by John Darer® CLU ChFC MSSC RSP CLTC
Ever wondered what goes on behind the scenes at an insurance company that writes structured settlements? After watching the paint dry, perhaps you've contemplated how these companies figure out how much to charge so they can afford to pay you for the rest of your life, even if that is to age 105?
During my research for the previous post I happened upon the recent Form 8-K for White Mountains Insurance Group, Ltd that was filed with the Securities and Exchange Commission ("SEC") and reported April 29, 2010.
White Mountains of course owns a piece of Symetra Financial and the 8-K provides some good educational insight into the accounting and investment challenges faced by insurers participating in this market segment.
Specifically referring to White Mountains' Symetra investment, the 8-K states (bullets and bold added for easier reading):
- "Adjusted comprehensive income is a non-GAAP financial measure that excludes the change in equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio from comprehensive income. In the calculation of comprehensive income under GAAP, fixed maturity investments are marked-to-market while the liabilities to which those assets are matched are not.
- Symetra attempts to earn a “spread” between what it earns on its investments and what it pays out on its products.
- In order to try to fix this spread, Symetra invests in a manner that tries to match the duration and cash flows of its investments with the required cash outflows associated with its life insurance and structured settlements products**. As a result, Symetra typically earns the same spread on in-force business whether interest rates fall or rise.
- Further, at any given time, some of Symetra’s structured settlement obligations may extend 40 or 50 years into the future, which is further out than the longest maturing fixed maturity investments regularly available for purchase in the market (typically 30 years).
- For these long-dated products, Symetra is unable to fully match the obligation with assets until the remaining expected payout schedule comes within the duration of securities available in the market. If at that time, these fixed maturity investments have yields that are lower than the yields expected when the structured settlement product was originally priced, the spread for the product will shrink and Symetra will ultimately harvest lower returns for its shareholders.
- GAAP comprehensive income increases when rates decline, which would suggest an increase in the value of Symetra - the opposite of what is happening to the intrinsic value of the business. Therefore, White Mountains’ management and Board of Directors use adjusted comprehensive income when assessing Symetra’s quarterly financial performance".
The 8-K demonstrates the risk when writing long tail liabilities particularly those with rated ages, which have the potential to squeeze margins further if a market environment requiring reinvestment at lower than expected yields comes into play.
** as a consumer protection function, most state insurance laws require an annual actuarial certification that liabilities are matched with a corresponding asset.