Study Finds 18% of Financial Institutions Weak

October 10, 2001
More than 18% of insurance companies, HMOs, banks, thrifts, and brokerage firms (a total of 2,634 institutions) currently exhibit weaknesses that make them vulnerable to financial difficulties in a recession, according to a broad-based study of all major financial industries by Weiss Ratings, Inc.

"After a decade of nearly nonstop earnings growth, most companies have accumulated a large enough capital cushion to insulate themselves against bad times," commented Martin D. Weiss, Ph.D., chairman of Weiss Ratings. "However, there are still many companies with inadequate capital positions, low earnings, risky investments or other problems that could make them vulnerable to failure in tough times."

Among the 2,327 property and casualty insurers rated by Weiss, 546 companies, or 23.5%, receive a rating of D+ or lower, indicating they are vulnerable to financial difficulties in a recession. Among the 1,146 rated life and health insurers, the number of weak companies is 297, or 25.9%.

"Considering the low inflation and positive growth of the last decade, this is a surprisingly high percentage of weak insurers," Dr. Weiss stated. "Fortunately, however, only a handful of these weak companies is large, unlike the early 1990s when we last saw a jump in failures."

Large insurers (with $1 billion or more in assets) deemed vulnerable by Weiss Ratings include: Hannover Life Reassurance Company of America (Fla.), rated D+; Southwestern Life Insurance Company (Texas), rated D+; Nuclear Electric Insurance (Del.), rated D; and First State Insurance Company (Conn.), rated E.

In a recession, the demand for insurance policies weakens, as consumers and businesses postpone or drop plans to buy new policies. In addition, some financially strapped consumers and businesses choose to let their policies lapse as a cost-saving measure. Already, in the first three months of 2001, profits at property and casualty insurers have fallen by $1.1 billion, or 17.1%, compared to the same period last year, while life and health insurers suffered a profit plunge of $3.8 billion, or 53%.

Many insurance companies are also exposed to a downturn in the stock and corporate bond markets. At the end of last year, property and casualty insurers' stock holdings equated to 36% of the industry's capital and loss reserves, while corporate bonds represented an additional 47% of capital and reserves.

By comparison, life and health insurers hold stocks equaling 12% and corporate bonds equaling 377% of their capital and reserves. Particularly worrisome are the industry's junk bonds, which equate to 40% of capital and reserves.

"Insurers often don't need to sell their stocks or bonds when markets are down. But if borrowers default, companies go out of business, or insurers have to raise cash to meet rising claims, the paper losses become real," Dr. Weiss added.

One sector which stands out as a safe haven is the Blue Cross Blue Shield plans. Out of 54 Blues plans, only one is considered weak by Weiss Ratings -- Blue Cross Blue Shield of New Mexico (rated D+).

192 Vulnerable Health Maintenance Organizations

The HMO industry suffers both from the highest failure rate of all financial industries covered by Weiss and the highest percentage of companies still vulnerable. In the four years from 1997 to 2000, a total of 52 HMOs failed, and, based on the most recent data, 192 companies are rated D+ or lower, representing a large 40.9% of the 469 HMOs rated by Weiss.

The financial weaknesses in the HMO industry are currently concentrated among smaller HMOs (those with fewer than 100,000 enrollees). While both large and small HMOs have experienced a sharp rise in medical costs per enrollee, the large HMOs have been able to offset the increase by boosting revenues at a quicker pace. "In a recession, however, most HMOs - regardless of size - will encounter renewed cost pressures," Dr. Weiss noted.

1,591 Vulnerable Banks and Thrifts

The percentage of banks and thrifts receiving a weak rating from Weiss is lower than that of the insurance industry, currently at 16.2%, or 1,591, of the 9,821 institutions rated. Nevertheless, a recession will likely have a greater negative impact on the banking industry as commercial and consumer loan defaults take their toll.

Despite relatively small declines in the gross domestic product in the late 1980s and early 1990s, the bank and thrift failure rate rose dramatically, reaching a peak of 33.8 per thousand in 1989, with an average of one bank failure per day between 1989 and 1992.

"The banks' recent sharp rise in bad loans, even before an economic decline began, does not augur well for the industry if we're slipping into a bona-fide recession," said Dr. Weiss.

Seven Vulnerable Brokerage Firms

Based on the most recent data available from the Securities Exchange Commission, Weiss Ratings has issued a weak grade to seven of the 507 brokerage firms it rates. Of all the major financial industries, the brokerage industry has the lowest percentage of vulnerable institutions, reflecting the 10-year-long bull market in stocks.

Even so, Weiss Ratings has noted several recent events which could weaken brokerage firms, including sharp declines in commission revenues and initial public offerings (IPOs), a surge in arbitration claims by discouraged investors, direct and indirect losses from the World Trade Center crisis, and the possibility of a continuing bear market.

Advice for Consumers and Investors

"As we've seen recently, the more immediate impact of a recession is on a company's earnings and share price," noted Dr. Weiss. "As such, I recommend investors consider selling investments in sectors and companies that are vulnerable to a recession. The best time to buy is after the impacts of a recession are already in the market - not now."

Consumers can feel the impact of a recession in four ways: Lower yields on whole life insurance policies, annuities, and bank deposits; rising fees from the companies with which they do business; reduced service as companies move to trim expenses; and in the worst case, a failure. To help guard against these difficulties, Weiss Ratings recommends consumers do business with institutions that are rated B+ (good) or better.

Weiss issues safety ratings on more than 15,000 financial institutions, including HMOs, life and health insurers, Blue Cross Blue Shield plans, property and casualty insurers, banks, and brokers. Weiss also rates the risk-adjusted performance of more than 11,000 mutual funds.

Weiss Ratings is the only major rating agency that receives no compensation from the companies it rates. Revenues are derived strictly from sales of its products to consumers, businesses, and libraries.

Back to the top | Consumer News