Fulvia Fringuellotti and Saketh Prazad

Following the Silicon Valley Financial institution collapse, the inventory costs of U.S banks fell amid issues concerning the publicity of the banking sector to rate of interest threat. Thus, between March 8 and March 15, 2023, the S&P 500 Financial institution index dropped 12.8 % relative to S&P 500 returns (see proper panel of the chart beneath). The inventory costs of insurance coverage firms tumbled as effectively, with the S&P 500 Insurance coverage index dropping 6.4 % relative to S&P 500 returns over the identical time interval (see the middle panel beneath). But, insurance coverage firms’ direct publicity to the three failed banks (Silicon Valley Financial institution, Silvergate, and Signature Financial institution) by way of debt and fairness was modest. On this publish, we look at the potential components behind the response of insurance coverage buyers to the failure of Silicon Valley Financial institution.

Inventory Value Efficiency within the Interval Surrounding the Collapse of Silicon Valley Financial institution 

Supply: Authors’ calculations primarily based on information from S&P Capital IQ. 
Notes: This chart reveals the S&P 500 index, S&P 500 Insurance coverage index and S&P 500 Financial institution index over the time interval February 15-March 15, 2023. The shaded space highlights the proportion change within the three indexes from March 8 to March 15 following the Silicon Valley Financial institution collapse. 

Why Did Inventory Costs of Insurance coverage Corporations Drop after the Failure of Silicon Valley Financial institution? 

An in depth take a look at the asset and the legal responsibility sides of insurers’ stability sheets supplies some insights on their publicity to rate of interest threat. Our focus is on the life insurance coverage sector, which accounts for 71 % of U.S insurance coverage business property.  

Life insurance coverage firms held $5 trillion in invested property on the finish of 2022. Company bonds represented the asset class during which life insurers invested essentially the most, totaling $2 trillion, or 43 % of invested property. Mortgages, widespread shares, municipal bonds, and authorities bonds adopted subsequent with portfolio shares of 13 %, 4 %, 4 %, and three %, respectively. Life insurance coverage firms invested nearly solely in funding grade bonds, however 37 % of bonds of their portfolios are rated BBB, the bottom credit score notch throughout the investment-grade area.  

The overwhelming majority (96 %) of bond investments are reported within the ebook at value, with the remaining being reported at truthful worth. Because of the rate of interest hikes, unrealized losses from marking-to-market bonds that have been reported at value within the statutory filings represented on combination 56 % of complete adjusted capital (the numerator of risk-based capital necessities) of life insurance coverage firms in 2022, with important heterogeneity throughout insurers. Thus, our first speculation is that the scale of life insurers’ unrealized losses on bond investments in 2022 relative to complete adjusted capital might have performed a task in driving insurance coverage buyers’ response to the failure of Silicon Valley Financial institution.   

If and the extent to which these losses could also be realized will depend on various factors together with downgrades of securities, policyholders’ surrenders, and losses skilled on the life insurance coverage and annuity enterprise. On the liability-side, long-term insurance coverage insurance policies and annuities characterize crucial sources of funding for the life insurance coverage business. Annuities accounted for 60 % of complete liabilities associated to life, annuity, and deposit-type contracts within the normal and separate accounts in 2022.

This funding supply is taken into account fairly secure given the boundaries and prices related to withdrawals (for instance, give up charges and tax penalties). Surrenders are topic to swings and should enhance in an surroundings of rising rates of interest, particularly within the case of mounted annuities. In 2022, withdrawable liabilities (that’s, contracts that enable discretionary withdrawals) accounted for 55 % of complete liabilities associated to life, annuity, and deposit kind–contracts. We hypothesize that the scale of withdrawable liabilities relative to complete liabilities might be a further issue behind insurance coverage buyers’ issues after the failure of Silicon Valley Financial institution.  

In recent times, specific consideration has been devoted by teachers and policymakers to variable annuities with minimal return ensures (Drexler et al., 2017; Ellul et al., 2022; Koijen and Yogo, 2022), which represented 39 % of combination reserves for annuity contracts in 2022. These encompass saving merchandise the place the funds contributed by policyholders are allotted to subaccounts invested in property and a minimal development price within the annuity stability is assured. Since variable annuities balances are principally invested in shares, insurers’ legal responsibility related to assured variable annuities will increase not provided that rates of interest decline, but in addition if the inventory market drops. If the returns generated by the investments aren’t sufficient to fulfill the ensures, life insurers face a loss and should have to fund the ensures by promoting property of their normal account. Thus, we hypothesize that the scale of variable annuities with minimal ensures to complete liabilities might be a 3rd issue explaining buyers’ response to the failure of Silicon Valley Financial institution.  

The Inventory Returns of Life Insurers across the Silicon Valley Financial institution Occasion Correlate with Their Unrealized Losses and Legal responsibility Situations 

To check our hypotheses, we gather inventory costs and stability sheet information on twenty-nine U.S. insurance coverage teams primarily engaged within the life insurance coverage enterprise (henceforth abridged “life insurance coverage corporations”). For every agency, we calculate the next three metrics: i) unrealized losses on bonds issued by unaffiliated entities and reported at value as a share of complete adjusted capital, ii) withdrawable liabilities as a share of complete liabilities associated to life, annuity, and deposit type-contracts, and iii) assured variable annuity reserves as a share of complete liabilities associated to life, annuity, and deposit type-contracts. Though these metrics exhibit a optimistic pairwise correlation, they need to however seize completely different dimensions of threat to some extent. Subsequent, we assemble a set of size-weighted portfolios of those publicly listed corporations primarily based on whether or not every of the three metrics is above or beneath its median in 2022 after which calculate the cumulative inventory returns for every portfolio over the time interval March 7 to March 15, 2023. 

Cumulative Inventory Returns of Life Insurers across the Silicon Valley Financial institution Collapse by Sub-groups primarily based on Unrealized Losses and Legal responsibility Situations 

The three plots introduced within the chart above present empirical proof that’s according to our hypotheses. Specifically, insurance coverage corporations with unrealized losses publicity, withdrawable legal responsibility publicity, and variable annuity publicity above the median skilled detrimental cumulative returns which are 8 %, 4 %, and 5 % decrease than below-median corporations, respectively. Our end result for the variable annuity publicity is according to Ellul et al. (2022) and Koijen and Yogo (2022), who doc that life insurance coverage corporations with giant assured variable annuity enterprise exhibited a worse inventory efficiency than the insurance coverage business through the world monetary disaster and the COVID-19 pandemic. General, the detrimental efficiency of life insurance coverage shares amid the failure of Silicon Valley Financial institution displays the strongest relation with the scale of unrealized losses relative to complete adjusted capital.

Sensitivity of Life Insurance coverage Corporations’ Inventory Returns to Bond Returns 

Sensitivity of Life Insurers’ Shares Returns to Curiosity Charges 

How did the general publicity of life insurance coverage corporations to rate of interest threat evolve following the rate of interest hikes of 2022? To deal with this query, we estimate the sensitivity of life insurance coverage inventory returns to adjustments in rates of interest counting on a two-factor mannequin as in Brewer, Mondschean, and Strahan (1993) and Berends et al. (2013).  The above chart reviews the estimates for annually of the coefficient capturing the sensitivity of life insurers’ inventory returns to the return on a ten-year Treasury bond. Through the 2016-22 interval, the response of life insurers’ inventory returns to bond returns is detrimental, according to a detrimental length hole (that’s, liabilities having an extended length than property). The upward bounce within the estimated coefficient between 2021 and 2022 is according to a shortening of liabilities in comparison with property (for instance, as a result of surrenders are extra possible) following the rate of interest hikes of 2022. The more severe inventory efficiency of insurance coverage corporations with bigger unrealized losses publicity and withdrawable legal responsibility publicity after the failure of Silicon Valley Financial institution is in keeping with this market-implied shift in insurers’ publicity to rate of interest threat.  

Fulvia Fringuellotti is a monetary analysis economist in Non-Financial institution Monetary Establishment Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.  

Sakteh Prazad is a senior analysis analyst within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

How you can cite this publish:
Fulvia Fringuellotti and Saketh Prazad, “A Retrospective on the Life Insurance coverage Sector after the Failure of Silicon Valley Financial institution,” Federal Reserve Financial institution of New York Liberty Road Economics, April 10, 2024, https://libertystreeteconomics.newyorkfed.org/2024/04/a-retrospective-on-the-life-insurance-sector-after-the-failure-of-silicon-valley-bank/.