Why Insurance Companies Fail
By Hartley Hartman, Manager, Johnson Lambert LLP

Insurance has existed for several hundred years and has helped shape society as we know it.  During that span countless insurance companies have operated successfully and others have seen hardship and failure.  These successes and failures led to the regulatory oversight that governs the modern insurance industry. State insurance departments monitor insurance company operations to help ensure the mistakes of their unsuccessful peers aren’t repeated. Insurance company failures can be generalized into three categories: looting company assets, failed investment strategies and management schemes.


Looting Company Assets

During the 1980’s many large corporations invested in insurance companies. However, when asbestos and environmental claims were prevalent, those corporations divested their insurance company holdings.  Background checks for insurance company owners were not required at the time, so many individuals with little to no insurance experience purchased these companies and began liquidating the assets to purchase personal property and pay off loans.  Millions of dollars were looted leaving insurance companies unable to pay their claims.


Failed Investment Strategies

During the 1970’s interest rates spiked which prompted insurers to invest in mortgage loans, real estate, and junk bonds. The 1980’s saw a construction boom and many individuals defaulted on their mortgage loans leaving insurance companies holding the collateralized properties. To get the real estate off of their books, insurers offered generous financing. Many of the new loans failed and the insurers were stuck with the property again. Liquidation sales on these properties commenced and insurers with insufficient capital saw AM Best downgrade their ratings. This led to the downfall of many insurers heavily invested in long-term assets as they took large financial hits, which resulted in a significant decrease in insurer surplus. Many insurers were acquired or forced into liquidation.

Management Schemes

Unfortunately many insurance company failures result from management’s unethical behavior and fraudulent financial reporting. Management may feel pressured to meet certain goals or financial benchmarks, and look for creative “opportunities” to make the financial statements appears as though these goals have been met. These creative opportunities may take the form of:

  • Phantom year-end transactions
  • Stripping of equity
  • Undisclosed related party transactions
  • Undisclosed transactions with the Board of Directors (Board)
  • Manipulation of premium prices and reserve levels


Preventing Failure

It is crucial the Board is actively involved in the daily operations of the company. An effective Board should exercise appropriate professional skepticism and continually educate themselves on industry regulations and trending behaviors.  This will allow them to ask the right questions of management so they can do their part to prevent another insurance company failure.

For more information, please view our recent webinar on Why Insurance Companies Fail, or contact Hartley Hartman at hhartman@johnsonlambert.com.