Snarls in Insurance Investigation, Part 2

Editor's note: This is Part 2 of David Merkel's discussion of the issues surrounding New York Attorney General Eliot Spitzer's insurance investigation. Be sure to read Part 1, in which Merkel discusses four issues where Spitzer may encounter difficulty as he investigates.

Economic and Political Implications

I'm not worried about present or future investigations by New York Attorney General Eliot Spitzer. I rely on my saying, "Political systems rely on economic systems, which in turn rely on cultural systems." It is genuinely difficult, in a culture that embraces the free market to the degree the U.S. does, to radically and permanently alter economic structures. Banned structures have a way of going into hiding and reappearing in a new form (Glass-Steagall Act, anyone?).

There is the danger that a too-broad regulatory change would diminish capacity in the market, leading to higher premiums. There is the tendency in American politics for all sorts of players to say, "This must never happen again!" But every legal and regulatory change has both intended and unintended consequences. The question should be whether new laws and regulations do more harm than good. Potential legal and regulatory damage tend to get ignored at times like this.

We also need to pose the question of how we want our society to enforce standards of behavior. We face three nonexclusive choices here:

Injured parties can sue for damages in a court of law. The attorneys general can press criminal charges as needed.
Regulators can investigate and move to limit the conduct of bad players in the marketplace.
Spitzer can file charges against those for whom he has strong evidence of wrongdoing and use the media to bring attention to all of the alleged wrongdoing. He then can negotiate for changes in industry practices, together with damage claims. A posse of tort lawyers and other regulators then can follow up as needed.

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Even in the hands of a good man, option three is the scariest to me because of the concentration of power in a single man. Division of administrative, legislative and judicial functions is so key to our republic that when we mix up aspects of them on a practical, if not a de jure, basis, our liberties are threatened. I would stick with options one and two, even if option three seems to solve some problems that lazy regulators and courts don't handle in the short run. Discretionary power, presently wielded by a good man, eventually will be wielded by a bad man.

And lest I be viewed as a shill for the industry I cover, and for which I served as an executive for more than a decade, note that I am critical of many of the industry's practices. My columns on life insurance and annuities have lost me friends in the industry.

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At time of publication, Merkel and/or his fund was long Assurant, Allstate, Endurance Specialty Holdings, MetLife, Montpelier Re Holdings, Old Republic International, PartnerRe, Prudential, Reinsurance Group of America, Safety Insurance and StanCorp Financial Group, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send your comments to [e-mail].

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.