Financial Stability Oversight Council 2015 Annual Report Details Insurance, Financial Issues

 

At its meeting on May 19, 2015, the Financial Stability Oversight Council (“FSOC”) approved its 2015 Annual Report, which featured a comprehensive overview of various financial and related issues, interspersed with FSOC goals, insights and recommendations.

To view the complete 150-page report, click here.  To access supplementary charts and data, click here.

In regard to the insurance industry, the FSOC made the following notations, among others:

 

Low Interest Rates

While low interest rates have helped to improve financial stability by strengthening the balance sheets of households, firms and most financial institutions, these conditions continue to incentivize depository institutions, broker-dealers and bank holding companies to seek additional yield by holding longer-duration assets, easing lending standards, or engaging in other forms of risk-taking, according to the FSOC.

A similar dynamic is playing out in the insurance industry, the FSOC explained, inasmuch as some insurers are taking on incremental risk by extending the durations of their portfolios, or investing in assets of lower credit quality to boost returns.  Some have also moved into less liquid investments, such as commercial mortgage loans, real estate, or alternative assets like private equity or hedge funds.

The FSOC recommends that the Federal Insurance Office (“FIO”) and state insurance regulators continue to closely monitor and assess the growing risks that insurers have been taking through the aforementioned methods.

 

Big Data and the Legal Entity Identifier

Efforts to address financial data gaps and promote standards must keep pace with changes in market activity, the FSOC emphasized.  Analysis into potential vulnerabilities in the financial system by market participants, regulators and researchers requires more detailed and frequent data, as well as new ways of integrating existing data.

The FSOC recommends that regulators and market participants continue to collaborate to improve the quality, access and comprehensiveness of financial data in the United States and across global markets.  Regulators and supervisors should seek to attain greater visibility into certain sectors of the financial system, it was suggested.

Specifically, the FSOC recommends that state insurance regulators and the National Association of Insurance Commissioners (“NAIC”) continue to work to improve the public availability of data, including financial statements relating to captive reinsurance activity, and that FIO continue to monitor and publicly report on the regulatory treatment of issues relating to captive reinsurance, which it previously noted as an area of concern in its landmark Regulatory Modernization Report.

Legal Entity Identifier

An alphanumeric code that uniquely identifies legal entities that engage in financial transactions, the Legal Entity Identifier (“LEI”) provides a globally accepted standard for identifying market participants and serves as a linchpin for making connections in the massive daily volumes of financial data that course through the international economy.  As of March 31, 2015, more than 356,000 LEIs have been issued to entities in 189 countries and 20 operational issuers have been approved to issue LEIs for use in regulatory reporting.

Regulators are increasingly encouraging or requiring use of the LEI.  However, its full benefits will not be realized without broader adoption. 

The FSOC recommends that its members and member agencies continue moving to adopt the LEI in reporting requirements and rulemakings, where appropriate.  It also recommends that regulators and market participants continue to work together to improve the quality, access and comprehensiveness of financial data in the United States and across global markets.

 

Nonbank Financial Companies

Classified in the report under the heading of “nonbank financial companies,” the insurance industry provides an array of important financial services to individuals and businesses in the United States.  It also composes a significant part of the U.S. economy, the FSOC reported.  Altogether, insurance companies and related businesses added $421.4 billion to U.S. gross domestic product, or 2.5 percent of the total, in the latest figures for 2013.

Gross revenues received by U.S. licensed insurance companies–both life, which includes some accident and health, and property and casualty (“P&C”)–from premiums and deposits on insurance policies, and annuity contracts totaled $1.2 trillion in 2014.

Leverage in the life insurance sector, as measured by the ratio of capital to assets, has remained close to 9 percent over the past five years.  The P&C sector operates with far less leverage, because its core business model faces greater risks from unexpected losses and focuses more on earning premium income from underwriting insurable risks, rather than from investment income.  The capital-asset ratio in the P&C sector increased from 35 to 38 percent over the same period.

 

Life Insurance Issues

The FSOC explained that the use of captive reinsurers in the life insurance industry is motivated by several possible factors, including tax benefits and relief from statutory reserve requirements.  Captives add complexity and impact the potential resolvability of certain life insurance companies.  Moreover, at least for purposes of insurance regulatory accounting, captives can reduce clarity about the financial condition of such companies, the FSOC specified.

Regulators and rating agencies have noted that the broad use of captive reinsurance by life insurers may result in regulatory capital ratios that potentially understate risk.  Efforts to address these concerns with regulatory reforms are ongoing. 

An important development in the life insurance market has been the transfer of pension risk by corporate-sponsored pension plans to insurance companies and derivatives markets.  The potential consequences of pension risk transfers include the growth in the number of counterparties, as well as changes in the type and amount of financial counterparty risk arising from the risk-shifting transactions.  

In the case of buyouts, the beneficiaries have their credit exposure shifted from the pension plan to the life insurer. Accordingly, the backstop for pension plans switches from the Pension Benefit Guaranty Corporation to the state insurance guaranty funds.

In the case of longevity swaps, the counterparty risk is like that of other derivatives and resides with the dealer or insurer.

 

Recent Regulatory Developments

Toward the end of its report, the FSOC also devoted a significant portion of its overall regulatory developments review to the insurance industry, detailing the activities of the Federal Insurance Office, the National Association of Insurance Commissioners, the International Association of Insurance Supervisors and others involved in global regulatory standards convergence throughout the year.

 

 

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