Fed Worries About Life Insurers' Leverage

The Federal Reserve Board is worried enough about the health of life insurers to include them in the financial stability section of its new monetary policy report.

Federal Reserve Board Jerome Powell is briefing congressional committees on the report this week.

The Fed started off the report by emphasizing the impact of the COVID-19 outbreak.

“The COVID-19 outbreak is causing tremendous human and economic hardship across the United States and around the world,” the Fed says in the report summary.

Resources

• A link to a House hearing on the Fed’s Semiannual Monetary Policy Report, which includes a link to a copy of the report, is available here.
• An article about how the Fed chief sees the economy is available here.

Because of the strain, the Fed has taken unprecedented measures to keep the market moving, including setting up mechanism for pumping cash into the economy, the Fed says.

In a section of the report on “Developments Related to Financial Stability,” the Fed says that, in some ways, changes made in the wake of the 2007-2009 Great Recession have increased financial system resilience.

But ”financial system vulnerabilities — most notably those associated with liquidity and maturity transformation in the nonbank financial sector — have amplified some of the economic effects of the pandemic,” the Fed says. “Accordingly, financial-sector vulnerabilities are expected to be significant in the near term.”

“Maturity transformation” is the process of borrowing money at low, short-term interest rates and making a profit by lending the money out for long-term loans at higher rates. The reference to “maturity transformation” in the Fed report appears to refer mainly to banks, not to life insurers, because life insurers generally try to match the duration of their assets to the duration of their liabilities.

Life insurers usually have large holdings of cash and other liquid assets, but they may have derivatives arrangements or other financial arrangements set up in such a way that they must provide large amounts of cash collateral quickly when conditions change rapidly. That means it’s possible that the Fed’s reference to “liquidity” could, possibly relate to life insurers.

Later in the financial stability section, the Fed refers specifically to leverage — or ratios of debt to assets — at life insurers.