OFR_2016_Financial-Stability-Report

2.5 Pressure on U.S. Life Insurance Companies
Life insurance companies could pose systemic risk. Low long-term
interest rates continue to strain their earnings. They are also increasingly
vulnerable to equity market declines. A large common shock
to all life insurers or the failure of a large and interconnected insurer
could adversely affect U.S. financial stability. Our research suggests
that life insurers’ systemic risk measures are related to their exposures
to low interest rates and to their use of derivatives.
We ranked life insurance
as a key threat because
of the vulnerabilities
of the industry and
because of its relative
unpreparedness for
widespread failures.
U.S. life insurance companies could pose financial stability risks through
three main channels. First, life insurers are exposed to common factors.
These include low interest rates and a decline in equity values that could
reduce their profits and capital adequacy. The insurance resolution regime
has not been tested for multiple failures, but is instead geared toward idiosyncratic
failures.
Second, the failure of a large insurer could lead to failures outside the
industry or cause spillover effects due to asset fire-sales. Material financial
distress at a large life insurer could result in contagion, which could impair
other financial firms and markets. Life insurers are interconnected with
global systemically important banks and other financial institutions of all
sizes through institutional products and capital markets.
Also, some insurers are involved in nontraditional life insurance businesses,
such as assuming large private pension plan obligations, writing variable
annuities, and issuing long-term care insurance. These obligations are
exposed to declines in long-term interest rates and asset returns.
The impact of shocks through these channels could be substantial. We
ranked life insurance as a key threat because of the vulnerabilities of the
industry and because of its relative unpreparedness for widespread failures.
Steps to reduce risk could include more robust stress testing industry-wide,
a liquidity standard to address short-term liquidity risks posed by activities
such as derivatives and securities lending, and a stronger resolution
framework.
Insurers Face Common Risks
Sustained low long-term interest rates put pressure on life insurers’ earnings.
Potential declines in the value of equities and other assets can put pressure
on solvency. This double-hit scenario of low rates and a decline in asset
prices is made worse by some firms’ growing exposures to retirement products,
including variable annuities and private pension obligations, where
earnings can be stressed by both risks at the same time.
58 2016 | OFR Financial Stability Report