“What can we do to improve profitability and grow our business?” is a question that often comes up in conversations with life industry colleagues. Very often, I tell them, the potential answer is to intensify your focus on asset/liability management. In this task, structured settlements frequently play an important role.
One person who has figured out the benefits of structured settlements is Warren Buffett. In recent years, Berkshire Hathaway has moved aggressively into structured annuities, capturing about 15% of the total market in 2012. A quick scan of life insurance members of the National Structured Settlements Trade Association shows about a dozen other companies: Amica, Liberty Mutual, American General, New York Life, MetLife, Pacific Life, Prudential, Mutual of Omaha, and USAA.
There are multiple reasons that a life insurer should look at starting a structured settlement annuity program. The most obvious would be that this product is spectacularly well-suited for both the insurer and the beneficiary. Since 2008, structured settlement annuities have proven themselves through all investment cycles with every payment going out on time and in full. There couldn’t be a better testimonial of insurers’ financial strength and the social and moral value of the product.
More substantively, a life insurer’s internal financials will drive a desire to be in or out of a business. An insurer’s operations are really nothing but a combination of asset and liability management. To be profitable and maintain regulated levels of financial security, you have to be effective at managing them both.
During my years managing annuity operations at Travelers, we strove to manage both long and short liabilities. We felt strongly that by managing the liability side of the balance sheet, we enhanced our overall profitability and our ability to manage risk. This gave us the ability to seek out compatible risk and/or non-correlated risk that, in aggregate, balanced our book of business and increased our flexibility.
In a rising interest rate environment with increasing inflation, the primary sources of long liabilities are annuities related to pension buyout arrangements and structured settlement annuities, both of which required long-term liabilities that were both fixed and determinable, and did not have a surrender feature. Structuring annuities for workers’ compensation claims became especially appealing because payments usually only continue until the claimant reaches age 65 and dovetail nicely with pension annuities, which commence at age 65.
Equally as important to us was the asset side of the equation. By being an active player in both pension buyouts (closeouts) and structured settlements, Travelers could be aggressive in taking advantage of the entire yield curve. As a buyer of assets across the entire term structure, we were aware of and could take advantage of transactions across the investment spectrum. In combination, the end result was, in our opinion, a more robust management of risk and return.
The ancillary benefit on the asset side was the ability, should the opportunity present itself, to internally strip assets to more closely match our liability profile. Clearly, the long assets are the driving force in this strategy.
From a business perspective inside of Travelers, we married our structured settlement business with the institutional business. Not only did this make sense to use from a liability exposure, but the cost basis of structured settlements seemed more in line with the institutional business in that structured settlements don’t incorporate things such as trail commissions, agency expenses and load recoveries.
In addition, we felt that structured settlements represented a two-level sale. Obviously, the end user is the injured party but the primary decision maker is the casualty company. Specific motivations will vary but these buyers are focused on quickly and cost-effectively extinguishing claims. In this simplistic approach, casualty companies were very much like large, sophisticated pension funds.
In our experience, there’s a striking similarity between the structured annuity business and the institutional pension annuity market. Both involve insurers’ use of annuities to manage long-term liabilities and reduce required assets or, in the case of casualty companies, effectively manage reserves.
For the claimant, income from a structured annuity is completely exempt from all federal and state taxes. It is also exempt from taxes on capital gains, interest, dividends and the AMT. For claimants in high-tax states, this offers a significant financial advantage. This, in combination with the financial strength of the insurance industry, aligns the needs of the claimant with the casualty company offering the annuity.
In our particular case, we were in both businesses. The realignment and refocus made sense and proved very successful. But even companies not in these businesses would be well served to look at the dynamics of structured settlements and gauge the impact and benefits to their existing business lines.
Finally, one question I occasionally hear about structured annuities involves “commoditization.” People wonder whether the margins are enough to justify the program. My response is this: On one hand, all financial products are or will quickly become commoditized and while structured settlements will not be an aggressive, high-margin business by itself, it needs to be evaluated on the benefit it offers to a life company’s aggregate business. It is an important product that will prove an effective tool to manage risk and return.
Viewing structured settlements through this prism, it makes a great deal of sense for a savvy and patient investor such as Berkshire Hathaway to increase its exposure. Warren Buffett and others like him see the value of blending businesses to maximize return for the enterprise.