How Important Is MetLife?

MetLife, the parent company of the Metropolitan Life Insurance Company, is one of the largest financial institutions in the world. Founded in New York City approximately 150 years ago, the firm now manages insurance, annuity, and employee benefit programs for 90 million people across the globe.

It’s an important firm, isn’t it? That’s why U.S. government officials voted to propose that MetLife be labeled a “systemically important” financial institution. Such a decision would serve to acknowledge the insurer’s dominant position within the nation’s economic system. And, accordingly, it would place the insurer under a more intensive spotlight of oversight and regulation.

Understandably, MetLife is eager to avoid any additional regulatory oversight activities, especially in light of its high profile failure of a government “stress test” two years ago. Thus, it is acting vigorously to avoid the “systemically important” label, even going so far as to threaten the government with a lawsuit.

To a certain extent, we can certainly understand MetLife’s argument about the inappropriateness of being labeled a “systemically important” financial institution. After all, the firm only began to expand from its insurance origins into the banking sector in 2001. And it didn’t receive any TARP bailout funds at all during the 2008 – 09 global financial crisis.

On the other hand, during the crisis in the autumn of 2008, American Express, Goldman Sachs, and Morgan Stanley all converted their corporate structures into bank holding companies in order to qualify for billions of dollars in TARP funds. One can easily argue that MetLife, by refraining from any reliance on TARP funding, should (out of a simple sense of fairness) be spared the levels of oversight that are now imposed on these other institutions.

And yet three non-bank institutions — AIG, GE Capital, and Prudential — have now been labeled “systemically important.” How can one argue that MetLife deserves to be excluded from this group?

So what should we make of MetLife? Is it a “systemically important” firm? Should a global financial giant that did not accept TARP funds, but that did fail a stress test in 2012, be given a label that draws enhanced regulatory scrutiny?

As the global financial crisis recedes into history for contemporary decision makers, it becomes less relevant than recent events. Because MetLife failed a stress test just two years ago, and given its current dominant position in the insurance sector, its designation as a “systemically important” institution may be inevitable.

AIG: Your New Public Relations Firm!

Imagine, for a moment, that your organization is suddenly confronted with an embarrassing crisis of monumental proportions. A crisis so severe, in fact, that you believe you need to hire Public Relations (P.R.) professionals to help you cope with the demands of an outraged public.

A few years ago, as you may recall, this was the type of crisis that confronted AIG, the global insurer that churned out billions of dollars of financial weapons of mass destruction. When AIG’s senior officers decided to pay themselves substantial performance bonuses after receiving taxpayer-financed government bailout funds, angry American citizens pressured those officers to voluntarily return their compensation.

AIG undoubtedly could have used some P.R. advice at that time. Surprisingly, the insurer is now helping to provide such advice to firms in crisis today.

Reputation Guard: Is It Insurance?

AIG’s service, provided through its Chartis subsidiary,  is called Reputation Guard. It is designed to help small and mid-size organizations that cannot afford to hire permanent P.R. staffs, but that may nevertheless require P.R. expertise in times of crisis. For an annual fee, AIG arranges for such organizations to receive advice from Madison Avenue P.R. firms; it also reimburses these organizations for various out-of-pocket expenditures related to crisis management activities.

But instead of structuring Reputation Guard as a simple prepaid contract, AIG has decided to design it as a complex insurance policy. According to the policy, a public relations crisis is defined as a rare but costly insurable event. A policy holder pays an annual premium to protect himself against the risk that he will suffer a loss from reputation damage as a result of a crisis.

The insurance policy does not reimburse a policy holder for the direct costs of “fixing” the problem that caused the crisis; nor does it cover the legal costs of fighting or settling litigation. Furthermore, the primary benefit of the policy does not involve any loss reimbursement at all, but rather arranges for the delivery of a limited array of P.R. advisory services.

This unusual contractual arrangement raises the following simple question: can this truly be labeled an insurance policy? Indeed, how can we differentiate between an insurance policy and a prepaid service contract? And why should we care?

Insurable Interest

As far back as the 1700s, the global insurance industry agreed to require that a policy holder maintain a quantifiable insurable interest in any object of insurance. A property owner, for instance, could only purchase an insurance policy if he could demonstrate and quantify the extent to which he would incur losses if his property were to be destroyed. Likewise, a family relative could only purchase a life insurance policy if he could demonstrate a personal relationship with the insured party, one that would likewise lead to losses if his relative were to lose his life.

Furthermore, the level of the benefit was historically defined by (and limited to) the level of the projected financial loss, a value that could be estimated through standard actuarial processes. Thus, by requiring that any policy holder possess a bona fide insurable interest in an insured asset or person, and by defining the payment benefit in terms of the projected loss, regulators could prevent speculators from developing gambling contracts that masquerade as insurance policies.

Otherwise, gamblers who wish to pace wagers on the deaths of total strangers could simply purchase insurance policies on those persons’ lives. In fact, morbidly speaking, they might even be tempted to cause the death events that would trigger the insurance payments!

Concerns about insurable interests have reverberated throughout various contemporary debates as well. Industry critics have complained, for instance, that credit default swaps allow financial speculators to bet on the “death” (i.e. the bankruptcy) of corporations without requiring them to own stock in those firms. And the United States Securities and Exchange Commission continues to receive appeals to strengthen regulations of firms that purchase life insurance policies from total strangers in the pursuit of profits.

Buying A Sales Pitch?

Measured against these standards, one cannot help but wonder whether AIG’s Reputation Guard should be classified as an insurance policy at all. Although companies do indeed incur losses when their corporate reputations are damaged in times of crisis, AIG’s actuaries have not estimated those projected financial losses and established premium and benefit levels that purport to cover them. Instead, the firm has simply developed a prepaid referral service that can be accessed in time of need, something akin to an Employee Assistance Program in the Human Resources field.

And what does a policy holder actually receive when, in a time of crisis, he accesses the service of the P.R. firm? At best, he may indeed receive the valuable advice of a highly qualified P.R. professional. At worst, though, he may instead receive an unwanted sales pitch to purchase additional services that fall outside of the scope of the Reputation Guard benefit package.

The Mini-Med: Our New Health Reform Threat!

Runaway cost inflation. A stagnant bureaucracy. Mind numbing complexity.

These are the monumental challenges that are confronting America’s federal government during the implementation period of its new system of universal health care. Though regulators certainly don’t need any additional headaches, last week we learned of an entirely new problem, one with a deceptively innocuous name: the mini-med!

Like Dr. Evil’s tiny clone Mini-Me in the Mike Myers comic film series Austin Powers, the mini-med health plan is a diminutive version of a full fledged insurance plan. Yet, despite its meager dimensions, it poses a sizable threat to the government’s program of national health reform.

Aflac! Aflac!

What, exactly, is a mini-med? It’s a tiny health plan that costs very little and thus delivers very little in exchange. It is sold directly to individuals by insurance companies, although businesses often help insurers to market these policies to their employees.

Aflac, for instance, offers a health policy that pays $1,000 for an initial hospitalization stay resulting from an accident, and an extra $1,000 for an admission to an intensive care unit. The insurer pays these amounts to individual policy holders, i.e. not to medical providers.

Are there any “catches” to this Aflac plan? Well, for a start, its coverage is limited to one hospital admission per year. Perhaps more importantly, its $1,000 or $2,000 stipend barely begins to cover the cost of a single day in most American hospitals, let alone the total cost of a typical multiple day stay. If we consider the additional costs of ambulance and other ancillary services as well, we can understand why insurers refer to these contracts as “mini” plans.

Nevertheless, companies as large as McDonald’s offer such plans to part time employees and other workers who would otherwise receive no employer health benefits whatsoever. Many of these companies are now complaining that new government health regulations may prevent them from helping insurers market these policies at all.

Making Business Difficult

How is the federal government making business difficult for insurers that offer mini-med plans? One new legal restriction is a requirement that all plans spend at least 80% to 85% of their revenues on medical care. Many mini-med insurers spend far less than this percentage on health care services; they explain that their average policy payment tends to be relatively small, while their administrative costs in total are large and fixed in nature. Thus, on a percentage basis, they assert that far more than 15% to 20% of their total revenue must inevitably be dedicated to paying administrative costs.

Another new legal restriction prohibits insurers from placing certain limits or “caps” on payments over specific periods of time. Coverage limits such as “one hospitalization per year” run afoul of this prohibition; mini-med plan providers are now arguing that unlimited or “uncapped” exposure to multiple claims would drive them out of business.

Such concerns have led supporters of mini-med plans to request waivers of these new regulatory requirements. Although McDonald’s publicly denied that it explicitly requested such a waiver, the Wall Street Journal reported last week that the firm indeed did so. Then, on Friday, HHS formally confirmed that it is evaluating a number of such waiver requests.

Is It Really Insurance?

There is, of course, an underlying question whose answer may determine how HHS establishes health policies for the mini-med industry sector; namely, is a mini-med plan actually a health insurance policy at all? If it is, then the new health insurance regulations may inevitably apply to it. But if it isn’t, then regulatory waivers or exemptions may indeed be granted by HHS.

On the one hand, any health cost reimbursement contract that pays a mere flat fee of $1,000 for a multiple day hospitalization cannot rationally be considered a comprehensive insurance policy. Aflac itself acknowledges this fact on its home web page, stating that “Aflac is not major medical insurance. Aflac pays you cash benefits when you are sick or hurt to use however you want.”

In other words, Aflac is disclaiming any responsibility for covering the full costs of health care. To the contrary, the firm urges individuals to spend their proceeds however they want, and not to rely on its payments exclusively to finance health care costs.

Nevertheless, the page title of Aflac’s internet home page is “Supplemental Insurance for Individuals, Insurance Coverage.” And the page title of its employer business web page is “Health Insurance Policies, Employee Benefits Program.” In other words, while Aflac disclaims any responsibility for paying “major” insurance claims, the firm does refer to its own products as “health insurance policies.” And it is explicitly positioning its program as an employee benefit.

Regardless of HHS’s pending policy decision, certain constituencies will clearly be dissatisfied with the direction of health insurance reform. But who could have predicted that one source of this dissatisfaction would be the smallest health insurance policy of all: the mini-med?

Introducing the NY Insurance Exchange!

If you were the Governor of New York State, what would you propose?

The recent collapse of Wall Street has damaged the downstate N.Y. economy. And the closures of large manufacturing facilities by former industrial titans like Bethlehem Steel, General Electric, General Motors, IBM, and Kodak have devastated the upstate N.Y. economy as well. As a result, Governor Paterson used his State of the State address last week to criticize his state legislators for failing to reduce state spending to levels that could be sustained by its shrunken economy.

But then how did Governor Paterson suggest improving New York’s economy? With stronger public education? Less government bureaucracy? More effective regulation and oversight?

Well, he did indeed address all of these issues, but he also proposed a dramatic new private sector initiative as well. Namely, he proposed the relaunching of the New York Insurance Exchange.

Back to the ’80s!

If Paterson’s mention of the New York Insurance Exchange makes you reminisce about the go-go times of 1987, when Michael Douglas conquered the financial markets in Wall Street and Michael J. Fox rose from mailroom to chief executive in The Secret of My Success, it’s likely because New York City actually did host an Insurance Exchange that folded that very year.

First launched in 1980, and patterned on the famous Lloyd’s of London market, New York’s original Insurance Exchange collapsed under the weight of its own complexity and lack of capitalization. Lloyd’s, a firm that once insured Betty Grable’s shapely legs, then resumed its role as the world’s only operator of a global exchange for insurance products.

But if an Insurance Exchange couldn’t survive in New York in 1987, why does Governor Paterson believe that it might succeed now? Does the world now require a second trading market for insurance? And is New York City now prepared to operate it?

A Persuasive Case

To be sure, an Insurance Exchange in New York City may make more sense today than it did two decades ago. One reason is that the world has become far more complex in nature, and thus insurance products have become more complex as well. Instead of simply negotiating with individual insurance companies for customized policies, organizations may well benefit by accessing a commercial market to devise risk management strategies.

Then why don’t they go to the Lloyd’s market, you may ask? Well, many organizations do so, but American firms may prefer to process transactions in an American insurance market. Organizations outside of the United States, but doing business in America, may prefer to do so as well. And even European firms that are doing business in Europe may appreciate an alternative to Lloyds; after all, a little competition is always a healthy situation!

Yet another reason for New York’s improved chances of success is today’s use of modern technology to operate electronic global markets for financial products, markets that were only in their infancies during the 1980s. The internet facilitates the shifting of financial transactions from one corner of the world to another, and global electronic market places have become commonplace; thus, a fledgling insurance exchange in New York City may well find it possible to gain acceptance (and new business) relatively quickly.

A Few Nagging Questions

Sounds like a great idea, doesn’t it? Nevertheless, before New Yorkers erect another Romanesque building with a gigantic trading floor next to the venerable home of the Stock Exchange, they might wish to ponder a few nagging questions.

First of all, who is going to regulate the new insurance products to be traded on the floor of the exchange? The N.Y. Insurance Department, after all, failed to stop AIG from creating what Warren Buffet called financial weapons of mass destruction, instruments that claimed to reduce financial risk but that eventually destroyed AIG and threatened the global economic system as well. A relaunched Insurance Exchange would challenge N.Y.’s regulators with a new array of complex securities.

Second of all, how much benefit would the state actually derive from the exchange? All trading activity on the NASDAQ exchange, and most trading activity on the New York Stock Exchange,  is electronic in nature. If an electronic system is employed by the new Insurance Exchange as well, would traders move their residences and establish offices in New York City? Or would Wall Street simply serve as a virtual address for trades that are consummated in cyberspace?

And third of all, who is going to invest in the products that are traded on this exchange? Governor Paterson suggested that hedge funds, private equity firms, and other parties who have no direct interest in insurance might establish trading strategies there. Such momentum traders, of course, have been blamed for wild and destabilizing swings in the prices of crude oil, food commodities, and other exchange traded products; it is therefore possible that new markets for insurance products would produce similarly detrimental effects.

So do the prospective benefits of an insurance exchange outweigh the risks? A believer in open competition would undoubtedly recommend that New York launch the endeavor, thereby allowing the free market to determine whether it becomes a success. Nevertheless, like the products to be traded on its exchange floors, a new Insurance Exchange would itself represent an initiative with great promise that is fraught with great risk.