Insurers Avoid Getting Soaked In Subprime Storm

The one financial industry that seems to be dodging the subprime bullet is insurance. Only a handful of companies have had their safety ratings knocked down because of an excessive exposure to Wall Street's toxic waste. The vast majority have enough capital to withstand the known problems on their balance sheets, the rating companies all say.

Nevertheless, you should pay attention to the downgrades when you're shopping for a new insurance policy or annuity. You buy insurance to transfer risk, not to take it on yourself, said David Schiff, editor of Schiff's Insurance Observer, an industry newsletter. You want super safety from a highly rated firm. With 30 to 50 insurers rated A+ or higher from A.M. Best and AA or higher from the other rating companies, there's no point settling for anything less, he said.

So far, Standard & Poor's has downgraded four life insurance companies and their subsidiaries, at least partly because of their risky subprime holdings -- American International Group, Beneficial Life Insurance, Scottish Re Group and Security Benefit Life Insurance. They were downgraded by Fitch Ratings, too. Another dozen insurers have been clipped for various other reasons.

Security Benefit specializes in variable tax-deferred annuities. It carries ratings in the A-minus to BBB-minus range, with a chance of further downgrades to come.

Those are still investment-level grades (although the BBB- minus barely hangs in there). No alarm bells are ringing for people who already hold insurance and annuities from downgraded players. New buyers, however, have other choices.

Security Benefit President Thomas Swank says his company is primarily an asset manager and should be judged on performance rather than insurance ratings. Its subprime debt is still performing, he said, and the company has enough assets to back its annuity guarantees.

AIG's problems stem from the insurance against defaults that it sold on investments linked to subprime mortgages. S&P said that if AIG's earnings don't stabilize by the third quarter, it will probably be cut another level, to A+ from its current AA-minus. AIG thinks its capital position is strong enough for an AA-range rating but will consider raising additional capital.

None of the ratings companies say the insurers are teetering toward insolvency, although more of them will face downgrades if the economy stays weak. The industry is better capitalized than it was a few years ago, said Robert Swanton, managing director of life and health insurance in North America for S&P. Historically, life insurers rarely fail.

That attitude worries Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics in the District. She thinks solvency is an outdated yardstick for measuring the health of large, diversified insurance companies, operating internationally and trading in the global derivatives markets. Liquidity has become a risk, too, she said. Like investment banks, insurers could suffer a crisis of confidence that cuts off their short-term funds and interrupts their ability to pay.

At present, failing insurers are managed by the states where they're licensed to do business. But the states aren't equipped to handle too-big-to-fail insurers that present a global investment risk. Petrou thinks companies such as these should come under the purview of federal regulators, who ought to be developing contingency plans.

"We keep learning hard lessons," Petrou said. "Fannie Mae and Freddie Mac were supposed to be bulletproof, too."

If your life insurance company fails, your state's guaranty fund will step in and transfer the policy to a new insurer. In most states, you're protected for as much as $300,000 in death benefits and more if the failed insurer has enough assets. If you have, say, a $1 million policy, however, you may be at risk. The policy might be transferred with a reduced cash value, which could lower the benefit if you died. (A few states protect as much as $500,000 in death benefits. Cash values are usually protected up to $100,000.)