External Financing in the Life Insurance Industry: Evidence from the Financial Crisis

Article 1: External Financing in the Life Insurance Industry: Evidence From the Financial Crisis

Summary

Roughly 30 percent of U.S. life insurance companies raised new capital during 2008 and 2009 in the time of the financial crisis, which was approximately double the rate of the prior 5 years. New issuance was concentrated in insurers specializing in annuities, who saw they profits take a huge blow due to their exposure to equity markets through variable annuity products. The injection of new capital assisted life insurers in maintaining capitalization levels close to their historical levels, despite the large reduction in their retained earnings.

An examination is done to show the causes and costs of life insurers issuing external capitals from the 1999-2010, a focus will be done on two sample periods which are the periods of recession. The need to extra growth that are not sustained by existing capital and retain earnings and also the need to replace old capital that has been exhausted are the forces driving the issuance of capital from life insurers. From the results it is shown that firms with a high amounts of premium writings, low levels of capital and an undesirable net income their new issuance is concentrated.

Results are gathered from the financial statements of life insurers which is provide, they are based on regulatory filing with the National Association of Insurance Commissioners (NAIC). The use of these documents that are regulated are to ensure that the calculations that are done of the capital issuance are not tampered with by internal groups. An estimation was developed of the relationship between insurer’s characteristics and capital issuance. An increase was seen in the 2008-2009 sample period where the changes in the characteristics of the insurer triggered an increase in capital issuance mainly due to the fall in earnings in 2008.

 Following the crisis life insurers were provided with access to government provided capital this lines up with the results that were concluded that there is a direct implication for policies that were enacted following the financial crisis. The results also show that the uncertainty that might be faced when given government provided capital is false, the results show that there are no disturbances in the supply side of the capital market and that the capital issuance function as how it is supposed to as seen in past years.

There was a difference in the raising of capital by insurers and the banking industry. Although they raised some capital in the period, most of which were preferred equity and subordinate debt from companies that utilized TARP funds. The banks battered their common equity capital by importunately paying dividends and common stockholders when they also have access to TARP funds that would assists them, where on the other hand, insurers cut dividends by a significant amount in the year.

Evidence was gathered on the correlation between the issuing of new capital and other general factors. It shown that insurers distribute new capital when there is a shock, this is a response from the insurer to the shock and also if there is opportunity to grow the insurer will then issue capital. From the overall results we see that insurers have an optimal capital structure and from this they have the ability tweak their target with freshly distributed capital.

Discussion of Findings

Insurers were separated into annuity writers, defined as insurers with more than two-thirds of net premiums written in annuity lines of business. The 2008-2009 period was the period of recession that was highlighted. The profits of insurers were assessed using the Return on Assets ratio which shows the sharp fall in profits in 2008. Due to insurance being seen as a normal good mainly because of the positive correlation between consumer disposable income and amount of premiums written, this suggest that firms and consumers cut back on goods such an income when there is a decrease in income.

Following the crisis life insurers were provided with access to government provided capital this lines up with the results that were concluded that there is a direct implication for policies that were enacted following the financial crisis. The Federal Reserve also assisted insurance firms by implementing programs that would see them improving the conditions on the financial market alongside other financial institutions. Due to the benefits that were given from these programs life insurers capitalized due to the alignment of the programs and their industry.

It is concluded that there is a positive correlation between the issuance of capital by insurers and the insurers characteristic as seen in the financial crisis as capital depleted there was a rise in the issuance of capital by insurers. New capital helps companies increase their levels of capitalization. If insurance companies were able to withstand the financial crisis like they did with past economic crisis, the additional regulations will not be a necessity.

Relevance of the articles to the theoretical concepts discussed in the module

The article is much related to the Insurance module where it shows the ability of life insurers to quickly generate new capital through external issuance and reducing dividends, this lets them maintain a healthy level of equity capital. The text show that even though insurances companies suffered a loss within the financial crisis it is less compared to other financial intermediates. The article also correlates with the module where shows insight of life insurance companies and how they go about recovering from financial crisis. The article also shows the risks that life insurance companies face and also the comparison of the insurance companies towards other industries during the financial crisis. The text shows that it is quite costly for insurance company to hold capital because the capital can be more efficient when it is invested elsewhere.

Article 2: Systemic Risk in Financial Markets: How Systemically Important Are Insurers?

Summary of the Literature Review

      The article that is under review is “Systematic Risk in Financial Markets: How Systemically Important Are Insurers?” a case study which was fulfilled and written by; Christoph Kaserer and Christian Klein. In the article it states that a financial crisis from 2007-2009 was exposed to insurance companies because of a systematic risk. One of the typical reasons is largely based on the fact of observations where the insurance company size results from a well-diversified selection of specific risks, which means that insurance companies would depend on shorter leverage in widespread, and that they would engage in a reduced maturity transformation. Surprisingly, an assumption of insurance company was to abort, reduced analogy and intention processes would diminish the impact of the wider financial market. Insurers are associated with the systematic risk of financing, investing activities and traditional underwriting. Under these systematic risks before the financial crisis occurred, there were vague frontiers among banks and insurance companies as a possible source of risks that needed to be appropriately examined.