Fed Study Cites Rising Risk in Insurance. According to a paper published by the Federal Reserve Bank of Minneapolis, more attention should be devoted to increasing risk in the insurance industry. "Two developments over the past 15 years have fundamentally changed the risk profile of U.S. life insurers. The first is growing demand for minimum-return guarantees in variable annuity products, due to the shift from defined-benefit to defined-contribution plans. The second is the increasing use of 'captive reinsurance,' which was triggered by tighter capital requirements for life insurance policies after 2000. . . . [A study by the authors earlier this year found] that liabilities moved to 'shadow reinsurers,' a subset of captives that are the least regulated and are unrated by the A.M. Best Company. . . . Total shadow insurance now exceeds total third-party reinsurance."
The Fed notes the following possible consequences of trouble in the insurance sector:
- Since insurance companies are interconnected to banks through their funding arrangements in reinsurance transactions, a systemic shock to the insurance industry could trigger a sudden demand for credit that constrains the banking sector.
- The perception that insurance companies are at risk could suddenly reduce the demand for insurance products, forcing households to bear additional risk.
- Insurance companies are the largest institutional holders of corporate bonds, and if they were forced to shrink their balance sheets, the demand for some types of bonds would decline.