suffered considerably more pain and failure during those same periods. Why is that? In this discussion, we will take a brief jet tour of one of those key economic mishaps and reasons for the industry’s resiliency. We will focus on economic instabilities rather than natural cataclysms and further concentrate on 21st-century progressions.

Historical Background

One of the key foundations of the U.S. insurance industry has been its campaign to be a self-policing trade. This self-governance feature has been a primary reason for the economic resiliency experienced by the industry over the past 150 years. Within the U.S., that goal has been accomplished through the coalition of the 50-state regulatory jurisdictions, which are coordinated through the National Association of Insurance Commissioners (NAIC). The NAIC was founded in 1871 with its precursor organization, the National Convention of Insurance Commissioners. The early involvement of state-based regulation leads us to the discussion on how the industry has progressed towards its own protection mechanism.

When the public hears the term “regulation,” it tends to leave an instinctive poor taste, regardless of the industry. Yet, in any industry dealing with personal money and security, human nature dictates the need for guardrails and oversight. The insurance industry’s early decision to self-regulate rather than capitulate to nationalized regulation has provided the backbone of its enduring financial stability over the past 100+ years. Those of us in the insurance arena recognize the terms conservatism and solvency as the two backstops to the state-regulated approach. We’ll begin with some dates that established the state regulatory solvency agenda and progress.

Key Milestones in Insurance Financial Resiliency

  • 1869 – Paul vs. Virginia – Supreme Court – eliminated insurance from federal regulation, effectively placing insurance under state purview
  • 1871 – first formal meeting of the National Convention of Insurance Commissioners (predecessor to the NAIC)
  • 1871 – standardized financial reporting blanks were introduced with a focus on solvency and the initial introduction of the non-admitted asset concept focusing on the balance sheet
  • 1905 Armstrong Committee – placed more authority within state regulation due to industry abuse of utilizing corporate resources on lavish expenditures
  • Early 1900s – rate filings evolved to corral overly fluid acquisition and other expenses
  • 1945McCarron-Ferguson Act was enacted, confirming insurance solidly under state oversight
  • 1960s – state guaranty fund system added to buffer policyholders from insurer insolvency
  • 1970s – NAIC Early Warning Tests (precursor to IRIS) implemented for advance regulator notice of potential insurer financial difficulties
  • 1990 – annual external audits by Certified Public Accountants and formal actuarial opinion required for regulatory compliance
  • 1993 & 1994 – Life Risk-based Capital and P&C RBC implemented (health RBC in 1998)

Though not all-encompassing, these milestones of the insurance industry progression reveal how focused solvency and monitoring at the state level have pre-supposed and adjusted to future concerns based upon actual historical events in our industry.

So, how has this preoccupation with conservatism panned out in reality? In this edition, we will take a glance at the grandest of all U.S. financial crises and how the insurance industry fared.

The Great Depression: The Deepest and Longest Downturn in American History (1929–1941)

Though this period was ruinous in our history, it is a fascinating journey in how we got there.  One could write tomes of fascinating events occurring during the failure, but we’ll have to suffice with generalities for the sake of space.

Much of the public is of the impression that the Depression of 1929 was a one-time cataclysm, with the stock market imploding on Black Tuesday, October 29. 1929. Actually, it was the culmination of a sequence of events.  There were previous contractions in 1920 (lasted 19 months), 1923 (lasted 14 months), and 1926 (lasted 13 months). These were build-ups to the coming culmination of Black Thursday and Black Tuesday. Suffice it to say, banking and investment regulation was quite lax. Quick mobilization of bank reserves became the nemesis, confounded by runs on the fractional-reserve banking process. When the crisis began, 8,000 commercial banks belonged to the Federal Reserve System (established 1914), and 16,000 did not. The carnage began with a domino effect, starting with non-member banks, and bank-by-bank began to fall, each upon the other. Deflation became another dire foe as the inventory of available money declined, and prices of goods followed that money supply decline.

Public confidence in banks was one of the initial catalysts.  What does this have to do with our insurance industry?  We know from history that as financial institutions failed, so did other industries and individuals, and in volumes. More than nine thousand banks failed during the 1930’s; 4.3 million Americans were not working; 32,000 businesses went bankrupt; $140 billion of personal and business funds simply disappeared from bank failures.

The Great Depression and Insurance Industry Resilience

We cannot forget that insurance companies are financial institutions with “available funds,” though a bit different than banks. Unearned premiums for property & casualty companies and cash surrender values for the life side represent “available funds” in a crisis. However, the offsetting psychology to that perspective is people want to keep their insurance benefits during climactic events for the protection of property, life insurance, health benefits, retirement annuities, etc.

The property/casualty and life and health industries did not go unscathed during the Great Depression. Yet, the industry held its ground and survived the financial onslaught that devastated other industries. Why? Because of an industry dedicated to years of a conservative solvency agenda.  Nevertheless, over the 1929-1933 period, written P&C premiums declined by 35%.  P&C policyholder surplus and invested assets declined 37% and 28%, respectively. Capacity was certainly reduced. However, insurers, for the most part, routinely return their earnings back into their capital positions to replenish that capacity.

The most significant P&C failure occurred in the 1930s with National Surety Company, then considered the largest surety company in the world (e.g., National Surety underwrote the construction bond that guaranteed the various contractor’s performance in the construction of the Hoover Dam in 1931). As strange as it may seem, the primary line of business that failed for National Surety was its guarantee of thousands of mortgage-backed securities, the same circumstances that brought AIG to failure 75 years later in 2008!  Government intervention took control of National Surety to circumvent the potential “run” on its assets.

The number of life insurance companies declined from 438 at the end of 1929 to 375 at the end of 1933, an approximate 14% decline. Compared to the banking issues at the time, it was a spit-in-the-bucket (to use some Texas nomenclature). Though unfounded, many insurance agents claimed that not a single customer lost their whole life insurance policy assets during the period. The long-standing principle of conservatism allowed invested assets to be carried at amortized value rather than mark-to-market under the concept of holding for the long term to support policy reserves. As such, balance sheets were not as heavily impacted by unrealized losses. Since life company cash flows were not placed in dire jeopardy, their investment portfolios weathered the battered markets.  Life companies did experience a tripling of cash surrender values from 1929-1932, thereby reducing their net cash flows. Further, policy loans grew to 18% of company assets by the end of 1932. Yet through it all, payments of death, endowment, and annuity benefits continued uninterrupted.

What’s the Rub?

From the financial perspective, over the 20th and now 21st centuries, the insurance regulatory process has adjusted and self-disciplined itself to subsist through major economic calamities. This writer’s judgment is that the evolution of state regulation has surpassed that of a potential national oversight alternative.

How does one make money in the insurance business? Slow and steady, and resilience will follow.