2015 Series • No. 2015–8
Current Policy Perspectives
A Post-Mortem of the Life Insurance Industry's Bid for Capital during the Financial Crisis 
A subsequent version of this paper has been published in the Journal of Insurance Regulation.
The 2008–2009 financial crisis was the most serious shock to the U.S. financial system since the Great Depression of the 1930s. A number of large financial institutions failed during the crisis. Many institutions that survived did so only because of extraordinary actions undertaken by company management to maintain solvency, or through the extension of extraordinary support by the federal government and the Federal Reserve System.
The impact of the financial crisis on the banking sector has been the subject of extensive research, discussion, and debate. Academic and policy researchers, as well as several government investigations, have examined the measures undertaken by bank managers, banking industry regulators, and governments in response to the crisis (Financial Crisis Inquiry Commission 2011, Stanton 2012). By comparison, relatively few studies have examined the experience of the life insurance sector during the crisis or the response of company managers and insurance regulators during the crisis period. This paper begins to fill that gap.
Key Findings
- During the crisis period, solvency concerns in the life insurance sector were not limited to AIG but were widespread: credit default swap (CDS) spreads for the largest U.S. life insurers exceeded by several times the spreads for the largest U.S. commercial and investment banks. These spreads narrowed appreciably after the Wall Street Journal reported that the Treasury had decided to expand the TARP program to include firms in the life insurance sector.
- The ability to access government funds, the benefit of regulatory actions, and the large internal capital transfers received by life insurers from their non-insurance parents during the crisis combined to contribute significant amounts of reported statutory capital to life insurance companies at during that critical time.
- Capital contributions to life insurers exhibit a business cycle pattern.
Implications
The findings of this study counter arguments that the life insurance business model has limited exposure to macroeconomic risks and provide evidence suggesting two important policy recommendations, calling initially for additional research on these issues: 1) insurance supervisors should have the ability to assess capital adequacy and availability beyond the level of the insurance operating company, including the ability to assess the capital adequacy of, and availability of capital from, holding companies not currently supervised by state insurance regulators, and these supervisors should take a consolidated view in monitoring the size, type, and direction of internal capital transfers when evaluating the viability of entity-level life insurers; and 2) life insurance supervisors would benefit from staff with expertise in understanding and forecasting the impact of macroeconomic and financial conditions on life insurers' balance sheets.
Abstract
In this paper, we show that life insurance companies were under significant capital strain during the recent financial crisis. This was the case not just for the notable case of American International Group, or for life insurers within the largest life insurance groups who applied for government funds, but for life insurers across the entire industry. The ability to access government funds, the benefit of regulatory actions, and the large internal capital transfers received by life insurers from their non-insurance parents during the crisis combined to contribute significant amounts of reported statutory capital to life insurance companies. Moreover, capital contributions to life insurers from their parents are not limited to crisis periods; they also exhibit a business cycle pattern. This study provides evidence suggesting two important policy recommendations and calls for additional research on these issues: 1) insurance supervisors should have the ability to assess capital adequacy and availability beyond the level of the insurance operating company, including the ability to assess the capital adequacy of, and availability of capital from, holding companies not currently supervised by state insurance regulators, and these supervisors should take a consolidated view in monitoring the size, type, and direction of internal capital transfers when evaluating the viability of entity-level life insurers; and 2) life insurance supervisors would benefit from staff with expertise in understanding and forecasting the impact of macroeconomic and financial conditions on life insurers' balance sheets.