The insurers that write the life insurance and annuity products you sell may not really be world-class incubators of systemic risk, but they can be risky, too.
Two economists take a close look at some of the risks that could leap out at life and annuity issuers from the economic closets in a new working paper published behind a paywall on the website of the National Bureau of Economic Research.
A working paper is like the academic research version of a draft regulation model: It's a serious document, but it hasn't yet gone through a peer review process.
Ralph S.J. Koijen, an economist who teaches at the New York University business school, and Motohiro Yogo, an economist at Princeton University, wrote the new paper to review recent trends in the kinds of risks that face life insurers, and how risk might flow between banks and life insurers.
The paper does not give the last word on how economists and others see life company risk.
The authors mention variable annuity risk frequently, for example, and do not mention indexed annuities, or the recent rebound in whole life sales.
The paper could, however, provide a framework that regulators and others might use to discuss life company risk. Even opponents may find themselves developing and improving their own arguments in reaction to the Koijen-Yogo paper.
Reactions to the paper could, eventually, affect what kinds of products life insurance companies want to write and how much the products cost.
If the authors are correct in their analyses, the paper could also give readers clues about how the next big problems at life and annuity issuers might surface.
Here's a quick look at some highlights from the paper.
Frosted window (Photo: Thinkstock)
1. Getting complete information about the issuers' finances is hard.
Understanding what is really happening at life and annuity issuers is difficult, partly because valuing some types of annuity guarantees is difficult, and partly because insurers now use capital management tools such as securities lending and derivatives that make understanding insurers' finances difficult, the economists write.
The economists acknowledge that some of the insurers that used to offer variable annuities with guaranteed benefits have left that market or reducing the amount of guaranteed annuity business they sell.
Since the Great Recession, however, risks associated with financial markets and policyholder behavior have interacted in ways that could affect the variable annuity contracts that are still in force, the economists write.
Low interest rates have contributed to a drop in variable annuity lapse rates, at a time when insurers might like to see lapse rates rise, the economists write.
(Photo: Thinkstock)
2. Understanding what's happening at "shadow reinsurers" is hard.
Minimum capital regulations and accounting rules have encouraged life insurers to increase use of financing from captive insurers, or insurers that they control. In many cases, insurers use "shadow reinsurers," or captive insurers that operate outside the jurisdiction of any regulators that might make them post detailed financial reports, the economists write.
The economists write, based on reports from New York state regulators and analysts at Moody's Investors Service, and a review of captive insurer reports posted in Iowa, that many captives appear to have weaker finances than the insurance company parents.
In some cases, the economists write, the captives may use mechanisms such as bank letters of credit to back the reinsurance they offer their insurance company parents.
