Stress testing and creating a cross-functional team are some of the approaches US insurers have taken to respond to stresses caused by recent market disruptions. What are the impacts of US mortgage delinquency and the banking crisis on the life insurance industry?

A series of failures from a number of small to medium-sized US banks made headlines in March, prompting interventions and close scrutiny by US authorities as well as regulators around the world. 

San Diego-based crypto bank Silvergate was one of the first to announce it was winding down its operations but around the same time Silicon Valley Bank, a Santa Clara-based commercial bank preferred by the technology industry, was hit by a bank run. Soon after, New York’s Signature Bank was closed by the state regulator following large deposit withdrawals from nervous customers. Weeks later, San Francisco-based regional bank First Republic was seized by regulators and sold to JPMorgan Chase.

According to ratings agency AM Best, US insurers have minimal exposure to Silicon Valley Bank bonds and are “not as vulnerable” as other sectors to a bank run scenario, but given the widespread vulnerability in the banking sector, what steps have insurers done to cope with stresses?

Steven Walker, vice chairman at Protective Life Corporation, said capital in the insurance industry was “very strong”, but when stresses started to kick in with the banking crisis in March, his firm had assembled a cross-functional team to ensure timely communication and the firm’s market positioning. 

The team, with meetings three times a week initially, consisted of representatives from across the board including the executive team, treasury, asset and liability management, investments, finance, retail business and corporate communications, he said.

“It's not that these groups were not working together before, but it really allowed us to have a more frequent touch point, so that we could react quickly and make sure we all knew what was happening in the capital markets,” said Walker during a webinar organised by the International Insurance Society on 11 July. 

Protective suffered modest losses from the crisis. He said the team now has weekly meetings but continues to monitor its market positioning and makes sure the company has strong liquidity. 

Walker said Protective had “brought down some of our repo balance that we have”, but added the company has access to the Federal Home Loan Banks and “regularly maintains about a billion of additional capacity”. 

The insurer also has access to a $1.5bn committed revolving credit facility, and most of its corporate bonds are public corporate bonds, he said, describing the firm’s overall liquidity profile as "strong”. 

However, Walker added: “Protective continues to be concerned about the banking market and what higher rates will do to their balance sheet. So we're continuing to monitor the situation. But I think things have subsided [from] what we saw back in March.”

The impact of the crisis has been relatively modest, he said: “So far, investment grade bonds perform well and credit spreads have not really widened, which is surprising, given some of the stresses that have been out there in the system.”

Robin Raju, chief financial officer at life insurance and financial planning firm Equitable Holdings, said credit risk is “the best risk to take” when there is market volatility. 

“You can hold it at book value, and you can manage through the volatility. You don't want to take risks like equity, enhanced equity risk or interest rate risk at an insurance company. I think the best risk to take is credit risk,” he said.

Raju’s comments came in response to a question about whether he had seen higher losses related to defaults. He acknowledged credit risk could bring exposure to defaults but said this depends on where the insurer is in the credit perspective.

“At Equitable, 96% of our fixed maturity bucket is in investment-grade products. We continuously stressed those asset classes, and we want to manage our risk profile across multiple cycles and not just plan for the current risks that we've seen in the marketplace overall,” he explained. 

For assets below investment-grade, Raju said if high interest rates persist, “it's going to put pressure on the borrowing capabilities and the credit profile of those companies.”

Apart from having investment grade assets, Raju emphasised the need to stress test products “for scenarios that we haven't seen before”. 

He added: “Test for things that you haven't seen before and ensure that you're prudent in where you put your money to work. But at the end of the day, the industry is pretty well capitalised. And the learning from prior crises always helps us hold more capital for the next crisis.”

Late payments from borrowers in the US commercial real estate industry have been widely reported after rising interest rates, falling property prices and weaker demand for offices following the Covid-19 pandemic.

Walker noted the impact it has on the sector’s profitability, including his firm’s, due to lower mortgage income in the commercial mortgage portfolio.

“Life insurers are also starting to see a little bit of an impact on profitability through lower variable investment income due to slowing up some of the repayments that we're seeing on some investments, such as commercial mortgages and corporate bonds,” he said. 

“And we've certainly seen that at Protective. Some of our variable investment income, particularly in our commercial mortgage portfolio where we get participating mortgage income on properties, has slowed down due to the lack of repayments.”

According to a report by the Mortgage Bankers Association, published in June, commercial mortgage delinquencies – loans for which borrowers fail to make repayments by the due date  – increased in the first quarter of 2023. 

For life insurance investors, where loans are delinquent for 60 days or more, the delinquency rate was 0.21%, an increase of 0.1 percentage points from the fourth quarter of 2022. 

The delinquency rate for insurers is better than that for investors such as commercial banks and thrifts, whose rate in Q1 was 0.58%, representing an increase of 0.13 percentage points from the Q4 2022. 

Raju noticed a “big difference” in the situation between life insurers and banks but said the commercial mortgage market as a whole is under pressure.

“Office exposure is a risk, and that's out there. So we continue to be careful about where we put money to work within,” he said,  stressing the importance of understanding the tenant profile, for example, by having class A properties for prime office users. 

“At Equitable, almost all of our offices are within class A buildings. That ensures that you're going to have a high tenant profile that leads us to having over 90% of our tenants in place.”