Research analysts at the Federal Reserve Bank of Chicago’s Insurance Initiative have issued a new paper that concludes a severe shock to asset prices would considerably reduce the value of life insurers’ asset holdings — but that a “significant portion” of the losses would be offset by gains on liabilities.
Published as a Chicago Fed letter, much of the April 2013 paper, What do U.S. life insurers invest in?, is a primer on life insurance’s role in the economy with a discussion of general accounts and separate accounts and their roles.
However, the Chicago Fed’s insurance analysts are busy analyzing the role that the insurance industry plays in financial markets and the economy as the Fed role increases in the supervision of the largest insurers and the smorgasbord of insurers that operate as savings and loan holding companies.
Many in the industry continue to express concern about how, and with what measures, the Fed will regulate under the Dodd Frank Act, from Section 171, which requires bank holding companies to be subject to certain capital requirements, to the looming, systemically important financial institution (SIFI) designations.
The Chicago Fed analysts displayed data that shows life insurers invest in a wide variety of financial assets with corporate bonds as the largest share.
“The financial crisis provided a powerful demonstration that asset values can decline quickly. Some of the asset classes heavily favored by insurers, especially nonagency MBS, experienced major losses during the crisis,” the analysts stated.
The paper’s authors are Robert McMenamin, Fed senior research analyst, Anna Paulson, director of financial research, Thanases Plestis, associate economist, and Richard Rosen, senior financial economist. All but Plestis are listed as members of the Insurance Initiative team.
|Courtesy Federal Reserve Bank of Chicago, SNL Financial, Mergent Financial, Standard & Poor’s|
The analysts estimated the potential decrease in the value of insurer assets from an extreme downturn in asset markets using data on market prices for a variety of financial instruments during the period from October 2002 through December 2012.
“Our back-of-the-envelope calculations suggest that a severe shock to asset prices could reduce the value of the industry’s investments by 7.8 percent, or $280 billion, using third-quarter 2012 data,” the analysts noted.
This corresponds to an 86 percent loss in total industry equity, or $325 billion.
“However, because insurers make investments to match liabilities, these losses would be partially offset by gains on insurance liabilities,” the analysts figured.