Some life insurers’ deals with big, institutional clients could lead to sudden, dangerous demands for enormous amounts of cash, according to three economists at the Federal Reserve Board.
Nathan Foley-Fisher and two colleagues write, in an informal article published on the Fed website in May, that those life insurers could face spikes in demand for cash that would amount to deadly “runs on the insurance company.”
“A life insurer’s asset holdings are a potentially misleading benchmark for the magnitude of their nontraditional liabilities,” the economists write. “We argue that a benchmark for the size of a life insurer’s nontraditional liabilities should be based on the cash flows of that insurer.”
(Related: 5 Ways Life and Annuity Issuers Could Break)
In a serious crisis, the economists write, institutional clients’ demands for cash could be so much bigger than a life insurer’s usual net cash-flow fluctuations that the insurer would have no practical way to come up with the required cash, even if, on paper, the insurer’s assets appeared to be much bigger than the institutional clients’ demands for cash.
Because of the way life insurers’ assets are invested, “dividing a life insurer’s nontraditional liabilities by its asset holdings is a potentially misleading benchmark for assessing the run risk,” the economists write.
Life Insurers vs. the Banks
Traditionally, life insurance sector executives and regulators have criticized bank regulators for over-emphasizing the possible risk of runs on life insurers.
Banks take in large amounts of cash, lend most of the cash out, and offer savers savings accounts and checking accounts that are supposed to provide instant access to cash. Banks face the risk that many customers could run in all at once and ask to empty out their checking accounts and savings accounts.
Life insurers, in contrast, create huge reserves, and they sell life insurance policies and annuity contracts that provide only limited access to the underlying cash value. Even when customers can cash out life insurance policies or surrender annuities, life insurers may have contract provisions and administrative procedures they can use to keep cash from rushing out the door.
Foley-Fisher and his colleagues write in the new article that many life insurers now have more “runnable liabilities,” because they are providing institutional customers with “wholesale funding instruments,” such as institutional funding agreements and securities lending arrangements.