Life insurers' evolving models pose financial stability questions
A Bank of Japan review compares the evolving business models and financial stability issues of life insurers in Japan, Germany, the United Kingdom, and the United States. It highlights a shift in product offerings, diversification into alternative investments, and the increasing use of asset-intensive reinsurance.
From savings to investment-linked products
Life insurers worldwide are transforming their business models, shifting from traditional savings-oriented products to investment-oriented offerings where policyholders bear more risk.
This trend is prominent in Japan and Germany, where liability durations for savings products historically exceeded 10 years.
Key drivers include a prolonged low-interest-rate environment, which dampened demand for guaranteed-yield products, and the implementation of economic value-based solvency regulations (ESR).
Insurers have responded by expanding variable products and foreign currency-denominated options.
Concurrently, a common trend across countries is the diversification of investment assets.
While bonds remain a high proportion, their share has declined.
Alternative investments, such as private equity (PE) and private debt (PD), have seen a notable increase, particularly in Europe and the United States.
These illiquid assets are well-suited for long-term asset-liability management.
Japanese insurers are also increasing PE/PD, though at a more modest scale.
The rise of asset-intensive reinsurance
Life insurers are increasingly leveraging asset-intensive reinsurance (AIR) to enhance investment yields and improve capital efficiency.
AIR involves transferring both insurance contract and investment risks to reinsurers.
This mechanism can reduce capital charges under solvency regulations.
By delegating asset management to reinsurers with strong investment expertise, ceding insurers can achieve higher investment yields.
Offshore reinsurers, often in Bermuda, are common counterparties.
Bermuda's supervisory framework allows for higher discount rates when valuing policy reserves, which can reduce reported liabilities and generate profits for the ceding insurer.
In Japan, AIR accounted for over 80 percent of life reinsurance by fiscal 2023.
Globally, the United States leads in AIR cessions to Bermuda, followed by Japan and the United Kingdom.
Interconnectedness demands vigilance
The growing interconnectedness between life insurers and non-bank financial intermediaries, particularly private funds, alongside increasing cross-border AIR transactions, presents new financial stability challenges.
While life insurers remain significant players in financial systems, these evolving business models necessitate continued monitoring by financial authorities worldwide.
Assessing potential stress transmission channels and amplification mechanisms is crucial to mitigate systemic risks.