There are not many companies whose fortunes are as closely tied to the stock market as those in the insurance industry. When the market is climbing, insurers will often soar beyond the market, and will fall harder when the market declines. With the recent uptick in the market, is now a good time to consider insurance companies?
Insurance companies make money using a very simple formula: They collect premiums from customers, then invest the premiums while waiting for the claims to come in. Hopefully, the claims will be less than the investment value, thus providing a profit for the company. This industry relies heavily on actuaries. These are people who compute premium rates based on probabilities using statistical records based giving consideration to risks and other factors. A bad assumption here could lead to a premium that is too low resulting in an ultimate loss.
If you have ever filed a claim with an insurance company, you know what an onerous task it is to get money out of them. Looking at the claims portion of the equation, it is easy to under why they want to minimize claims paid. Each dollar they don’t pay you and each additional day they hold unto dollars they do pay you, is additional investment income for the company.
During an extended bull market, it is easy to take for granted that the investment portion of the formula will be positive. However, a lesson the insurance industry recently had to relearn was that the stock market does not always go up. The collapse of American International Group, Inc. (NYSE: ) in September from ill-chosen investments was a dramatic event for those invested in the industry.
Manulife Financial Corp. (NYSE: ), North America’s largest insurance company, also has struggled as a result of the declining equity markets. The Company has reported huge losses in excess of one billion Canadian dollars in the fourth quarter of 2008 and the first quarter of 2009. Much of which can be attributed to increasing reserves to cover long-term segregated fund and annuity guarantees. Segregated funds are popular investments similar to mutual funds but contain insurance contracts that limit risk for the investors.
Recently the sharp market rebound has provided relief to insurers such as MFC who had to set aside cash for guarantees on performance-based products.
