OFR_2016_Financial-Stability-Report

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2015). These benefits are effectively long-dated put options (options to sell). They give policyholders the option to exchange their VA accounts for guaranteed life-time income payments. VAs with guarantees can leave insurers with exposure to equity markets because the benefits they guarantee to policyholders are typically triggered when equity values are down. When asset values fell during the crisis, insurers that offered VAs with guarantees saw pressure on their capital (see Barnes, Bohn, and Martin, 2015). Second, certain insurers engage in pension risk transfer transactions, taking over the defined-benefit pension liabilities of employers. Since 2012, employers have transferred about $137 billion of pension liabilities to U.S. life insurers through these transactions (see Ericson, 2016). As a result, insurers are exposed to the risks of promised guaranteed returns. Additionally, insurers with long-term care businesses are facing challenges from lower long-term interest rates. In addition, some insurers have inadequate reserves for their long-term care policies because they assumed fewer customers would retain the coverage (see NAIC, 2016). Interconnectedness. The failure of a large, interconnected insurance company could have direct and indirect adverse effects on financial institutions and markets. The $182 billion government assistance to American International Group, Inc. (AIG) in 2008 provides evidence of the potential risks of such spillovers. Since the crisis, insurance companies that are nonbank financial companies designated by FSOC have become subject to heightened regulation. The Federal Reserve has issued a draft rule describing how it would regulate these firms, as required by the Dodd-Frank Act. U.S. life insurers are connected to the rest of the U.S. financial system through several channels. These include derivatives and securities lending transactions. Life insurers may use derivatives to hedge market risk or to assume economic exposure. At the end of 2015, U.S. life insurers’ derivatives exposure, as reported in statutory filings, totaled $2 trillion in notional value. This $2 trillion does not include derivative contracts held in affiliated reinsurers, non-insurance affiliates, and parent companies that do not have to file statutory statements. Details on these entities’ derivatives positions are not publicly available. During the crisis, an AIG non-insurance subsidiary lost billions of dollars on credit derivatives. This unit was using derivatives to assume economic exposure, rather than to hedge risks. The sudden demand for margin by AIG’s counterparties threatened AIG’s liquidity. The government stepped in to help ensure that AIG could repay its creditors. Additionally, several other insurers, including Lincoln Financial, Voya (then ING Americas), and Aegon, met with increases in margin requirements on their derivatives hedging programs 62 2016 | OFR Financial Stability Report
due to credit downgrades, and later received government assistance (see Barnes, Bohn, and Martin, 2015). Greater use of central clearing is meant to reduce the ability of derivatives market participants to build up losses as large as those that AIG faced in 2008 (see Section 2.4). According to statutory data on insurance CME company legal entities, nine large U.S. and European Goldman Sachs banks are counterparties to about 60 percent of U.S. life Deutsche Bank insurers’ $2 trillion in notional derivatives (see Figure Bank of America 54). These data show that despite central clearing, derivatives interconnectedness between the U.S. life insur- Credit Suisse Citigroup ance industry and banks remains substantial. Morgan Stanley Insurance companies also engage in activities that Barclays may be considered shadow banking. For example, some JPMorgan Chase life insurers engage in securities lending, which can be a Wells Fargo channel of financial contagion (see Drivers of Insurers’ Systemic Risk Indicators). AIG’s losses from securities lending in several life insurance entities added to its difficulties in 2008. AIG managed its securities lending program centrally through a noninsurance subsidiary for the benefit of its insurance companies (see AIG, 2006). The life insurance companies provided securirties that were lent to banks and broker-dealers for cash. In turn, AIG reinvested some of this cash in securities backed by subprime home mortgages. As AIG experienced distress, securities lending counterparties sought to end the agreements. However, AIG had reinvested the cash in securities that lost value. AIG could not generate funds to meet redemption requests and return the cash (see McDonald and Paulson, 2015). In the end, AIG’s securities lending counterparties were owed $43.7 billion, compared with $52 billion the firm owed its credit default swap (CDS) counterparties (see AIG, 2009). Insurers’ required reporting of securities lending began in 2010. Securities lending activity is concentrated among the larger life insurers. Although securities lending activity for the industry appears flat between 2012 and 2015, more U.S. life insurers started engaging in this activity at the time that AIG de-risked itself (see Figure 55). Figure 54. U.S. Life Insurers’ Derivatives Exposure by Counterparty (percent) Some 64 percent of the notional amount of derivatives held by life insurers is concentrated in 10 counterparties Note: Data as of June 30, 2016. 0 2 4 6 8 10 U.S. bank European bank Central counterparty Sources: SNL Financial LC, OFR analysis Market-Based and Systemic Risk Indicators for U.S. Life Insurers Are Rising Since the crisis, researchers have proposed new metrics to quantify the potential contribution that individual firms make to systemwide risk (see Adrian and Brunnermeier, 2016; Brownlees and Engle, 2016; Huang, Zhou, Key Threats to Financial Stability 63
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OFFICE OF FINANCIAL RESEARCH 2016 F
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Contents Executive Summary ........
Page 8 and 9:
Chapter 2 provides deeper analysis
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of sharp decreases in U.S. equity a
Page 13 and 14:
1 Financial Stability Assessment Ov
Page 15 and 16:
Figure 3. Real GDP Growth (year-ove
Page 17 and 18: Figure 8. Ten-Year U.S. Treasury Yi
Page 19 and 20: Monitoring Shadow Banking Risks The
Page 21 and 22: An earlier OFR paper proposed an ac
Page 23 and 24: Figure 17. Size, Liquidity, and Con
Page 25: Figure 19. Top Systemic Risk Scores
Page 28 and 29: The analysis pointed to seven key t
Page 30 and 31: could. In early 2016, investor conc
Page 32 and 33: earnings or share issuance. But red
Page 34 and 35: Fund Monitor, the OFR assessed expo
Page 36 and 37: 2.2 Risks in U.S. Nonfinancial Corp
Page 38 and 39: Figure 31. U.S. Nonfinancial Corpor
Page 40 and 41: Figure 36. U.S. Corporate Bond Defa
Page 42 and 43: Commercial Real Estate Prices Have
Page 44 and 45: 2.3 Cybersecurity Incidents Affecti
Page 46 and 47: Hackers Breach Bangladesh’s Centr
Page 48 and 49: Figure 42. Banks that Include an Op
Page 50 and 51: The industry is working with the pu
Page 52 and 53: Figure 46. U.S. Financial Regulator
Page 54 and 55: 48 2016 | OFR Financial Stability R
Page 56 and 57: eleased the results of an unprecede
Page 58 and 59: Figure 49. CCP Default Waterfall ($
Page 60 and 61: Figure 50: CCP Ratios and Amounts f
Page 62 and 63: cause more-prudent CCPs to appear m
Page 64 and 65: 2.5 Pressure on U.S. Life Insurance
Page 66 and 67: The experience of Japan’s life in
Page 70 and 71: Figure 55. Life Insurance Securitie
Page 72 and 73: Drivers of Insurers’ Systemic Ris
Page 74 and 75: 2.6 Systemic Footprints of Largest
Page 76 and 77: Interest Rates and Derivatives Expo
Page 78 and 79: Figure 63. Components of U.S. G-SIB
Page 80 and 81: Figure 66. Five-Year Changes to G-S
Page 82 and 83: 2.7 Deficiencies in Data and Data M
Page 84 and 85: Figure 68. Examples of Key Post-Cri
Page 86 and 87: Broader Adoption of Data Standards
Page 88 and 89: Better Regulatory Sharing Needed Th
Page 90 and 91: The U.S. Census Bureau surveys publ
Page 92 and 93: The group will also consider how th
Page 94 and 95: and contracts would be crucial. The
Page 96 and 97: Figure 72. Scaling of Data Validati
Page 99 and 100: Glossary 10-Year, 10-Year Forward R
Page 101 and 102: Conditional Value-at-Risk (CoVaR) C
Page 103 and 104: Fire Sale Form N-MFP Form PF Fundin
Page 105 and 106: Liquidity Risk Liquidity Transforma
Page 107 and 108: Pension Funded Ratio Pension Risk T
Page 109 and 110: Stress Test Supplemental Leverage R
Page 111 and 112: Bibliography Adrian, Tobias, and Ma
Page 113 and 114: Board of Governors of the Federal R
Page 115 and 116: www.richmondfed.org/~/media/richmon
Page 117 and 118: Her Majesty’s Government and Mars
Page 119 and 120:
Paul, Ruma. “Bangladesh hopes to
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Zetter, Kim. “That Insane, 18M Ba
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