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March 16, 2023 at 03:50 PM
What You Need to Know
- In 2021, 226 U.S. life insurers were using derivatives to manage risk.
- When the indicators that are hedged move, insurers may have to add collateral.
- Life insurers include collateral posting when they go through stress tests.
Hedging programs that usually protect life insurers against big changes in stock prices and interest rates could sometimes add stress, by forcing the insurers to add cash, according to analysts at Moody’s Investors Service.
Manoj Jethani and other Moody’s analysts talk about the concern — calls to add collateral for derivatives arrangements — in a look at how the forces that led to the failure of Silicon Valley Bank and Signature Bank, and the effects of those failures, might affect life insurance and annuity issuers.
The big life and annuity issuers that Moody’s rates have plenty of cash, and many sources of “liquidity,” or quick access to more cash, the analysts note. But they suggest that one concern is the possibility that life insurers will have to feed cash into hedging programs.
“The higher interest rate environment has increased collateral posting requirements for companies that have hedge programs in place to protect them from capital movements,” the analysts say. “Just as life insurers run stress tests for lapses in a rising interest rate environment, they also test for liquidity needs related to collateral posting.”
Derivatives Basics
A derivatives contract is an agreement between two parties, or “counterparties,” that requires one party to pay the other if some specified indicator, such as an interest rate benchmark or a stock index, changes.
Counterparties have to provide cash, or evidence that they have quick access to cash, to serve as derivatives collateral, or proof that they can make good on their promises.
U.S. life insurers have about $8.6 trillion in assets. On Dec. 31, 2015, U.S. insurers had posted about $22 billion in derivatives collateral, up from $12 billion a year earlier, according to a National Association of Insurance Commissioners Capital Markets Bureau report that was updated in 2021. Life insurers accounted for 92% of the collateral.
