Hoping the worst is over for insurers
With MetLife, Hartford and Prudential set to announce dour third quarter results, rumors swirl as to whether the government will extend a lifeline to insurers.
NEW YORK (CNNMoney.com) -- A trio of major insurance companies will announce their third quarter financial results after the closing bell Wednesday and investors are bracing for poor results.
But now, Wall Street is waiting to see if the worst is over for Hartford Financial Services Group (HIG, Fortune 500), Prudential Financial (PRU, Fortune 500) and MetLife (MET, Fortune 500) or if there is more pain to come.
These three companies all warned earlier this month that they were not going to meet previously announced guidance for the quarter since they had to write down investments in troubled financial firms - especially Lehman Brothers, American International Group, and Wachovia.
Analysts are now forecasting that Hartford will report a loss for the quarter while earnings per share for both MetLife and Prudential are expected to fall more than 40% from the same period last year.
Shares of all three firms have been battered in the past few months. MetLife's stock is more than 55% below year-ago levels. Shares of Prudential are more than 60% lower than where they traded this time last year and Hartford's stock has lost about 80% of its value in the past 12 months.
All of this has sparked rumors about whether these and other issuers will be the next group companies to seek government assistance to help them make it through the credit crisis. It has also led to speculation about a possible wave of mergers overtaking the industry.
Here's a look at what exactly went wrong and what might be next for the industry.
Portfolios hit: How many people die each year is relatively predictable. In order to pay out life insurance claims, insurance companies take the premiums that consumers pay and invest them in massive portfolios.
Insurance companies have historically kept a large portion of their funds in corporate bonds, which provide a higher rate of return than government bonds but aren't as risky as holding equities.
Corporate bonds of banks and insurers, in particular, have been a popular investment class for life insurance companies. "Most life insurance companies have exposure to the financial sector," said Sunkeet Kamath, senior research analyst at Sanford C. Bernstein.
But as the credit crunch intensified, the value of these investments sunk rapidly.
"When there is a credit problem, insurance companies by their very nature can not escape it," said Steven D. Schwartz, life insurance analyst at Raymond James. "They are going to get hit."
But while these insurance giants haven't been able to dodge the crisis, Schwartz doesn't think it will be fatal for them either, because their investment portfolios are so massive and so diversified.
Analysts don't think that Wednesday's results will be much worse than the guidance that the companies already gave. Instead, analysts and investors will be listening intently for how the insurance companies expect to navigate the turbulent economic landscape ahead.
Treasury funding: Because of the problems facing some insurers, there have been rumors that the Treasury Department will include the industry in the $700 billion bank bailout, or Troubled Asset Relief Program (TARP).
On Friday, when the Wall Street Journal and Washington Post published articles indicting that the Treasury department may extend the benefits of the TARP program to insurance companies, stock of the three companies surged.
One analyst said it would make sense for insurers to receive an investment from the government since it would be hard for insurance giants to obtain capital elsewhere, given market conditions.
"We view this potential source of funding as a positive support as it is unlikely they could access capital on as favorable terms in the current environment," said Randy Binner, an analyst with Friedman, Billings, Ramsey & Co. in a report Monday.
Binner added that any support from the government could be used to fund acquisitions in the industry, especially of parts of AIG, which is looking to shed assets to help pay back the $85 billion loan it received from the Federal Reserve last month.
But he also cautioned that insurance companies could face more turmoil ahead if the credit crunch is not resolved soon.
"Issues of credit and liquidity still are paramount," he said.
In a letter written to Treasury Secretary Henry Paulson that was released Tuesday, Travelers CEO Jay Fishman said that his firm "does not require or intend to request any such assistance" and added that "the substantial majority of insurance companies represented by the American Insurance Association feel the same way."
Fishman also urged life insurers that might need funds to look to the private markets instead of the government.
Still, some insurers may have no choice but to take funding wherever they can get it. That's because credit ratings agencies like Standard & Poor's and Moody's may lower the ratings on a company's debt if they report significantly worse results and warn about the fourth quarter.
"They are taking a much more careful and cautious look going forward," said Bernstein's Kamath, watching for increases and decreases in the level of capital these companies have available.
Stock woes and your insurance policy: Despite the problems facing insurers, analysts said that policyholders should not worry about their life insurance plans.
Life insurance policies and payments are dispersed by subsidiaries of the main parent company and the subsidiaries are regulated at the state level, explained Kamath, and have to maintain a certain level of capital on hand.
Binner echoed that sentiment. Customers "should not associate stock price declines with the company making good on its obligations," he said.
Variable annuity products are a slightly different issue. People who buy variable annuities pay an upfront payment to an insurer that the insurer than invests, usually in mutual funds. Insurers then pay back the customer periodic payments of the principal amount and investment gains over time.
But since this is an investment, the annuity can lose value. However, Kamath said there are regulations with variable annuities to somewhat limit the amount of losses consumers face from variable annuities.
"There are some floors that have been put in place with respect to the variable annuities," said Kamath. "Ultimately, the whole idea behind offering these products and charging a fee," he explained, is "some protection for the consumer."