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close this bookLeverage for the Environment - A Guide to the Private Financial Services Industry (WRI, 1998, 108 pages)
View the document(introduction...)
View the documentFOREWORD
View the documentACKNOWLEDGMENTS
View the document1. INTRODUCTION
View the document2. COMMERCIAL BANKS
View the document3. INVESTMENT BANKS
View the document4. MUTUAL FUNDS
View the document5. PENSION FUNDS
View the document7. LIFE INSURANCE
View the document8. VENTURE CAPITAL
View the document9. FOUNDATIONS
View the document10. CONCLUSION
View the documentGLOSSARY*
View the documentABOUT THE AUTHORS



The life insurance industry consists of two distinct businesses: selling life insurance policies to consumers, and investing the funds derived from the premiums for these policies. Depending on the type of policy, life insurance guarantees the insured consumer a predetermined monetary sum if the consumer dies before a certain age or lives beyond a certain age. In the United States, life insurance annuity policies were once a primary vehicle for retirement savings for average citizens, but as social security and pension funds have become available, reliance on life insurance as a retirement savings vehicle has decreased. This industry generates revenue by charging premiums calculated to exceed claims and by accumulating the interest and capital gains earned from its invested capital. Figure 7.1 summarizes four key characteristics of the life insurance industry of particular importance to the public interest community.

Size and Leaders

While most people think of the industry in terms of the sale of life insurance policies, it also represents one of the largest pools of long-term investment capital in the world, with US$ 2.3 trillion in assets. Two primary types of life insurance firms exist: stock companies, which are publicly traded companies, and mutual companies, which are owned collectively by the policyholders. The world's three largest insurance firms (based on total assets) are Japanese, led by Nippon Life. The next largest is the French insurer, AXA. The largest U.S. stock firm is AETNA, with the mutual firms led by Prudential, Metropolitan, New York, Nationwide, Principal, and Northwestern.

Key Features

Life insurance companies tend to employ conservative investment strategies because of their high aversion to risk. In the past, the industry placed its assets in long-term bonds and mortgages with maturity dates that matched anticipated claims by policyholders based on actuarial forecasts. This approach, although secure and easy to manage, did not generate a high rate of return. Currently, the industry is significantly reevaluating its approach to managing investments. The move towards pension funds as a vehicle for retirement savings is negatively affecting the life insurance industry in most developed countries.


The United States is the only major country that does not regulate the insurance industry at the national level. Instead, the industry is regulated at the state level by 50 state insurance commissioners, who are appointed in some states and elected in others. The National Association of Insurance Commissioners (NAIC) serves as the umbrella oversight body for the entire U.S. insurance industry. NAIC establishes reporting and disclosure guidelines on liabilities and assets, and specifies information that must be included in a firm's "annual statement." In 1996, NAIC also issued guidelines on investment management for the insurance industry. The American Council of Life Insurance (ACLI) is the industry's major trade association; its 550 members represent some 85 percent of the U.S. industry's assets. ACLI exercises influence by providing information and educational materials and organizing conferences on new issues for its members.

Figure 7.1 - Key Characteristics of Life Insurance

Attention to Environmental Issues

The underwriting side of life insurance does not yet appear to be integrating the linkages between environment health and human health into its actuarial calculations. Nor has the industry drawn links between investment practices and the underwriting side of their business. On the investment side alone, however, the life insurance industry has acquired experience and expertise in a narrow set of environmental issues - toxic contamination related to real estate investment - due to its heavy investments in the real estate sector. (See Box 7.1.)

Relevance to Developing and Transition Economies

On the underwriting side, the life insurance industry is growing as a vehicle for savings in many developing and transition economies. For example. Chinas life insurance market is changing rapidly. The only foreign issuer, American International Group, is leading a boom in individual life insurance policies, a hitherto neglected segment of the market (1). On the investment side, the life insurance industry is relevant to the developing world as it invests its capital in various international securities. In this context the U.S. experience with the real estate market (see Box 7.1) may hold lessons for the global development of the life insurance sector. Important factors to consider include: the extent to which the host country places repatriation limits on earnings, the sectors in the host country that provide secure and predictable investment, and environmental regulations and enforcement in those sectors.


Figure 7.2 illustrates the operation of a life insurance company. The life insurance industry sells policies to clients, or policyholders, through independent agents, its own salesforce, and brokers. Before starting the sales process, the life insurance company evaluates the risk profile of the country or region where the firm will be marketing its products. The underwriter, with the support of the actuarial staff, performs extensive analyses to ascertain key risks and exposures in order to predict the average lifespans of various subpopulations. From these analyses, the overall credit risk pool is evaluated and submitted to senior management and the Board of Directors for approval.

Agents obtain approval to write a policy for a potential policyholder from the underwriter and policy committee. Once the policy is approved, the actuarial staff price the policy, which is then written and signed. Once the contract is signed, customer service, with support from the claims department, manages contact with the policyholder.

As the policyholder begins to pay premiums, the money is directed to the investment side of the life insurance company where the investment strategy is set and managed by the finance committee and the chief investment officer or treasurer. Mortgage bankers help identify quality mortgages to hold in the investment portfolio.

In general, company strategy is determined on an annual basis by dividing the assets of the firm among various internal and external portfolio managers who try to maximize rates of return by allocating funds across various investments.

Rating agencies, such as A.M. Best, provide a rating of each life insurance company's overall underwriting and investment portfolio.

The following questions are considered by portfolio managers:

· How will the rating agencies react to a change in investment approach?

· Given the calculated approach to the timing and size of investment returns to match claims, what are the necessary rates of return?

· How much risk can the portfolio assume?

· How should the overall portfolio be divided into different investment vehicles and financial instruments?



Chief Investment Officer/Treasurer - Bottom-line leverage. The chief investment officer and/or
the treasurer determine the firm's investment strategy. Because the life insurance industry requires predictable investment returns , these officers should be willing to consider evidence that integrating environmental consideration into investment decision makes financial sense over the long run.

Internal/External Portfolio Managers - Bottom-line leverage. Portfolio managers buy and sell securities for the insurance firm and could, in theory, be influenced in similar ways to the chief investment officer. However, portfolio managers are implementing the overall investment strategy set by others.

(Mutual) Policyholders - Values-based leverage. Similar to shareholders in a publicly traded company, mutual policyholders have certain rights to influence the insurer's actions because they are the owners. Policyholders could influence the firm's investment management approach to include environmental criteria.

Regulators - Policy leverage. In the United States, state insurance commissioners and the NAIC regulate both the underwriting and investment activities of the life insurance industry. Regulatory guidelines could be promulgated to integrate environmental criteria in investment strategies and to elevate the level of environmental disclosure included in the annual statement.

Box 7.1 The U.S. Life Insurance Industry: Environmental Management of Real Estate Investments

Background: The life insurance industry has traditionally focused on long-term investments that produce a fixed and predictable stream of income. In particular, a large portion of the industry's asset portfolio has been held in commercial mortgages, which it was presumed would fulfill this need. However, a series of real estate collapses around the world in the 1970s and 1980s proved this assumption unfounded. U.S. life insurers found themselves no longer holders of mortgages, but of the actual real estate. These changes attracted the attention of regulators, who changed industry reserve requirements to make real estate and mortgage investments less profitable. Between 1980 and 1997, the proportion of life insurance companies' investments allocated to commercial mortgages fell from 29.4 percent to 12.9 percent.

Action: In 1980, the United States passed the "Comprehensive Environmental Response, Compensation and Liability Act" (CERCLA) or "Superfund" legislation, which regulates the clean-up of toxic contamination. In the late 1980s, U.S. courts found mortgage-holders liable for the costs of cleaning up toxic contamination, even if contamination occurred prior to foreclosure of the mortgage, if they were involved in management of the facility. This alerted the life insurance industry to potential losses arising not only from real estate holdings but also from mortgage holdings.

Outcome: Many life insurance companies in the United States have now established special units to evaluate and manage environmental risks related to industry assets invested in real estate and mortgages. The lessons of the 1980s have led to three changes in practice by the investment side of the industry. First the industry is careful to do environmental due diligence prior to holding a mortgage. Second, in the event of default, the industry undertakes pre-foreclosure environmental due diligence. Third, upon assuming ownership of real estate due to default, life insurance companies have become environmentally proactive property managers.

Analysis: The example of the U.S. life insurance industry demonstrates that policy leverage can have broad and far-reaching consequences, often impacting sectors beyond the immediate goals of policy. In this example, holders of commercial mortgages were held accountable for the environmental integrity of the underlying asset. The exact circumstances under which lenders are liable, however, are a contentious issue and the subject of much debate in legal and regulatory circles. One positive outcome of this debate has been the enhanced visibility of environmental issues in the life insurance industry and the development of technical capability and instituted procedures for avoidance and management of toxic contamination.

Sources: Institutional Investment Report Vol. 2. No. I. June 1998; and Joseph S. Messer. "New Superfund Risks." Mortgage Banking. 50 (II).


1. Craig S. Smith. "AIG Reshapes China's Insurance Industry." Wall Street Journal. February 9, 1996.


National Association of Insurance Commissioners (NAIC), (816) 374-7259;

American Council of Life Insurance (ACLI), Washington, DC, (202) 624-2000

Risk and Insurance Management Society, New York, (212) 286-9292

Society for Risk Analysis, McLean, VA, (703) 790-1745

National Insurance Law Service:

Insurance Services Office, Inc., New York, (212) 898-6000

A.M. Best:

Annual statements (available at NAIC, libraries, or companies)

Annual reports (direct from companies)

Trade periodicals:

National Underwriter
Best's Review
Best's Week


Burgh, Edward M. Mortgage Investing by Life Insurance Companies. Atlanta, GA: FLMI Insurance Education Program, Life Management Institute. 1983.

Friedman, Amy S. "Snapshots of Some Emerging Markets." National Underwriter Life & Health. Financial Services Edition. No. 21. May 22.1995.

Mathewson, G.F. and John Todd. Information, Entry, and Regulation in Markets for Life Insurance. Toronto: University of Toronto Press. 1982.

Mehr, Robert and Sandra Gustavson. Life Insurance Theory and Practice. Piano, TX: Business Publications Inc. 1984.

Morein, Joseph. "Developing Countries Emerging As Untapped Opportunity." Best's Review P/C. August 1996.

National Association of Insurance Commissioners. Investments of Insurers Model Act. Kansas City, MO: National Association of Insurance Commissioners. 1996.

Outreville, J. Francois. "Life Insurance Markets in Developing Countries." Journal of Risk and Insurance. 1996. Vol. 63. No. 2. pp. 263-278.

Special Trustee Joint Committee of TIAA-CREF. TIAA-CREF. The Future Agenda. 1987.