The current size of the-called shadow insurance sector could lead to a possible loss of at least $15.7 billion for the life insurance industry, according to a new study by economists.
Economists at the regional Minneapolis Federal Reserve Bank and affiliated with the London Business School Department of Finance and the Cambridge, Mass.-based National Bureau of Economic Research, have written a paper, dated Nov. 15, on the scope of captives, or “the shadow insurance sector,” and its impact on the life insurance industry.
However, there are benefits, the study notes prominently, they say. Without captives in play, the marginal life insurance cost would rise by 5 percent or a $14.9 billion reduction in annual life insurance underwritten based on current demand, the study found. The insurance price falls when the operating company cedes reinsurance to the affiliated reinsurer, raising its equilibrium supply in the retail market, the study showed through applying differential equations.
This figure reports life and annuity reinsurance ceded by U.S. life insurers to affiliated and unaffiliated reinsurers. Reinsurance ceded is the sum of reserve credit taken and modified coinsurance reserve ceded.
Courtesy of the Shadow Insurance study.
Perhaps more worrisome, the economists found the possibility of systemic risk from captive transactions. The economists said they expect the actual experience — if things go south for larger life insurers that are involved in shadow insurance — to be more systemic, leading to larger losses for the industry. The study also laments to the lack of public disclosure by shadow reinsures which prevents “accurate assessment of their investment risk and the fragility of their funding arrangements.”
The shadow insurance sector grew rapidly from $11 billion in 2002 to $363 billion in 2012, note the authors, Ralph S.J. Koijen of the London Business School and Motohiro Yogo of the Minneapolis Fed.
Companies that are involved in shadow insurance, which capture 50 percent of the market share, ceded 25 cents of every dollar insured to shadow reinsurers in 2012, up from 2 cents in 2002.