Life Insurers’ Investment Risks and Offshore Reinsurance Threaten Stability

In addition to adopting alternative investment strategies and increasing the use of offshore reinsurers, the U.S. Financial Stability Oversight Council said there has been a shift in the composition of life insurers’ liabilities and an increase of private equity firms and other asset managers in the sector. Beinsure analyzed the AM Best’s report and highlighted the key points.

The U.S. Financial Stability Oversight Council said life insurers’ increasingly complex investment strategies and reliance on offshore reinsurers with more lax capital requirements could potentially undermine carriers’ financial stability.

FSOC was created through the Dodd-Frank Wall Street Reform and Consumer Protection Act and is composed of federal and state regulators, as well as insurance industry experts (see Largest Reinsurance Companies in the United States).

5 Key Highlights

• The life insurance sector has seen significant structural changes, including increased private equity involvement and reliance on offshore reinsurers, driven by low interest rates and regulatory differences.
• Offshore reinsurance has surged, especially in Bermuda, with more than 40% of life annuity reserves going offshore in 2024, creating potential regulatory arbitrage risks.
• Life insurers’ portfolios increasingly include illiquid and highly leveraged assets, raising liquidity concerns, particularly during periods of market stress.
• The FSOC and NAIC are implementing reforms to improve transparency, enforce asset adequacy testing, and address risks associated with nontraditional liabilities and offshore reinsurance.
• Despite rising commercial real estate losses, North American life insurer credit losses are expected to remain within ratings expectations, thanks to ongoing regulatory improvements.

Life insurance sector has seen the most structural changes

Since the global financial crisis, the life insurance sector has seen the most structural changes among insurance lines.

In addition to adopting alternative investment strategies and increasing the use of offshore reinsurers, FSOC said there has been a shift in the composition of life insurers’ liabilities and an increase of private equity firms and other asset managers in the sector.

These changes were driven by different regulations across jurisdictions, more limited risk appetites in other parts of the U.S. financial sector and a sustained period of low interest rates. These changes have two implications, FSOC said.

First, more illiquid assets are showing up in life insurers’ portfolios. These assets, which include
esoteric collateral and smaller, more highly leveraged borrowers, carry uncertainty as their value depends on mark-to-model accounting as opposed to mark-to-market accounting.

Further, carriers’ increasing use of nontraditional liabilities, like greater borrowing from capital markets and Federal Home Loan Banks, could raise concerns about insurers’ ability to manage cash flow during stressful times and a growing dependence on these credit facilities to maintain spread-based product lines.

The trouble with some nontraditional liabilities, such as FHLB loans, is that investors can withdraw funds with short notice.

FSOC said even well-capitalized insurers might struggle to cope with unexpected withdrawals if their investments aren’t sufficiently liquid.

Second, FSOC said the use of offshore reinsurers has grown substantially. This growth was particularly strong in Bermuda-based reinsurers that were wholly owned by the same insurance
group.

These offshore jurisdictions typically have lighter regulatory oversight, more lax tax policies
and less stringent accounting conventions than the United States.

Life annuity reserves from U.S. life insurers went offshore

More than 40% of ceded life annuity reserves from U.S. life insurers went offshore in 2024, an increase of 26% since 2016.

Almost 40% of life annuity reserves were ceded to Bermuda in 2024, up from less than one-third in 2021. Looking at just transactions in 2024, roughly 60% of reserves went through Bermuda, which is huge growth just in 2023 alone

Jason Hopper, associate director, AM Best

However, offshore reinsurers also enjoy fewer reserve requirements than their U.S. counterparts, and this could introduce a regulatory arbitrage incentive with the potential to erode policyholder protections.

Due to the increasing use of offshore reinsurers, federal and state regulators are looking at a proposal to require asset adequacy testing for offshore assets ceded in reinsurance transactions.

The proposal includes disclosure enhancements to monitor potential sources of credit, counterparty, liquidity and market risks stemming from the use of offshore reinsurers.

These regulatory efforts might improve confidence in the expanded use of offshore reinsurance, the oversight council said.

U.S. individual life insurance premium is on track to reach a record $16 bn in 2024 and continue growing in the current year, as the market continues riding a bounce first seen during the COVID-19 pandemic

Regulatory reforms support life insurer ratings

Increased complexity within the life insurance sector, including growth in offshore reinsurance, alternative investment manager tie-ups and higher allocations to illiquid structured assets has led to a highly dynamic regulatory environment in the U.S.

Recent block reinsurance transactions are mostly neutral to ratings. Cedants often experience an improved business risk profile, which is offset by reduced diversification.

The National Association of Insurance Commissioners initiatives focus on increasing transparency and enhancing monitoring to ensure an appropriate understanding of insurers’ risk.

Initiatives include the bond classification project, CLO capital charges, asset adequacy testing for reinsurance transactions and private letter ratings of investment securities.

North American life insurer credit losses will remain benign in 2025, despite modest increases due to ongoing pressure on commercial real estate (CRE) assets, reflecting secular shifts and macroeconomic trends.

Regulatory bodies, including the NAIC in the United States and the Bermuda Monetary Authority, have introduced reforms to enhance transparency and align with the industry’s rapid growth.

Commercial real estate losses will continue to gradually emerge but are expected remain within ratings expectations relative to capital.

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AUTHORS: Jason Hopper – Associate Director – Credit Rating Criteria, Research and Analytics at A.M. Best Company, Steve Hallo – senior associate editor, AM Best