Insurance and Interconnectedness in the Financial Services Industry

Life insurers
****************
Insert Figure 2 Here
****************
Life and accident-­‐health insurers provide financial protection from the effects of unexpected mortality
and morbidity losses. Typical lines of insurance include life insurance, annuities and accident & health
for individuals and groups. Life insurers also produce deposit-­‐type contracts including annuities certain
and guaranteed investment contracts (GICs). 14 As a result, a significant portion of life insurer operations
involve long periods of premium accumulation and/or claim payout and large amounts of invested
assets of varying duration. It is not uncommon for premiums to build for 20 or more years until a
mortality event occurs, and payouts then may be made over a long period of time. Hence, life insurance
involves a long-­‐tail liability.
Due to the size and duration of invested assets required in long tail lines, life insurers are more
exposed to fluctuations in the financial markets. Further, their product is sensitive to the economy; life
insurers experience a drop in insurance during recessions. Other than the effects on its investments and
the indirect effect on sales of policies, insurance firms are not directly linked to the subprime crisis and,
hence should have little interconnectedness with other financial service firms. 15 , 16
More specifically related to the financial crisis are life insurers use of insurance-­‐linked securities
(ILS) that were most often “wrapped” by financial guarantor firms. 17 When the financial guarantee firms
were downgraded, this ushered in problems associated with the structured finance securities that
backed the ILS, and the inability to continue to issue additional ILS during the credit crunch in 2008.
According to Swiss Re, there was over $6 billion life insurance ILS issued in 2007, compared to the $100
million in 2008. 18 Baluch, Mutenga and Parsons (2011) find life insurers experienced a greater loss of
14
Deposit-­‐type services offered by life insurers also include dividend and coupon accumulations, lottery payouts,
structured settlements, and premium funds. Cummins and Venard (2007).
15
As pointed out by Fitch Ratings, most life insurers have low exposure to the subprime crisis, especially because
their investments were limited to the better-­‐quality tranches in securitizations [“No Subprime Crisis for U.S. Life
Insurers, Fitch Says,” Seeking Alpha, August 20, 2007].
16
In contrast, health insurance is renewed annually and a policy must be in effect at the time of treatment for
claims to be paid. Generally, claims are filed very close to the time services are rendered leading to a relatively
short claims payout period from the time premiums are received. As a result, insurers with primary operations in
accident-­‐health lines must be analyzed separately from insurers operating primary in life insurance.
17
These ILS are referred to as “XXX transactions” because of the reference to the NAIC model regulations.
18
The issuance has risen slowly, with over 400 million life insurance ILS issued in 2011.
5