5 Things to Know About Life Insurers' Investment Machinery, for Agents

Economists at the Fed, who generally are writing papers that express their own opinions, not the views of the Fed, have tended to be more skeptical about life insurers' finances.

Kyal Berends and Thomas King, for example, wrote a paper in 2015 that was published by the Federal Reserve Bank of Chicago.

The Fed econonomists noted that, in 2014, U.S. life insurers accounted for a relatively small share of the total derivatives market.

The economists wrote that over-the-counter derivatives contracts have been regarded as being riskier than arrangements made through an exchange, and that life insurers had about $1.1 trillion in exposure to over-the-counter derivatives.

Now big life insurers, including TIAA-CREF and Northwestern Mutual, had to little exposure to derivatives to show up in a derivatives exposure table.

4. The typical counterparty for a life insurance company derivatives arrangement is a financial services giant.

According to the NAIC Capital Markets Bureau report on insurers' 2018 derivatives use, the 10 largest sources of U.S. life insurers' counterparty exposure accounted for about 49% of the exposure, and they are well-known companies.

The four biggest, which account for 31% of the exposure, are J.P. Morgan Chase, Barclays Bank PLC, Bank of America Merrill Lync, and AIG Financial Products.

5. At this point, what's really happening to life insurers' level of counterparty risk appears to be murky.

James Hyerczyk, a trader and technical analyst, wrote in a blog entry for FX Empire that, apparently, the debt markets were close enough to "the brink of collapse" to "cause the Fed to take aggressive action."

Analysts at J.P. Morgan Asset Management wrote, in an article aimed at bond investors, that flows of cash "have dried up, not only in equities and high-yield credit, but also in high quality credit funds… Liquidity has also become challenged, as primary markets have essentially shut down, and secondary markets are demanding a higher price for liquidity."

But rating agencies seem to be assuming that the hedging arrangement counterparties will make good on their obligations.

In February, for example, analysts at Fitching Ratings wrote that, "Many, if not all, insurers that sold variable annuities with living benefits have hedged their market risk or interest rate risk or both in some fashion…. Insurers with more effective hedging programs are expected to weather the disruption better than insurers with ineffective programs."

Today, Fitch changed its overall rating outlook for U.S. life insurers to negative because of all of the turmoil.

Fitch said in the announcement of the outlook change that its analysts have concerns about falling stock prices and interest rates, and the potential for a sustained disruption in the broader economy.

A disruption in the broader economy could "cause deteriorating in the credit markets, which could lead to increased bond and loan defaults and further pressure statutory capital levels," the analysts wrote.

But the analysts also said that U.S. life insurers have very strong capitalization levels, good asset quality and very strong liquidity, and they did not even mention the possibility of counterparty risk being a concern.

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