Regulators Raise Issue Of Early Warning Liquidity Signals
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Regulators are discussing possible weak points in insurers' liquidity profiles as well as potential ways to make sure that there are early warning signals of any stress that lack of liquidity might cause.
During a recent discussion, regulators raised the possibility of such things occurring as an uptick in corporate bond defaults or another disaster like the World Trade Center attack and what the ramifications of these events would be.
"We need to understand an insurer's concentration of risk," said Larry Gorski, chief actuary with the Illinois insurance department, during a discussion among regulators conducted by the National Association of Insurance Commissioners.
Investments, reinsurance programs, and the smooth running of systems such as the settlement of bond agreements are all potential sources of liquidity risk, said Gorski and other regulators.
If corporate bond defaults increase, regulators might need to take more of a look at that area, he said.
Insurers hold sizable bond investments, according to the 2000 ACLI Life Insurers Fact Book. The American Council of Life Insurers in Washington says corporate debt represented 39% of life insurers' assets in 1999.
To date, Gorski says he has not seen an uptick in insurers investing in junk bonds. He adds that one area regulators will need to watch is investments in collateralized debt obligations, which are fixed income securities that have cash flows linked to underlying debt collateral.
Rating agencies are aware of the potential problem.
Patrick Finnegan, a senior vice president with Moody's Investors Service in New York says that although default risk has risen as a result of the Sept. 11 events, it is more of a disruption than a long-term threat. If a company is impacted and there is downgrade, it will probably not be more than a notch, he adds.
Collateralized debt obligations are an area of weakness that will need to be watched more closely, Finnegan says. And any increase in liquidity risk is at least in part the result of a change in insurers' liabilities resulting from the kinds of contracts that they offer.
For instance, insurers that sell variable annuities or mutual funds may need to be more liquid to be ready for any possible increase in redemptions. Companies offering institutional products such as guaranteed funding agreements may also need to be more liquid, he adds.
