Eliot Spitzer has just launched a major frontal attack on the insurance industry. But it’s just the first battle in a long and bitter war.
I know. I’ve fought a similar battle myself for many years, albeit on a much smaller scale.
That’s why most insurance companies still don’t like me very much. Some may even want me dead.
About 12 years ago, soon after I launched my Weiss insurance ratings, I sent out a press release listing the ten largest insurance companies most likely to fail. The media picked it up, and U.S. News & World Report featured it in a major story.
The next day, my phone began to ring off the hook with calls from insurance company lawyers. They yelled at me and threatened me with litigation. They said my ratings were slanderous. They talked about suing me for many times the money my small Florida company made in a lifetime.
One large company on my “most vulnerable” list, First Capital Life of California, went even further: They sent an entourage of top executives to visit our offices and intimidate me.
Insurance company exec:
“Weiss better shut the @!%# up or get a bodyguard.”
We welcomed the group into our humble conference room, and they distributed copies of their presentation.
Then for the next two hours, they ranted about their grand plans for the future. They raved about the top ratings they were still getting from S&P, Moody’s, and A.M. Best. They even talked about how they could “help” Weiss build its own business.
But I didn’t budge from my D- rating. “Look,” I responded. “Your own filings with the state insurance commissioners show you’re loaded with sinking junk bonds, but you have virtually no capital to cover the losses. Your own books show you’ve got money from investors that could be pulled out at a moment’s notice, but you have virtually no liquid assets to sell to meet their demands for cash.” I made it clear that the company was a time bomb that could go off almost any day.
That’s when one of First Capital’s executives issued the ultimate threat: “Weiss better shut the @!%# up,” he whispered to my associate during a break, “or get a bodyguard.”
I did neither. To the contrary, I intensified my warnings. And within weeks, the company went belly-up – still boasting high ratings from major Wall Street firms on the very day it failed. In fact, the leading insurance rating agency, A.M. Best didn’t downgrade First Capital to a warning level until 5 days after it failed. Needless to say, it was too late for policyholders.
It was a grisly sight – not just for policyholders, but for shareholders as well: The company’s stock crashed 99%, crucifying millions of unwitting investors. Then the stock died, wiped off the face of the earth. Three of the company’s closest competitors – Executive Life of California, Executive Life of New York, and Fidelity Bankers Life – were also biting the dust. Unwitting investors lost over $20 billion.
If you have cash-value policies
in failed insurance company
YOUR MONEY WILL BE FROZEN
Meanwhile, the regulators stepped in to take over and froze all the money policyholders had paid in for whole life polices and fixed annuities.
The people weren’t allowed to cancel their policies. They weren’t even allowed to take the money out through a policy loan. And by the time the freeze was finally lifted many months later, they had lost up to 50 cents on the dollar.
All told, over six million policyholders were trapped. Among these, about two million had cash-value policies, such as whole life and fixed annuities, frozen in limbo for months. (For details, see, “Toward a Full Disclosure Environment in the Insurance Industry,” my 1992 testimony before the U.S. Senate Committee on Banking, Housing, & Urban Affairs.)
These policyholders asked: “How could this happen? All of these insurance companies got “good” or “excellent” ratings from A.M. Best, S&P, Moody’s, and Duff & Phelps (now Fitch). Why is it that Weiss was the only one that gave them bad ratings?”
Congress asked the same question. So did the U.S. General Accounting Office (GAO), now called the Government Accountability Office.
Indeed in a special study comparing Weiss to the other rating agencies, the GAO concluded that Weiss was the only rating agency to consistently warn consumers of the failures in advance; all of the other rating agencies typically issued their first warnings only AFTER the companies failed.
According to the GAO, for the six largest insurance companies that failed in the early 1990s, “Best assigned a ‘vulnerable’ rating before [failure] in only one of six cases and this was only six days before the [failure] occurred. In one case, Best stopped rating the insurer and never assigned a ‘vulnerable’ rating. In the remaining four cases, it assigned a ‘vulnerable’ rating only after the [failure].”
Best complained bitterly. They said their “B” ratings, listed as “good,” in their own manual, should also have been considered “warnings of failure” in the GAO study. The GAO disagreed. But they added: “If we had placed Best’s “B” and “B-” ratings in the “vulnerable” category, Weiss would still have been first overall. Weiss’ advantage would have been decreased from about three to one to about two to one.”
But still, the GAO still didn’t answer the original question: Why? Why did the other rating agencies fail so miserably?
I can assure you it wasn’t because we had better access to insurance company management than the other rating agencies. Nor did we have more analysts. Rather, the fundamental difference between us and them was embodied in one four-letter word: BIAS. The ratings of our competitors were biased by serious conflicts of interest. Ours were not.
You see, A.M. Best, Moody’s, S&P, and Duff & Phelps were paid substantial sums BY the insurance companies to provide ratings FOR the insurance companies, a blatant and direct conflict of interest.
To make matters worse, if the company didn’t like the rating, the rating agencies agreed not to publish it. The leading insurance company rating agency, A.M. Best, even created a special category for ratings that were non-published because the companies “disagreed with their rating.”
Ironically, nearly everyone in the industry knew what was going on. They knew that most of the ratings were bought and paid for by the rated companies. They knew the industry’s capital had deteriorated over the years. And they knew that too many large companies were loading up with too many high-risk bonds and speculative real estate. They just didn’t talk about it in public, and did everything possible to keep it secret.
For example, in the January 1990 issue of Best’s Review, Harold Skipper, Professor of Risk Management and Insurance at Georgia State University, pointed out: “with increasing competition from all quarters, insurers are seeking ways to operate on thinner margins, to enhance investment performance through the purchase of … riskier investments.”
In the same issue, Earl Pomeroy, President of the National Association of Insurance Commissioners (NAIC), wrote: “State insurance regulators are observing ominous signs of emerging solvency problems in what traditionally has been the most secure line of all-life insurance.”
Similarly, in the March 1990 issue of Best’s Review, David F. Wood, past president of the National Association of Life Underwriters, under the title “The Insolvency Chill,” stated: “It is widely acknowledged that life insurers’ profit margins have declined significantly, primarily because of rapidly increasing costs, slower growth, declining interest rates in the face of long-term higher rate guarantees and stiffer competition. All these factors have severely eroded the capital base of many companies….”
Thus, Best itself was publishing this alarming information on the industry. But they did nothing to downgrade their own ratings.
You’d think the industry and its regulators would have learned a lesson from this experience. But today, very little has changed. The insurance industry continues to harbor deep conflicts of interest that everyone in the industry knows about, that routinely result in hardships to millions of Americans, but that persist just the same. Here are just three examples …
Conflict of interest #1.
The Insurance Industry with
The Insurance Company Rating Agencies
To this day, the established rating agencies – A.M. Best, Moody’s, S&P, and Fitch – are still paid huge fees for their ratings.
Plus, they typically empower the rated companies to decide when to be rated, how, and by whom. They often give the companies a preview of the rating before it’s published and some agencies grant them the right to suppress publication of any rating they don’t agree with.
This is no secret. A.M. Best & Co. clearly states in its 1995 Insurance Reports, page xv: “NA-9 Rating (Company Request): Assigned to companies eligible for ratings, but which request that their rating not be published because they disagree with our rating.” And beginning with its 1996 Insurance Reports (page xiv), Best changed its “NA-9” category to “NR-4,” but the definition is very similar.
With this mechanism, ratings which might otherwise have served as warnings to the public are removed from public view, with disastrous consequences for consumers.
Indeed, in its 1994 report, the GAO states that in four out of 30 cases rated by both Best and Weiss, “Best never actually assigned a ‘vulnerable’ rating. Instead, Best changed these ratings from ‘secure’ to one of its ‘not assigned’ categories.” And in a follow-up report using the same methodology as that used by the GAO, I found that, subsequently, there were another 16 companies in Best’s NR category that failed.
In each case, Best’s standard operating procedure was to cooperate with the companies, remove the bad ratings from circulation, and hide the financial weaknesses from the public. And in each case, the companies failed, causing severe hardships to consumers.
Some of the agencies have since modified some of their worst practices, but they have not altered their basic business model – the ratings are still bought and paid for by the rated companies.
How much exactly do they charge? No one knows for sure. But one of the nation’s most stubborn critics of the insurance industry, Joseph Belth, has documented the fees charged by insurance company rating agencies in his widely respected monthly publication, The Insurance Forum.
A few years ago, Belth reported that Standard & Poor’s charges from $10,000 to $50,000 per company per year, Moody’s charges from $15,000 to $45,000, and Best’s fees were similar to those of Standard & Poor’s and Moody’s. Belth has not reported on this since, but I suspect that the fees are probably significantly higher today.
This is uncanny. You wouldn’t eat at a restaurant or send your children to a movie if you knew that their ratings were based on this kind of a payola system. Yet millions of Americans have entrusted a good portion of their life savings – and their life’s safety net – to companies that are rated precisely in this way.
Conflict of interest #2.
The Insurance Companies with
Insurance Agents and Brokers
Last week, Eliot Spitzer accused some of the nation’s largest insurance companies and the world’s largest insurance brokers of rigging bids for insurance polices and taking millions of dollars in kickbacks as a standard operating procedure in their business model.
Joseph Treaster, in his New York Times article of October 16, provides the specifics:
“The lawsuit brought by Mr. Spitzer against the broker, Marsh Inc., a unit of the Marsh & McLennan Companies, contends that Marsh conducted sham bidding to mislead customers into thinking that they were getting the best price for the coverage they needed. …
“In addition to the lawsuit, two executives of the American International Group, one of the world’s largest insurance companies, pleaded guilty to criminal charges of rigging bids with Marsh.
“While Mr. Spitzer’s target yesterday was Marsh, he made clear that he was taking aim at a widespread practice in the insurance industry. ‘This investigation is broad and deep and it is disappointing,’ he said.
“Mr. Spitzer suggested that he had also come across indications of wrongdoing in the sale of many kinds of personal insurance, including coverage on cars, homes, and health insurance. ‘Virtually every line of insurance is implicated,’ he said.”
“The lawsuit names American International, or A.I.G., and three other insurers, as participants in the bid rigging and steering: the Hartford, a unit of Hartford Financial Services; Ace Ltd., which is based in Bermuda but is a major player in the American insurance market; and Munich American Risk Partners, a unit of Munich Re with offices in Princeton, N.J.”
My view: Mr. Spitzer has barely begun.
Reason: The entire system of selling insurance in America – through agents that are ostensively working in the best interests of the consumer but who are actually driven by commissions determined by the insurers – is, itself, a massive and fundamental conflict of interest.
Look. If you want to buy insurance – for health, life, or an annuity … or for your auto, home, or business – you almost invariably MUST go through an agent. You rarely have the option of buying directly from the insurance company. And it is the insurance company that effectively sets the goals and agenda for most agents.
To get a better idea of how this works, our company once ran an analysis of the ads in an insurance industry magazine for insurance agents.
Most of the ads were placed by insurance companies offering agents all kinds of special commissions to direct business their way. In addition to cash bonuses, they touted special premiums like two-week vacations at Club Med or free cruises in the Mediterranean. The ads appealed to agents selling annuities, life insurance policies, and more.
So I called the publisher to ask if he thought these special commissions deals wouldn’t push the agents to sell policies to consumers that might not be in their best interest.
The publisher was indignant: “Are you a registered insurance agent? No? Then how did you get a hold of our publication? Our publication is not for you. It’s strictly for insurance agents!”
Apparently, I wasn’t supposed to know. Nor were millions of American consumers.
My main point: Insurance agents are routinely driven to sell the policies that make them the most money – not the policies that are best for you. Some agents bend over backwards to do what’s best for their customers. But to do so, they must often sacrifice their own livelihood.
That’s a system that’s rotten to the core, and Mr. Spitzer’s opening salvo barely scratches the surface.
Insurance Newspeak
Long ago, insurance agents discovered that their customers didn’t want to talk about their death, let alone buy insurance for it. So taking a chapter out of Orwell’s 1984, they called it “life insurance” instead.
It didn’t seem to help much, though. Life insurance was still a very hard sell, and agents who pushed it too hard got a bad reputation for bringing up unpleasant subjects. “Want a row of seats all to yourself on your next flight to Chicago?” went a popular joke. “Then just tell your fellow passengers that you sell life insurance.”
Prudential, the Rock-of-Gibraltar, largest insurance company in the world, came up with another very “creative” solution. They figured out a way to disguise the life insurance as an annuity, trained their agents to obfuscate the real nature of the product, and sold it to millions of investors from 1982 through 1995. All annuity policies sold by insurance companies do have a small life insurance component. But that’s a far cry from being an actual life insurance policy.
It took many years of litigation before the regulators caught up with them. Prudential execs said they were sorry. The regulators said that wasn’t quite enough to make amends. After much heated debate and negotiation, the company belatedly agreed to pay $2.7 billion in restitution to more than 1 million maligned customers, many times more than the largest previous settlement in insurance history. They sold insurance as a “retirement plan,” failing to disclose the risks and using policy illustrations, which projected fabulous dividend accumulations as foregone conclusions.
So did agents at New York Life and Allstate. Meanwhile, Equitable Life Assurance Society was fined $2 million for selling more than $100 million of improper life insurance policies. If the larger companies can do it, just imagine what the smaller, fly-by-nights are getting away with!
The Prudential, Metropolitan, Allstate, and Equitable messes were finally cleaned up. However, the fundamental problem inherent in the insurance agency system remains.
Conflict of interest #3
The Insurance Industry with
The Insurance Regulators and Legislators
You know about the long-disputed “revolving door” between private industry and government: Key officials in an industry are appointed as officials to write laws or regulate the same industry … and then go back again to become lobbyists or executives for top corporations.
This is an inevitable aspect of our democratic, capitalist society. But it is especially egregious in the insurance industry.
For example, in an analysis released over a year ago, the Consumer Federation of America (CFA) found that “at least 40 percent of the leadership of the National Conference of Insurance Legislators (NCOIL), an organization that offers model bills and resolutions on how to regulate insurance, have worked for or with the insurance industry.
“Furthermore, most of these NCOIL members have current business ties to the insurance industry. NCOIL, which says its primary mission is to ‘help legislators make informed decisions on insurance issues,’ has taken a series of recent positions on high-profile insurance issues that are favorable, if not identical, to insurance interests and have frequently undermined consumer protections.”
“Too often, NCOIL’s advocacy is virtually indistinguishable from those of insurance interests,” said J. Robert Hunter, CFA’s Director of Insurance and former Texas Insurance Commissioner.
Bottom Line
When you buy insurance, watch out! Shop around aggressively, and get quotes from more than one agent and from as many insurers as possible. Despite all the problems in the industry, there are still good companies and good policies worthy of your money. Just make sure the insurer is safe and won’t die before you do. I recommend companies that have earned my rating of B+ or better, but I can’t vouch for all their policies.
And if you own shares in an insurance company or insurance brokerage firm, take advantage of any rally to get out. Yes, they’ve already fallen sharply in the past few days. But given the enormity of the scams and conflicts still to be revealed, the share price declines you’ve seen so far are small in comparison to what’s likely still ahead.
Good luck and God Bless!
Martin
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com
Martin Weiss and “Martin on Monday” are non-partisan. Third-party ads do not necessarily represent their opinion and should not be interpreted as an endorsement.
c 2004 by Weiss Research, Inc. All rights reserved.
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