2014 0310 – Letter – Sheila C. Bair to Senator Sherrod Brown (D-OH) – 6p
I question the argument that insurance organizations should have weaker bank/thrift holding company protections because their insurance policy holders can’t easily cash out if they make bad investments.
Law Professor – Daniel Schwarcz
AAA – William C. Hines, American Academy of Actuaries – 6p
Senate – Banking, Housing, and Urban Affairs Committee – Subcommittee on Financial Institutions and Consumer Protection
Though insurance companies are different than banks, it is important to remember that they put their money in many of the same assets: government and corporate bonds, mortgage-backed securities, and real estate loans.
Indeed, according to the American Council of Life Insurers’ data, life insurers have over a trillion dollars in real estate exposure, including $600 trillion in mortgage-backed securities and $354 billion in commercial and residential mortgages. [Bonk: Typo? Trillion – Billion]
Though their run-risk may be different from banks, it is real. While banks hold short-term deposits, most are backed by the FDIC, and are quite stable, as we saw during the crisis. Even if we concede these differences, insurance policy holders can “run,” just differently. A life insurance policy is not indentured servitude. Policyholders can cash out whole life and annuity products, and halt premium payments on term products. Indeed, one of the biggest life insurance failures – $15 billion Executive Life – suffered debilitating policy surrenders contributing to its failure in 1991.
I question the argument that insurance organizations should have weaker bank/thrift holding company protections because their insurance policy holders can’t easily cash out if they make bad investments.
Moreover, given the long-term nature of life insurers’ obligations to their policy holders, they are exposed to substantial risk based on market fluctuations and turns in the economic cycle. Thus, it could be easily argued that they need more, not less, capital than banks based on the long tail of their liability structure.
(p6) – Conclusion
The Collins Amendment/Section 171 was designed to strengthen the integrity of capital standards by imposing a generally applicable floor that would constrain destabilizing leverage for all systemic institutions, regardless of business model, so that they would have to hold at least as much capital as that generally required of smaller banks.
(p10) – Daniel Schwarcz, Law Professor, University of Minnesota Law School
People like to say, ”Oh, well, AIG, the portion of AIG that got AIG into trouble was not about insurance.’ Well, that is true with respect to its credit default swaps.
But a major problem at AIG was its securities lending business. Its securities lending business involved the lending of insurers’ assets.
So insurers’ at AIG were intimately involved in the problem.
(p10) – Daniel Schwarcz, Law Professor, University of Minnesota Law School
(p10 ) – Moreover, if you look at FSOC’s report designating Prudential as a SIFI, you will see that FSOC, after looking at the portfolio of Prudential quite carefully, says that they are, in fact, potentially susceptible to a run.
Now, I admit and I want to emphasize this risk is different and less substantial than the risk of a run in banking.
But at the same time, it is real.
There, in fact, have been runs on insurance companies. Executive Life in 1991 was subject to a run wherein policy holders removed from the company $3 billion within the course of a single year.
Why is this significant?
It can result in systemic risk not because the insurer fails necessarily, but because an insurer facing massive liquidity problems can immediately try to dump its portfolio, thereby interfering with broader capital markets.
There is emerging research showing that insurers were a big part of the problem in their purchase of mortgage-backed securities leading up to the crisis and in triggering a fire sale of mortgage-backed securities when they offloaded those assets.
So the point I want to make is this: Insurance is less systemically risky than banking, but it can be systemically risky.
Why then does that lead to the conclusion that we need to have distinct capital requirements at the Federal level?