Treece: The coming caveat emptorWritten by Dock David Treece | | firstname.lastname@example.org
Several weeks ago, The Wall Street Journal readers may have noticed an article outlining a number of recent purchases of insurance companies by money management firms. This recent trend may have far-reaching implications that few have considered.
Many of these insurers were ideal targets for money managers, given that insurers tend to make a good deal of their revenues by investing their “float” — money paid into the company as premiums not yet paid out on claims or in the form of annuities. Because insurance companies are cautious by nature, the past few years have left them with skimpy investment-related profits. Obviously some money managers felt they could expand profits by investing floats more aggressively.
The real concern here is that these money managers may be inadvertently laying the first bricks in what could become another financial crisis. Undoubtedly, some of these money management firms that purchase insurers will mismanage their floats. Sooner or later they will buy something stupid — like mortgage-backed securities, or bonds in a rising interest rate environment — which will ultimately implode.
When that happens, rest assured that money managers won’t be subsidizing losses. They’ll leave policy and annuity holders to foot the bill just as insurance companies like AIG were ready to do in 2008 before the government stepped in to make good on derivatives that had gone sour.
To be fair, this is a great business model for managers. They’ve found a new and innovative way to take advantage of perhaps the best tool used by financiers: OPM or other people’s money. By investing premiums (aggressively), these money managers not only make money on fees, they also get to keep the spread between investment gains and interest paid out on insurance products (e.g. annuities and insurance policies).
Even more important to this discussion is that money managers have all this profit potential with absolutely no risk of loss. Therein lies the problem; it’s the insured who are put at risk of loss.
In the world of modern finance, most of the investing public perceives insurance products as relatively “safe” investments. They look at these products the same way many looked at bonds backed by pools of mortgages or other “collateralized debt” as safe, just as real estate, or European bonds, or Argentinean bonds were.
Unfortunately every now and then circumstances change, and major shifts in the investment world can teach people difficult lessons about what qualifies as a “safe” investment.
And yet, it seems that today investors aren’t the only ones learning lessons. For years, financial advisers made great livings just by executing transactions for clients. Over the past 20 years, technology has changed the financial services industry at its core. Financial professionals can no longer make a living simply by acting as a broker.
Instead, industry professionals can only make money based on the value they add to client portfolios — their capacity to research and interpret information that impacts the markets is the only value they have for clients. As a result, many advisers have found themselves increasingly irrelevant. They can no longer do anything for clients that clients can’t do for themselves online at almost no cost.
Because of this shift, there are some major changes taking place in the industry. Firms are being bought and sold; there has been a wave of mergers and acquisitions. Other firms have been dropping their registrations or changing their business models entirely. In short, there has been a mad dash of firms scrambling to find and exploit new profit centers.
For these displaced professionals, nothing is sacred. Things like buying insurance companies to take advantage of the float — something few would have ever considered — are now real options on a narrowing list of choices to remain profitable. It’s up to members of the investing public to be aware of what they’re buying from whom, and the risks involved with both.
Dock David Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and is licensed with FINRA through Treece Financial Services Corp. He provides expert content to numerous media outlets. The above information is the express opinion of Dock David Treece and should not be construed as investment advice or used without outside verification.