Life Insurers Increased Currency Swap Exposure in 2018: NAIC

The National Association of Insurance Commissioners' Capital Markets Bureau has published a new report on U.S. life insurers' use of a complicated investment risk management tool: derivatives.

U.S. life insurers ended 2018 with $2.3 trillion in exposure to derivatives, up 8.8% from the 2017 total, according to the bureau.

Interest rate swap exposure increased 7.4%, to $968 billion.
Currency exchange swap exposure 26%, to $126 billion.

Life insurers were also heavy users of options tied to stock prices and interest rates.

Equity option exposure increased 12%, to $693 billion.
Interest rate option exposure increased 18%, to $343 billion.

Derivatives Basics

A derivative is a financial instrument with a value that goes up or down when the value of a specified financial asset, group of assets or investment index changes.

A swap is an instrument that lets one party trade exposure to a specified investment variable, such as interest rate changes, with a counterparty.

An option helps a party insure the value of an investment, by giving the party the right to buy or sell an asset at a predetermined price.

Life insurers have built up trillions of dollars in reserves to support their products. They use derivatives to protect the reserves against changes in interest rates, stock prices and currency exchange rates, and to protect themselves against the risk that some credit users might fail to pay off their debts.

Life insurers have much bigger investment portfolios than property and casualty insurers or health insurers, and they accounted for about 97% of U.S. insurers' 2018 derivatives exposure, according to the new NAIC Capital Markets Bureau Report.

The bureau does not break out separate data for life insurers' use of options and other types of insurers' use of options. But the bureau did break out insurers' option exposure by type of risk hedged. About 95% of the option exposure in that table appears to reflect life insurers' use of options.