Liquidity Risk

  • We have a committee within the ACLI that has been looking into the whole liquidity question, and on the basis of those discussions, I believe there is much more liquidity in the industry today.
  • If I recall correctly, the biggest surprise came about 15 years ago, when the first discussions were held with the Federal Reserve because of the first policy loan crunch.
  • That was the real shock, because it had never happened before in the industry.
  • This is the fourth wave now, and I believe the industry is used to it and is getting its portfolios in order to meet these demands when they come.

--  John Booth, ACLI

1981 - SOA - The Life Insurance Business--The View of Consumerists, Society of Actuaries (rsa81v7n38) - Daniel F. Case - Moderator - 18p

  • 1995 - SOA - Liquidity: The Hidden Risk Factor, Society of Actuaries - 20p

  • In terms of liability management, the long-term liability of life insurance companies leads to the problem of long-term mismatch between their assets and liabilities and the increase in liquidity risk.

2020 02 -  SOA - Systemic Risk in China’s Insurance Industry, Society of Actuaries - 55p

  • 2020 / 2021 - IAIS - Resolutions to Public Consultation Comments on Development of Liquidity Metrics: Phase 1 – Exposure Approach, 9 November 2020 – 9 February 2021 - 106p
    • 235. ACLI - American Council of Life Insurers:
      • The Consultation seems to acknowledge that the protection purpose for which a policy is purchased plays an important role in the risk of surrender, yet the methodology contains no classification by product type that would incorporate this important factor.
      • This would need to be remedied if the ILR is to provide a meaningful assessment of an insurer’s liquidity risk.
  • 43. A few examples of materialisation of liquidity risk:
    • If policyholders have the legal right to surrender a policy at short notice with little or no economic disincentive, insurers could face sudden cash outflows from withdrawals.
    • If an insurer has not sufficiently invested in liquid assets, it may be forced to sell less liquid assets to raise the necessary funds

2017 1208 - IAIS - Activities-Based Approach to Systemic Risk, Public Consultation Document - 62p

  • Interest rate volatility in the 1980's, accompanied at times by an inverted yield curve -- short-term rates were paying more than long-term rates -- prompted insurers to change traditional practices.
    • Asset maturities shortened (from 1969 to 1981, the proportion of life insurance assets acquired that were short-term went from 53% up to 81%).

--   John D. Hogan, not a member of the Society, is Senior Vice President, Investments, of American General Corporation.

1983 - SOA - Disintermediation, Investment Strategy and Product Design, Society of Actuaries - 22p

  • At times, liquidity risk arises because liquid markets become temporarily illiquid. Moreover, a liquidity event can be triggered by factors that are noneconomic, such as a loss of confidence related to a ratings downgrade.
  • It is somewhat less clear that the scope criteria are congruent with the microprudential objectives of the framework.
  • It may be useful to review historical significant liquidity-related events (above a certain size) to determine whether the scope criteria would have captured these entities within the exercise.
    • For example, neither cash-outs of life insurance policies nor contractual downgrade provisions are included within the proposed scope criteria.

2018 0831 - Letter - AAA, American Academy of Actuaries to NAIC (Liquidity Assessment (EX) Subgroup, Re: Scope of Insurers Subject to Liquidity Stress Test - The American Academy of Actuaries Life Practice Council’s Macroprudential Task Force (MPTF) - 4p

  • Almost all of the life insurance and annuity policies that we issue are separate account policies, where the issuing insurance company does not make any return or liquidity guarantees to the policy owner.
  • Almost all of our insurance contracts allow us to pay out policy assets in kind to the beneficiary, or to the owner in the event of an early surrender or cancellation.
  • Because of this feature of our life insurance contracts, we do not face the risk of mass surrender that would require us to liquidate general account assets to fund payouts.
  • Liquidity risk of assets held in our life insurance policies issued is borne by the policy owner and beneficiaries, not by us.
2017 - SEC- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 - ADVANTAGE INSURANCE INC. - [link]
  • The Life Liquidity Risk Working Group met.
    • This working group, chaired by Mike Boerner of the Texas Department of Insurance, reports to the NAIC’s Life Insurance and Annuities (A) Committee.

2001 - SOA - Life Liquidity Risk, Jon E. Niehus, Society of Actuaries - 2p

  • Industry experience indicates that the increase in policy lapses and surrenders follows closely behind a rising trend in policy loans.
    • During 1982, policy surrenders ran well above the 1981 level.
    • This development poses the threat of another liquidity drain reminiscent of 1980.
    • The rise in surrenders appears to stem partly from the current economic recession and partly from policy replacement.
  • Many insurance executives are concerned about the possibility that newer forms of life insurance products--universal and variable life--once their tax status has been clearly settled, could be sold in such large volume that they replace a large share of traditional whole life policies, thereby causing severe liquidity drains for companies that cannot or do not undertake adequate defensive measures.
  • The danger of having to sell large volumes of bonds at depressed market values is a recurring specter for these executives.

1983-2, NAIC Proceedings

  • In particular, with respect to liquidity risk, the ability of an insurer or group to access capital and liquidity in a stress scenario is fundamental in solvency regulation.

2018 0213 - American Academy of Actuaries (AAA) Letter to IAIS, Re: Interim Consultation Paper on Activities-Based Approach (ABA) to Systemic Risk - 2p

  • All of these will result in the inadequacy of the liquidity of insurers’ assets, serious solvency problems and large capital shortfalls.
  • Owing to systemic contagion, the insolvency of one insurer is likely to lead to the bankruptcy of other insurers that have an economic connection with it directly and further spread to the whole industry.  (p12)

2020 02 -  SOA - Systemic Risk in China’s Insurance Industry, Society of Actuaries - 55p

  • Liquidity Problems
  • Richard Minck, representing the American Council of Life Insurers (ACLI), was requested to provide a general review, from the ACLI's perspective, of the concern over life insurance industry cash flow and liquidity problems. 
  • Mr. Minck noted several factors:
    • (1) In the pension area, funds which normally would accrue to insurers were moved to short term high interest rate money markets, thereby reducing cash flow. This has been coupled with withdrawals of funds from insurers with guaranteed interest contracts <GICs>.  Similar problems have occurred with respect to deferred annuities.
    • (2) In the policy loan area, high interest rates caused heavy borrowing for reinvestment. However, the pressure on policy loans is levelling off due to reductions in interest rates and reduced pressure from banks due to credit restrictions.
    • (3) Confronted with declining cash flow, life insurance companies investment forward commitments have virtually ceased.
  • Nevertheless, some which were made last year are still coming due.
    • However, by Labor Day, the pressure on life insurers from this source should be pretty well over.
  • Traditionally, when an insurer's cash flow was inadequate, resort would be made to lines of credit.
    • However, this time new lines were drying up and some existing lines were not honored.
      • Mr. Minck said that this problem is also easing.
  • (4) With respect to the bond market, Mr. Minck said that not many life companies were forced to sell bonds at depressed prices.
    • Instead, they were able to resort to the sale of stocks or draw upon cash from affiliates.
  • (5) To date, cash flow problems have been limited to the area of meeting forward commitments.
    • Claim payments have not been a problem.
  • [ACLI] Re: Policy Loan Developments of 15 Life Insurance Companies
    • The purpose of the meeting was to discuss concerns about the liquidity conditions and the possibilities of future adverse developments.
    • The company people wanted to be sure that Mr. Volcker  <Chairman of the Federal Reserve> was fully aware of the potentials of the situation and to arrange a liaison between his staff and the staff of the Council and this aim was accomplished.
    • In the meantime, we have begun to explore the means by which the resources of the business might be applied to alleviate any temporary extreme liquidity problems that might arise for a particular member company.
    • [Bonk:  Mr. Volcker  = Paul Volcker, Chairman of the Federal Reserve]

1980-2, NAIC Proceedings

  • EVALUATION OF THE ADEQUACY OF THE MSVR FOR EXISTING PURPOSES
    • Industry experience indicates that the increase in policy lapses and surrenders follows closely behind a rising trend in policy loans.
    • During 1982, policy surrenders ran well above the 1981 level.
    • This development poses the threat of another liquidity drain reminiscent of 1980.
    • The rise in surrenders appears to stem partly from the current economic recession and partly from policy replacement.
  • Many insurance executives are concerned about the possibility that newer forms of life insurance products--universal and variable life--once their tax status has been clearly settled, could be sold in such large volume that they replace a large share of traditional whole life policies, thereby causing severe liquidity drains for companies that cannot or do not undertake adequate defensive measures.
  • The danger of having to sell large volumes of bonds at depressed market values is a recurring specter for these executives.
  • The prospective volatility of future interest rates stemming from the Federal Reserve's new monetary procedures poses another threat to life insurers in the years ahead.
  • The potential for increased volatility could involve interest rate "spikes" which cause policyholders to accelerate the volume of policy loans and to withdraw or withhold their pension contributions to life insurance companies.
  • The events of 1980 when policy loans, surrenders, the shortfall of pension inflows, and scattered withdrawals of employee benefit funds forced sizeable borrowings and even some asset liquidations to meet the drain are not necessarily a unique set of circumstances.

1983-2, NAIC Proceedings - Securities and Insurance Regulation (EX) Task Force