OFR_2016_Financial-Stability-Report

exposure consistently is associated with an increase in systemic
risk indicators and in realized equity volatility.
Consolidated assets are also correlated with an increase
in insurers’ systemic risk as measured by DIP. By contrast,
a decrease in portfolio yield, non-insurance liabilities
(a proxy for non-insurance businesses), and securities
lending are correlated with an increase in realized equity
volatility for U.S. insurers. The effect on portfolio yield is
suggestive of risks due to low long-term interest rates
and consistent with some other research suggesting low
interest rates may pose a risk to the U.S. life insurance
industry (see Hartley, Paulson, and Rosen, 2016).
There was no apparent positive correlation between systemic
risk metrics and securities lending and non-insurance
liabilities. However, due to lack of data, this analysis
does not capture AIG’s activities during the crisis. These
results may suggest that equity markets reward insurers
for these nontraditional activities. These activities can
increase and diversify an insurer’s profits and strengthen
its capital, but they may pose risks if done to excess, as the
example of AIG illustrates.
Figure 59. Distribution of Life Insurers Subject to
Regulatory Action by Size of Company’s Capital
(percent)
Most life insurers subject to regulatory action have been
small
$25 to $500
million
Under $25
million
Small unrated
insurers
More than
$500 million
Note: Data are from 1969-2014. Excludes companies identified
as solely offering health insurance. Size is defined as capital and
surplus of the company at the date of regulatory action. A.M.
Best Co. designates an insurer as a financially impaired company
the first time an insurance department officially deems that
the insurer’s ability to conduct normal insurance operations is
adversely affected, capital and surplus are deemed inadequate to
meet legal requirements, or general financial conditions trigger
regulatory concerns.
Sources: A. M. Best Co., OFR analysis
interest rates is worrisome because the U.S. resolution
framework for insurers relies largely on state guaranty
funds. The state guaranty funds are not prefunded and
rely on surviving firms in that state to cover shortfalls to
policyholders of a failed insurer. The state-based guaranty
fund system has not faced an industry-wide solvency
crisis (see Cummins and Weiss, 2014). Past failures have
been small and firm-specific, so the state guaranty fund
system remains untested for failures of larger firms or for
an industry-wide event (see Figure 59).
Conclusion: Gaps remain
Life insurance companies could pose financial stability
risk. While regulators have adopted measures since the
crisis, key policy gaps remain. These gaps include the
need for more robust stress testing industry wide, the
adoption of a liquidity standard to address short-term
liquidity risk for insurers materially engaging in activities
such as derivatives and securities lending, and the
evaluation of options for strengthening the resolution
framework. As of Aug. 31, 2016, only 14 U.S. states
had adopted legal changes necessary to permit group
supervision of internationally active insurance groups
(see Schwarcz, 2015). This policy gap hinders the reguhlatory
oversight of insurers’ enterprise-wide risk-taking.
Key Threats to Financial Stability 67