Lawmakers in Washington are working on bills that could reduce the role of federal financial systemic risk managers in overseeing life insurers.
But at least some economists still believe that, whatever happens in Congress, some life insurers still engage in activities that, in theory, could rattle the U.S. financial system.
Yaron Leitner, a senior economist at the Federal Reserve Bank of Philadelphia, talks about his concerns in a paper in a recent issue of the bank’s quarterly economics journal. Leitner has written papers in the past about topics such as government bailouts of private financial institutions, stress testing, and ideas about why financial markets freeze.
In the new paper, Leitner gives economists and bankers a general overview of life insurance company activities that could, possibly contribute to financial instability. He agrees with life insurers’ premise that traditional insurer efforts to protect people against death and longevity create little risk for the rest of the financial system.
Leitner argues, however, that some life insurers have branched out and do things that could add to national financial problems when overall conditions are already bad. He says one of the activities that could make bad conditions worse is offering variable annuity living benefits guarantees.
A full copy of the paper is available here.
Some in the life insurance industry have argued that bank-centric economists tend to be easier on banks because they’re usually closer to banks. Leitner, for example, works for the Federal Reserve Bank of Philadelphia, not the Federal Life Insurance Company of Philadelphia. But his views could influence colleagues who, in many cases, may also have more experience with banks than with life insurers.
Here’s a look at five things Leitner says about his concerns about variable annuity living benefits guarantees.
1. Offering variable annuity living benefits guarantees is not a traditional insurance company activity.
Life insurance agents may think trying to help retirement planning clients earn a decent return, while protecting the clients’ assets against a stock market crash, is a commonsense extension of letting variable annuity users control the investments used inside the annuities.
Leitner says the problem is that life insurers use their own assets, or “general account assets,” to back the minimum living benefits guarantees.
“These guarantees may kick in during an economic downturn, as when equity prices drop, adding stress to an already-stressed economy,” Leitner writes.
2. The VA guarantee obligation total has been growing.
Many insurers that were in the variable annuity market have talked about getting out of that market, adjusting the guarantee options available with new products, and, in some cases, finding ways to pay annuity holders to give up benefits guarantees.
In spite of those moves, the dollar value of variable annuities with living benefits guarantees increased to $843 billion in 2014, from $292 billion in 2008, Leitner writes.
“Rapid growth of an activity is a particular source of regulatory concern because it suggests that risks may not have been fully priced in,” Leitner writes.
3. To economists, the biggest insurers look as risky as the biggest banks.
Analysts at the New York University Stern School of Business V-Lab have come up with an indicator, “SRISK,” that shows how big of a capital hole a firm might face if a broad market index falls by 40% over the next six months.
The SRISK charts show that, in August, the four biggest publicly traded banks have could have faced a combined capital hole with a total value of about $100 billion in the SRISK scenario, and that the four biggest publicly traded life insurers could also have faced a combined capital hole of about $100 billion in that scenario, according to a Leitner figure based on the SRISK data.
4. To economists, banks look as if they’ve been de-risking more than life insurers have.
“Since 2008, SRISK has declined significantly for large banks but has increased for large insurance companies except AIG,” Leitner writes.
He presents charts showing that two large banks’ SRISK exposure shot up around the time of the Great Recession but has since dropped; the charts show that four big life insurers’ SRISK exposure levels rose somewhat during the Great Recession and have stayed at Great Recession levels.
5. State insurance regulators may have different goals than federal banking regulators.
Life insurers, and state insurance regulators, have argued that state insurance regulators are closer to life insurers than federal banking and securities regulators, know more about insurance, and are better equipped to handle problems at banks.
Leitner contends that state insurance regulators’ goals may be different from federal regulators’ goals.
“Those who argue that federal regulation is necessary note that an individual insurance company does not take into account the negative consequences of its failure on the rest of the economy,” Leitner writes. “Likewise, an individual state does not take into account the consequences of its actions for other states. Individually or collectively, the states are not responsible for the stability of the U.S. financial system.”
One solution could be to let state regulators oversee traditional insurance activities, while letting federal regulators oversee nontraditional activities, but that’s difficult, in practice, because the nontraditional activities are often deeply intertwined with the traditional insurance activities, Leitner writes.
— Read 5 Ways Life and Annuity Issuers Could Break on ThinkAdvisor.