How Life and Annuity Issuers Could Get Silicon Valley Bank Flu

The failures of Silicon Valley Bank and Signature Bank of New York — two banks that began the year with solid credit ratings and good 2022 earnings — raise questions about whether other solid-looking financial services companies, such as life insurers, could be suffering from similar types of hard-to-detect problems.

Life insurers have emphasized, over and over again, that writing life insurance policies and annuity contracts is much different than offering consumers instant access to the cash in checking accounts, and that they face strict solvency oversight from state insurance regulators.

Unlike banks, which typically have less than 10 cents of reserves backing each deposit dollar, life insurers set aside huge amounts of reserves to support their benefits obligations.

But regulatory consultants, economists, securities analysts and others have talked about ways that some life insurers could run into liquidity problems of their own, even if insurers’ cases would likely be mild when compared with the kinds of cash-flow crises that lead to “bank runs,” or customers lining up to pull deposits from foundering banks.

What It Means

If the current level of alarm about Silicon Valley Bank and other troubled banks continues, finding attractively priced life and annuity products with attractive benefits guarantees and cash access features could become more difficult.

Rising Rates

Details about the Silicon Valley Bank and Signature Bank failures are still evolving, but one major contributing factor appears to be the rapid increase in interest rates over the past 12 months.

For years, key U.S. interest rate benchmarks hovered near zero. Banks and life insurers tried to scrape up a little more yield by investing in longer-term bonds, which tend to pay higher rates than shorter-term notes and bonds.

Banks rely heavily on U.S. Treasurys, and they know the U.S. government will pay off the bonds when they mature.

But increasing rates have cut the current resale value of the long-term bonds. When a bank has to sell a long-duration, low-rate bond today, it loses money on the sale. That means raising cash to meet  the demand of depositors and other parties can be difficult and expensive.

Because life insurers can accumulate asset value without paying income taxes on the buildup, they typically rely on higher-yielding, taxable, fixed income arrangements, such as corporate bonds and mortgage-backed securities, rather than U.S. Treasurys, but they have also been trying to scrape up extra yield by buying longer-duration assets, and rising rates have decreased the “fair market value,” or resale value, of life insurers’ long-duration assets, too.

10 Possible Gaps in Life Insurers’ Financial Masks

Here are 10 potential weaknesses in life insurers’ defenses that could lead to life insurers running into at least some liquidity concerns, in spite of the many differences between life insurers and banks in terms of products, investments and reserving arrangements.

1. Product Cash Access Features

Edward Toy and other consultants at Risk & Regulatory Consulting, a firm that helps state insurance regulators oversee insurers’ finances, noted in a 2020 comment letter to the National Association of Insurance Commissioners that life insurers have loosened their hold on customers’ cash.

Many annuity issuers have reduced the contract surrender charges, and they have also added other features that make it easier for customers to get cash out of the products, Toy and his colleagues wrote.

2. Investment Duration

Toy suggested in an analysis posted in January that the push toward longer-duration investments could lead to surprising effects on fixed income assets when changing conditions force life insurers to sell assets early.

If, for example, interest rates rise by 4 percentage points, that might cut the resale price of a note with a duration of two to five years by just 9%, but it could cut the resale price of a bond with a duration over 20 years by 44%, according to Toy’s analysis.

3. Private Equity Sales Woes

A private equity fund is a company that uses cash from pension funds, life insurers, wealthy individuals and other big, sophisticated investors to invest in companies that are not publicly traded, or in other securities that are not publicly traded.

Policymakers sometimes worry about the effects of private equity firms and other investment firms buying life insurers.

Toy talked in December about the problems life insurers face when they themselves act as private equity investors.

“One of the things I noticed a little while ago was the drop-off in terms of private equity funds’ ability to sell their investments,” Toy said. “If they can’t sell off their investments, they can’t distribute cash to their investors.”