One consequence of the financial services crisis that is likely to linger is the emphasis on capital management.

A Web seminar convened by New York-based Deloitte, “Capital Management for Insurers: Cracking the Code to Monetize the Business and Rebuild Capital,” tracked how this emphasis is reflected in the regulatory codes, in rating actions and in the technology purchasing decisions of carriers.

“We are seeing a flight to quality, so high capital levels are a key to growth.” said Aniko Smith, a partner at Deloitte & Touche.

Smith said the while financial crisis impacted balance sheets across the insurance industry, the pain was particularly acute for life insurers as variable annuity contracts with guarantees caused a significant increase in liabilities, which in turn caused a significant decrease in their capital levels at year-end 2008.

Moreover, with the capitals markets still somewhat constricted, life insurers are largely precluded from issuing new debt and are thus looking for new avenues to buoy their capital positions. She juxtaposed "traditional" capital management alternatives such as buying reinsurance and accessing public debt markets with "non-traditional" methods such as hedging/swaps, private placements and the securitization of cash flows.

With investment portfolios depleted and capital bases eroded, Smith suggested life insures take a page from P&C insurers, who needed large capital infusions after Hurricanes Katrina, Rita and Wilma and found two-thirds of the capital from non-traditional sources. “This is not the first time this has happened,” Smith said.

Eric Clapprood, Sr. Manager at Deloitte Consulting LLP, noted that strategies such as hedging should theoretically reduce capital needs, but that carriers should seek a balance between hedging and holding more capital.

What's more, with the derivatives market likely to come under strict new regulations, tapping these non-traditional sources is no sure thing for insurers going forward.

In addition to constraining growth, this limited access to capital has operational implications, Clapprood noted.  “As capital becomes scarce, insurers must account for this fact in their pricing," he said. To do this and run stochastic models of ever-increasing complexity, carriers are investigating areas such as predictive analytics. They are also focusing on hardware and linking servers together in grid computing networks in order to muster more raw computational power for the models. "Looking at multiple scenarios has become something of a human capital challenge, so insurers are spending more on technology to help compute future capital needs," he said.

Capital constriction has also played a part in temporarily slowing another well-worn means to growth, acquisition. Since the multi-billion merger of Liberty Mutual and Safeco in 2008, the merger and acquisition market has been noticeably quiet. "There has not been a lot of M&A activity in past 12 months," Clapprood said.

Add to this the impact of downgrades by rating agencies and the ability of insurers to acquire the capital necessary to grow new business, which is diminished further. Agency ratings increasingly matter to consumers, Smith added. “Ratings are critical to insurers," she said. "But they also have an impact on policyholder behavior."

As steep as rating requirements have become, regulatory requirements are steeper still, and may be the primary challenge to managing capital. Accordingly, Clapprood advised carriers to pay close attention to their risk-based capital (RBC) ratio, noting the ratio is used by the National Association of Insurance Commissioners (NAIC) as a primary measure to determine a company’s capital adequacy to meet policyholder obligations.

A successful capital management strategy should seek to dampen volatility both on the upside and the downside, he said. Clapprood said carriers seem to have been widely heeding this advice. "Only two insurers needed TARP funds. That’s a good sign for the industry."

Register or login for access to this item and much more

All Digital Insurance content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access