When the whole global economy teetered on the edge of failure a few years ago— remember that?— one of the reasons was that insurers had insured lots of things that they could not, in fact, afford to pay for, when the bill came due. Now, they're marching down that path once again.
State insurance regulators in New York put out a report yesterday on the pervasive use of "shadow insurance" by life insurance companies. The details are somewhat arcane, but the main idea isn't: insurance companies are using financial trickery to evade regulations, increase their own profits, and increase their risk— and the risk that they will one day have to be bailed out by the public once again.
Essentially, regulations require insurance companies to have enough assets on hand to cover the payouts they might need to make, if something bad happens. (Hurricane? Wall Street crisis? Asteroid strike? You never know, in the insurance business, so you always have to be prepared.) Insurance companies would rather put that cash to use boosting their own profits, rather than just sitting there in case of disaster. In order to keep their risk levels down, insurance companies often get other insurance companies to insure part of their portfolios. This is the practice of reinsurance. But now, the new report finds, many insurance companies are simply setting up their own little offshore shell companies and claiming that those companies are reinsuring them— when in fact, they're merely an accounting maneuver to free up cash, not a real way to mitigate risk. This is called "shadow insurance." And it makes the entire insurance industry more dangerous. From Dealbook:
[New York finance regulator Benjamin] Lawsky said he was struck by similarities between what the life insurers were doing now and the issuing of structured mortgage securities in the run-up to the financial crisis of 2008.
“Those practices were used to water down capital buffers, as well as temporarily boost quarterly profits and stock prices,” Mr. Lawsky said. “And ultimately, those practices left those very same companies on the hook for hundreds of billions of dollars in losses from risks hidden in the shadows, and led to a multitrillion-dollar taxpayer bailout.”
Complex details, simple conclusion: our financial system incentivizes companies to constantly seek to increase their short-term profits, even at the risk of long-term disaster. (Which always comes, sooner or later.) The public bails out companies when disaster strikes, because not to do so would mean disaster for all of us. But then— shucks— we forgot to pass regulations that would prevent the same thing from happening again. So here we are.
Whether or not you have faith in god, you better have faith in your insurance company.