It's also worried about the effects of low interest rates on
their finances.
The Federal Reserve Board is worried enough
about the health of life insurers to include them in the financial stability
section of its new monetary policy report.
Federal Reserve Board Jerome Powell is
briefing congressional committees on the report this week.
The Fed started off the report by emphasizing
the impact of the COVID-19 outbreak.
“The COVID-19 outbreak is causing tremendous
human and economic hardship across the United States and around the world,” the
Fed says in the report summary.
Because of the strain, the Fed has taken
unprecedented measures to keep the market moving, including setting up
mechanism for pumping cash into the economy, the Fed says.
In a section of the report on “Developments
Related to Financial Stability,” the Fed says that, in some ways, changes made
in the wake of the 2007-2009 Great Recession have increased financial system
resilience.
But ”financial system vulnerabilities —
most notably those associated with liquidity and maturity transformation in the
nonbank financial sector — have amplified some of the economic effects of the
pandemic,” the Fed says. “Accordingly, financial-sector vulnerabilities are
expected to be significant in the near term.”
“Maturity transformation” is the process of
borrowing money at low, short-term interest rates and making a profit by
lending the money out for long-term loans at higher rates. The reference
to “maturity transformation” in the Fed report appears to refer mainly to
banks, not to life insurers, because life insurers generally try to match the
duration of their assets to the duration of their liabilities.
Life insurers usually have large holdings of
cash and other liquid assets, but they may have derivatives arrangements or
other financial arrangements set up in such a way that they must provide large
amounts of cash collateral quickly when conditions change rapidly. That means
it’s possible that the Fed’s reference to “liquidity” could, possibly relate to
life insurers.
Later in the financial stability section, the
Fed refers specifically to leverage — or ratios of debt to assets —
at life insurers.
“Leverage at life insurance companies has
reached post-2008 highs,” the Fed says. “Moreover, the capitalization of the
life insurance sector is likely to deteriorate in coming quarters because of
lower-than-expected asset valuations and lower long-term interest rates.”
The Fed does not assess the possible impact of
its own actions to hold down interest rates and increase investment market
liquidity on life insurance company capitalization levels.
Life insurers do invest heavily in corporate
bonds.
The Fed says cash outflows at money market
funds and bond mutual funds in March led to “severe strains in markets funded
by these institutions — notably, commercial paper (CP) and corporate bond
markets. The tensions began to ease only after the Federal Reserve took several
actions targeted at these markets.”
The action with the most direct effect on life
insurers is the Fed’s creation of the Secondary Market Corporate Credit
Facility. The SMCCF buys corporate bonds that are already out in the market.
Life insurers hold trillions of dollars of bonds that are already on the
market.
The Fed says in its report that some observers
have concerns about the emergency programs.
“The Federal Reserve is deeply committed to
transparency and recognizes the need for transparency is heightened when it is
called upon to use its emergency powers,” the Fed says. “Transparency helps
promote the accountability of the Federal Reserve to the Congress and the
public. For the few programs that are targeting financial market functioning,
the Federal Reserve will provide a full accounting of transactions in these
facilities. Real-time disclosure would risk stigmatizing participation in these
facilities and undermining the Federal Reserve’s ability to provide assurance
that these systemically important markets will continue their critical function
in times of severe market stress. The delay in disclosure will be no longer
than necessary to ensure that participants do not hesitate to participate.
While the facilities are operating, the Federal Reserve will disclose extensive
and regular aggregate information on total borrowing, collateral and fees, and
interest income.”
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