Keeping The Promise

In order to imagine the outline of a successful U.S. life
insurance company in the year 2020, it’s important to think
for a minute about what the world in which that company
operates will be. There are a lot of possibilities for nearly
every aspect of life in the United States, but one demo-
graphic fact above all others has potential to dominate the
landscape. In 2020, almost half of the baby boomers will
be on Medicare and nearly all will have reached an age
at which retirement is either a current reality or a rapidly
approaching one. The implications are many, and some
are ominous:
•  Pension plans, which for many, many years have been
  major buyers of stocks and other securities in this
  country, will be  in or near liquidation status where
  investments will be sold  rather than bought. The effect
  on the securities markets may be profound.
•  Governments which have the responsibility of paying
  for the promises made  in earlier, less demographi-
  cally challenging times, will  be cash-strapped, more so
  than today. State  and local governments will face
  daunting problems relating to  pensions and retiree
  health benefits for their workers, as will the federal
  government but with vastly differing means of financing
  the liabilities.
•  The Social Security system  in total, and Medicare
  specifically, will be facing severe financial problems.
All these issues will threaten the social contract under
which we’ve operated for a long time. In that setting, with
so much of life in flux for all generations, and with all of
society entering rougher and more uncharted waters each
year, the life insurance company that will be successful is
one that can market, manage and deliver on guarantees.
Making and keeping promises will separate the successes
from those that don’t last. This position is nothing new.
Insurance has always been the vehicle that promised a
result to its customers and delivered it. But along the way,
we thought that in order to compete with other financial
institutions we needed to look more like them and less like
our traditional selves. The years 2020 and beyond should
refocus both our customers and our companies on the value
of meaningful long-term guarantees.
A successful guarantee business requires three distinct
focuses as the business develops:
•   Choosing which of life’s risks to insure and how to do so,
•  Managing the assets and liabilities until the guarantee
  comes due, and
•  Making good on the promise.
The first of these focuses is essentially the marketing
function. Insurance companies choose which business(es)
to be in, find adequate capital to fund the business, and then
develop and market products. Marketability will depend
on finding a delivery system that can sell the promise at a
price that is both attractive to the customer and sustainable
for the insurer. There’s nothing magic here. This is what
insurance companies have done for well over 100 years.
But in the past few years, guarantees have lost ground to
the sexier market-based financial products that, because of
their (sometimes) spectacular performances, made guaran-
tees seem stodgy and unnecessary. Why go for a low-return
guaranteed product when you can buy a market-value prod-
uct that will greatly out-perform it over the long haul? Of
course the answer is that in the short haul, which is where
we actually live, things aren’t always quite so rosy, but
except in times of pronounced volatility people tend to
forget that fact. The demographics of the third decade of
this century look likely to have a negative effect on stability
in a lot of things.
The second focus, managing the promise, is fraught
with difficulties relating to risk management. There are
obvious financial issues. How best to fund a particular
promise—the old fashioned way, via conservative invest-
ments that over time bring the desired yield and preserva-
tion of capital, or via hedging and other financial strategies
that rely in part for their success on the financial stability


of a variety of counterparties? Or perhaps it is a mix of the
two, or an approach that has not yet been used for these
types of products. The financial approach to products of-
fering meaningful guarantees will require decisions that are
complex, difficult and very important. Beyond the financial
aspects of guaranteed products, how sure are we that the
promise itself won’t change over time? For life insurance,
it used to be that dead was dead. Now medical technol-
ogy can keep alive someone who a few years ago would
already have come to the end of life. A simple promise to
pay at death has become somewhat fuzzy. Other forms of
guarantees have similar risks. A court decision that changes
the meaning of a well-established provision of a long-term
care policy could wreak havoc on that line of business over-
night. The same goes for critical illness policies,  disability
and many others. Only payout annuities seem somewhat
secure, but as mentioned above, medical technology can
affect longevity, in both directions. The bottom line is
that, except for the very simplest forms of insurance, it isn’t
certain that the promise assumed at the beginning of an
insurance policy is what will eventually have to be delivered.
Which brings us to the final focus: delivering on the
promise. The simple “you die, we pay” premise of a life
insurance  policy  reflects  the  ultimate  delivery  on  this
contract. Along the way, a lot of things may have happened
to both parties to the deal but at the death of the insured,
the insurer must pay. For other forms of insurance, and
their guarantees, things are not so simple. As noted above,
a court decision can undo many years of practice in a
particular line of business. Think of the potential legal
risks inherent in a long-term care policy where any or all
of the activities of daily living can be redefined by a court
at any time or where changes in methods of treatment can
radically change what long-term care means. Consider the
effects of the current economy on disability coverages.
Or what will happen to lifetime income guarantees if life
expectancy takes a leap because of medical advances in-
volving bionic parts and transplants that are unthinkable
today?  Being in the guarantee business means that no matter
what happens, for better or worse, the insurer must deliver
on the promise when the time comes, even if the promise
has changed in the meantime. Making that come true will
require that premiums, reserves and insurance company
capital levels be realistically conservative and not just
optimistically adequate. The guarantor is going to have to
be able to survive the thousand-year rain, even if it occurs
twice in five years.
Guarantees are what set insurance companies apart
from other financial institutions. In the insurance world,
however, life insurance companies are unique in the length
of time over which their guarantees may apply. A life
insurance policy, issued on a newborn in 2020, could well
be in force in 2120, and if there are settlement options
available, it could still be delivering on a guarantee many
years into the 22nd century. That uniqueness offers insur-
ers an opportunity to fill a product/marketing gap that
no one else can fill, but it also requires the discipline to
recognize that this different financial role carries with it
different management responsibilities. Selling guarantees
must ultimately be secondary to delivering on guarantees.
Life insurance companies may have to compete with
other financial institutions in the capital markets, but doing
so cannot be at the cost of abandoning their unique abil-
ity to offer the guarantees that no one else can. Guaranteed
products can be priced for returns that are competitive with
other financial products, but it may take longer for them
to bear fruit. Guarantees that last 25 or 50 or 100 years do
not lend themselves to a management style that focuses on
quarterly earnings. It isn’t realistic, and it isn’t prudent. If
insurers take advantage of their unique market, and man-
age their products and businesses appropriately, the re-
wards will be there, eventually, for all stakeholders. But if
for the capital markets, “eventually” isn’t satisfactory, then
it may be that the surviving, successful promise sellers of
2020 and beyond will be the remaining large mutual life
insurance companies who can, if they stick to the markets


they know best, generate the capital they need on their own.
Life insurance, like all businesses, offers unique oppor-
tunities and challenges to the companies manufacturing and
marketing those products. Like other businesses, success
will come to those that take advantage of their opportunities
and deal most successfully with their challenges. Time
will tell, but betting on the success of life insurance companies
whose marketing and management focus is on the guarantees
that are unique to their charter seems like a good choice.