Insurer At Risk - High Bond Yield

The life insurance industry is at risk if there is a sharp rise in bond yields, with an extreme situation potentially causing insurers to liquidate investments reaching $1 trillion in the United States and Europe, the International Monetary Fund warned on Tuesday.

Vulnerabilities have increased for life insurers, the IMF said in its Global Financial Stability Report , noting the industry is at the “center of fixed income markets” owning about 20% of global bonds and 30% of credit investments. Life insurers have long-dated liabilities and are a critical source of demand for bonds with long maturities.

A stress scenario of a large and sudden increase in bond yields and corporate spreads could induce mark-to-market losses of 30 percent for insurers in some jurisdictions - pointing to US and UK insurers particularly sensitive. This could lead to the emergence of policy surrenders, forcing life insurers to liquidate investments, which, in the extreme, could reach $1 trillion in the United States and Europe.

Rising rates could cause problems for a range of financial institutions as well as life insurers. Rising rates could generate mark-to-market losses (for insurers) but that’s also true for other investors.

Bond yields have been rising as inflationary concerns have increased. The benchmark 10-year Treasury is close to a 4-month high. Life insurers with “longer durations and a greater share of riskier corporate bonds in their portfolios would be hit the hardest by a sudden increase in yields.

A severe scenario of a sudden spike in yields could lead to policy surrenders. A scenario of bond yields increasing 200 basis points or more—similar to the worst-case yield increase and wider corporate stress scenario—could be associated with a significant increase in lapse rates.