Federal Reserve Suggests Life Insurance Companies Are Too Leveraged

A new report by the Federal Reserve has put into question whether life insurance companies in the U.S. have enough cash to pay claims amid the coronavirus pandemic.1 The main concern is that in a low interest rate environment, insurers are investing in assets with less liquidity. An inability to cope with a sudden rush of claims could potentially threaten the economy—a fear that may result in more regulations for the industry.

KEY TAKEAWAYS

• The Federal Reserve released a report highlighting leverage and liquidity risks among life insurance companies.
• The concern is that the coronavirus pandemic could trigger an increase in claims that insurers may not be able to pay.
• Insurers have taken steps to increase cash reserves through borrowing and limiting dividends and share buybacks.
• The life insurance industry worries about being labeled as “systemically important financial institutions” again, which would increase regulatory oversight.
• Insurance executives insist that their capital and liquidity levels are adequate, but the Fed’s report can’t be ignored.

Could Coronavirus Trigger Life Insurer Failures?

More than 250,000 Americans have died as a result of the coronavirus pandemic and as the country enters the winter months with another spike in cases, life insurance companies may start seeing an increase in claims compared with normal times.

In the Federal Reserve’s November 2020 Financial Stability Report, the agency raises concerns about liquidity in the industry, which could affect its ability to pay in the event of a sharp increase in claims.

Life insurance companies make money by investing the premiums they receive from policyholders. However, in a low interest rate environment, the standard safe investment of Treasury bonds loses its appeal. Instead, insurers have turned to corporate bonds, where the Fed says they hold a sizable portion of their assets, as well as commercial real estate and alternative assets.

While these investments can generate more income, they’re more difficult to offload in a hurry. The Fed also found that 35% of general account assets among life insurers are made up of risky assets. That said, credit analysts point out that life insurance companies have more capital than they did before the financial crisis of 2007-2008 and have managed to increase cash liquidity by decreasing dividends and share buybacks, while also borrowing. 

However, increasing leverage can be another cause for concern. Where leverage levels among banks, broker-dealers, and other financial institutions are modest, they’re higher in the life insurance industry. This increases their exposure to risks related to sharp drops in asset prices.

Life Insurance Executives Fear New Regulation

Industry executives have assured investors and analysts that their capital and liquidity levels are sufficient based on regulatory requirements. However, the Fed’s report shouldn’t be ignored.

One potential reason the industry is on the defensive is that insurers fear the incoming Biden administration will once again label them as systemically important financial institutions (SIFIs). Colloquially, these institutions are called “too big to fail,” which means if one fails, it could trigger another financial crisis.

Institutions with the SIFI label are subject to tighter regulations, which can include additional capital requirements, and they may be subject to stress testing, which could trigger restrictions if they fail the test.

MetLife, Prudential Financial, and American International Group have managed to get the label removed by reducing their balance sheets and exposure to risky assets. MetLife also sued the government to shed the designation. But reverting back to those labels could have a significant impact on the industry.

Source: Investopedia

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