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August 08, 2012 at 09:07 AM
Insurance companies are increasingly becoming involved in the stable value wrap business. Insurers are themselves seeing the value in becoming players in the market due to strong ROEs and minimal allocated capital according to new report released by Moody’s Investor Service, titled: Stable Book Value Wraps Generate Strong ROEs, but also Sizable Tail Risks.
Since the financial crisis, insurers have been replacing banks as the providers of book value wraps to pension plans partly because as the crisis developed, banks needed to focus on their core businesses and “capital needed to be marshaled,” according to Moody’s Joel Levine, Associate Managing Director, US Insurance Team.
While insurers have enthusiastically stepped in to fill the void they may be ignoring some of the tail risks involved as they look with wide-eyes at generous returns coupled with a significant increase in fees.
Book value wraps provide stable value pension plan participants with the guarantee of benefit withdrawals at book value. The aforementioned wraps work to absorb the difference between the market and the book value of assets during the withdrawal of a benefit and are designed to pass any gain or loss back to the remaining plan participants by adjusting the credit rating on their account values over time.
Insurers generally view the business as safe because the participant behavior is easily foreseen. There are, however, a number of inherent risks involved. “Companies make estimates based on past history and company experience over a period of years but what if we enter a period where interest rates were spiking and spreads on corporate bonds were high? Participant reaction could change which would make for higher withdrawal numbers,” said Levine.
