Innovative Financial :1ST Engineering Makes Life Insurance Now
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Is everything “normal” again? Following last week’s massive 50 basis point reduction in interest rates by the Federal Reserve, that is a question that many investors may now have.
as all, since the 2008 financial crisis, the financial system has been in a profoundly anomalous state.
To avert depression, central banks first reduced rates; as the pandemic struck, they doubled down; and eventually, in a panic, they raised rates when inflation skyrocketed.
However, in reaction to slowing growth, the Fed is currently lowering rates.
This appears to resemble the financial cycles before to 2008.
It makes sense why markets are rising in relief.
Before getting too excited, though, keep in mind one important point: the long-term effects of those anomalous quantitative easing trials are still unclear.
Because of the many semi-hidden ways in which cheap money has corrupted finance, there are some very real potential concerns.
Take life insurance, for instance. Since its business strategy was viewed as uninteresting, the media has often shunned this industry.
Companies collected fees from clients, invested those funds in secure assets like bonds, and utilized the returns to pay annuities.
However, life insurance has always provided an interesting window into society views about risk, as highlighted by sociologist Viviana Zelizer.
And there were some very interesting adjustments that happened during the cheap money era.
Most significantly, under QE, insurance firms’ investment income shrank, making it more difficult for them to pay annuities, as detailed in a recent essay from the Bank for International Settlements.
In a desperate attempt to increase yield, those corporations, along with many other asset owners, switched from bonds to riskier and less liquid assets.
In order to fulfill capital requirements more easily, they also adopted balance sheet “efficiency,” often known as financial engineering, through reinsurance agreements that offloaded assets and liabilities onto other organizations.
Most surprisingly, private equity firms began to target the industry because of the low cost of capital.
Particularly in the US, organizations like Blackstone, KKR, and Apollo have acquired minority or majority shares in insurance businesses.
According to an IMF analysis, by the end of 2021, PE-influenced companies held 10% of total assets in the insurance sector, up from less than 2% a decade earlier.
The PE invasion made perfect sense in theory: private equity groups needed a place to spend their funds, which would triple in size between 2016 and 2022, and insurance companies needed capital.
(Which, naturally, was another effect of QE as investors shifted into PE in search of yield.)
Furthermore, PE players appeared more capable of unleashing inventive financial “efficiency” than stodgy insurance authorities.
The most notable difference is that PE-influenced businesses have been significantly more aggressive than others in utilizing reinsurance agreements to inflate the balance sheets of insurance companies and moving capital into riskier assets in order to increase profits.
This has maintained the insurance firms lucrative enough to continue paying out those annuities in spite of the strain on revenues from low rates, so in some ways it has worked effectively.
Therefore, policyholders have nothing to be upset about.
However, the BIS and IMF are concerned because long-term dangers have also been created by this significant, albeit mostly invisible, shift.
One problem is that the private capital assets currently found on balance sheets related to life insurance are not only opaque and illiquid, but they are also occasionally connected to the same PE companies that hold those life insurance groups.
One transaction that is highlighted in the IMF report involves KKR purchasing Global Atlantic insurance, after which the company declared that it would raise its “fee income by $200 million per year or more…presumably through Global Atlantic allocating some of its investment portfolio to KKR managed assets.
Innovative Financial :1ST Engineering Makes Life Insurance Now
The reinsurance arrangements seem to involve connected entities, which is another issue.
Accordingly, the BIS states that by the end of 2023, “PE-linked life insurers in the United States had ceded risk to affiliated insurers equivalent to nearly half of their total assets (or nearly $400 billion)” and that “affiliate reinsurers with links to PE located in offshore centers assumed about two-thirds of the risks ceded by PE-linked life insurers.” Whoa!
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This indicates that both investors and regulators find the flows to be very opaque.
The fear shared by the BIS and IMF is that unanticipated losses could occur and set off a chain reaction if and when interest rates rise in the future or there is a downturn in the private capital world.
There have been some indications of investor disquiet. The failure of Silicon Valley Bank last year caused a sharp decline in the share price of life insurance firms, as noted by the New York Federal Reserve.
This decline was reportedly caused by investors becoming unsure about the long-term consequences of low-cost borrowing.
But for the most part, the risks that exist in the life insurance industry are still hidden from view, and this is probably going to continue as the rate cycle continues.
In the near future, that might not matter.
However, as the BIS and IMF worry, the risks could bite later.
Thus, if nothing else, the story should serve as a reminder that it is too soon to declare the QE experiment over.
Certain severe anomalies in the finance industry persist even under the new “normal.” We risk dying if we forget this.
Innovative Financial
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