IMF raises alarm over ‘contagion’ from private capital in life insurance

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The IMF has urged regulators to bear down on the liquidity risks presented by life insurers linked to private capital groups, warning of potential “contagion” to the wider financial sector and the real economy after a shift in ownership in the sector.

Groups including Apollo, Blackstone, Carlyle and KKR have flooded into insurance since the global financial crisis, as life insurers retreated from capital-intensive businesses in an era of rock-bottom interest rates. Almost 10 per cent — $850bn — of the US life insurance industry’s assets were owned or managed by private equity firms by the end of 2021, the IMF said.

The shift has meant a sharp rise in illiquid assets held by the insurers and a rapid expansion of offshore operations in less tightly regulated jurisdictions such as Bermuda.

“Supervisors are encouraged to work closely with other authorities in charge of systemic risk to analyse the possible contagion to other parts of the financial system and in the real economy,” the IMF’s Fabio Cortes, Mohamed Diaby and Peter Windsor wrote in a forthcoming report seen by the Financial Times.

More than 40 per cent of the assets of private equity-linked US insurance companies are allocated to illiquid strategies including structured credit, mortgage loans and mortgage-backed securities, compared with 30 per cent for other US insurers, according to the IMF.

Private equity-linked life insurers were “more vulnerable” than their peers if there was an increase in corporate defaults and credit downgrades due to rising interest rates, the IMF said. Valuation processes for illiquid assets held by the insurers should be subject to “intrusive” reviews by regulators, they added.

Regulators have become increasingly concerned about the risk that the value of an insurer’s illiquid investments drops sharply just as higher interest rates encourage life insurance policyholders to take their money back, sapping a firm’s liquidity and putting members’ payouts at risk.

Supporters of private capital groups’ moves into the sector argue that this view of the sector’s risks is outmoded, and that they are now often publicly traded alternative asset managers whose investment strategies have lifted the solvency of insurers in the sector.

Still, watchdogs’ fears have been amplified by the collapse earlier this year of the Italian life insurer Eurovita, which was owned by Cinven, the UK-based private equity group. 

“[Regulators] worry about the timescale of life insurance liabilities which can last for 20 or 30 years, whereas a private equity manager is looking at a much shorter timeframe for its returns,” said Andrew Crean of Autonomous Research.

The IMF officials also warned about the risks of private capital groups establishing offshore Bermuda-based reinsurance businesses.

Bermuda-based reinsurance assets have grown significantly since 2016 to reach more than $1tn, as private equity managers have sought out more flexible rules and tax advantages. Private capital managers use Bermudian operations to reinsure life insurance and annuity business from companies that they already own as well as from rivals.

That limits the scope for onshore regulators in the US and Europe to scrutinise their activities.

Regulators are concerned that such intragroup reinsurance transactions could create conflicts of interest and concentrate risk in a way that would be less likely if the reinsurance was done by an independent third party.

The IMF is calling for the application of a globally consistent consolidated capital standard to limit incentives for regulatory arbitrage by insurers shifting business to locations where rules are less stringent.

The Bermuda Monetary Authority said that it conducted “strong cross-border collaboration and transparent information exchange” with other regulators. “The BMA would not approve any transaction that the [insurance company’s home] regulator does not support,” said the BMA.