What’s next for the Insurance Industry?

I’m always impressed with how quickly Sop picks up clues and makes predictions that I read later in the news – and even more so now that his recent post Insurance taking a hit caught the eye of a reader who sent this related story.

Months after the stocks of big Wall Street financial firms first came under attack, insurance companies are now being battered, suggesting that a similar round of consolidation and recapitalization may be in store for that industry.

Insurance stocks have plunged more than 30 percent in the last five days, with Prudential Financial the big loser on Thursday. Prudential’s stock fell $10.02, to $33.27 a share, and it is now 42 percent lower than a week ago. A United States senator’s offhand remark hurt the group last week, but the group is continuing to suffer far more than the broader market. Investors are worried about falling earnings and the prospect that many in the sector may need additional capital, which would dilute their own shares.

Hartford Financial Services Group raised $2.5 billion by selling shares to Allianz , the German insurer, on Monday. The Hartford’s shares closed at $20.11 Thursday, down $4.75.

MetLife, the largest American life insurer, which warned earnings would be sharply lower in the third quarter, raised $2 billion in a stock sale on Wednesday. Even though existing shareholders were left with a smaller stake in the company, investors seemed heartened that the company could get funds readily, making it one of the few winners on a day when all 30 stocks in the Dow Jones industrial average fell. MetLife closed at $28 a share, up $1.

When the government bailed out American International Group , there was little talk of a widespread downturn in the insurance industry. A.I.G. was seen as unique because it was a large issuer of a type of derivatives contracts that were far less prevalent at other insurers. Those derivatives brought A.I.G. to the precipice.

But now a wave of losses is moving throughout the insurance industry, caused by the seize-up of the credit markets and declining investment values.

“Insurance companies tend to focus on high-quality investments,” said Douglas L. Meyer, an insurance analyst at Fitch Ratings . When the declines were mainly in the lower-quality investments, he said, the industry was relatively sheltered from harm.

Now, though, Mr. Meyer said, “the depths of the current credit crunch is starting to affect the high-grade securities, so that’s starting to affect the insurance companies more.”

For now, analysts do not see insurers in precarious situations. But if the investment losses keep mounting, they will start eating away at insurers’ capital. Even insurers with conservative investment portfolios, like MetLife, are not immune.

The investment losses will also pose a problem for insurers with big retirement divisions, especially life insurance companies. They deal in investment products that guarantee a certain rate of return. Now the insurers will have to make those payments out of their diminished assets.

Insurers whose business models involve large amounts of short-term paper, or other obligations that are maturing soon, also risk being caught short if the credit markets stay frozen. If they have to start selling securities to produce the cash to pay their obligations, they could end up dumping the instruments in a market that has many sellers and almost no buyers.

“If the distressed market conditions persist, this will negatively impact insurance company liquidity,” Mr. Meyer said.

Fitch lowered its outlook for the life insurance sector to negative from stable at the end of September. It said it thought some insurers had delayed recognizing unrealized investment losses this year, in hopes their impaired assets would regain value. But that has not happened, so the industry is likely to write down more impaired assets in the coming months.

Weaker institutions may have trouble raising new money if their capital is eroded, and the government may be unwilling to come to the aid of more insurers after rescuing A.I.G. That suggests a consolidation and reshaping of the industry is in store.

Though MetLife was one of the first big insurers to raise capital in this downturn, it appears to be one of the least in need. Even before it sold 75 million shares for $26.50 a share Wednesday, it had some $4 billion more than the level associated with a strong capital base.

John Hall, a securities analyst at Wachovia , said in a report issued Thursday that he saw MetLife’s stock sale “as a pre-emptive maneuver to facilitate the company’s ability to take advantage of emerging strategic opportunities, including the possible acquisition of A.I.G. units.”

A.I.G. has announced it is selling a large number of its insurance subsidiaries to raise money to pay off its $85 billion bridge loan from the Federal Reserve. MetLife, meanwhile, has expressed an interest in expanding its foreign operations.

As of Thursday, Hartford Financial Services had been among the most punished by investors. Its stock has lost more than half its market value this month, prompting the Connecticut insurance commissioner, Thomas R. Sullivan, to issue a statement on Thursday that the Hartford’s “financial strength remains solid.”

Hartford’s slide began in earnest after a comment by Senator Harry Reid , Democrat of Nevada and the majority leader, during the debate over the $700 billion Treasury bailout program. Mr Reid said in a television interview that he had heard that a major insurer, “one with a name that everyone knows,” was on the verge of going bankrupt. He later said he misspoke.

Property and casualty insurers tend to be somewhat less vulnerable to investment fluctuations than life insurers, but they are also showing signs of strain. Even the A shares of Warren E. Buffett ‘s well-known holding company, Berkshire Hathaway , have lost market value, closing Thursday at $114,000, down $4,000 a share, and off 17 percent in the last five days.

Mr. Buffett is nevertheless making big investments in municipal bond insurance and in companies like Goldman Sachs and General Electric .

But most insurers are under siege. Prudential Financial issued a statement Thursday saying the operating income from its financial services businesses would be no more than $375 million in the third quarter, compared with $907 million in the third quarter last year. Along with other investment losses, Prudential will write down investments on securities in Lehman Brothers , A.I.G. and Washington Mutual . Prudential, which will issue its third-quarter earnings on Oct. 29, also said it was suspending a stock buyback program to conserve capital.