The recent collapse of Silicon Valley Bank (SVB) sent shockwaves through the banking system and a reaction of uncertainty across regulators and the financial services sector. While SVB only comprised $200B of a $23T industry (about 1%), its failure has increased panic and accelerated several consolidations in the banking space.
Prior to the collapse, Institutional Owned Life insurance—bank-owned (BOLI), corporate-owned (COLI), and insurance company-owned (ICOLI)—markets appeared ready for another solid year and brighter days ahead. As we grapple with the events of the past few weeks, has anything substantially changed that outlook?
Over the past several years, the Institutional Life Insurance markets performed solidly. COLI growth was positively impacted by smaller case private placement products and larger insurance-owned transactions. BOLI and ICOLI were well positioned during a period of declining net interest margins and excess liquidity on hand. As the Federal Reserve began to increase interest rates to combat increasing inflation, and as consensus began to build around a recession narrative, bank liquidity began to edge down and concerns about loan loss reserves crept into the risk management narrative in the financial system. BOLI sales began to decelerate in the latter half of 2022.
BOLI traditionally reacts positively in a period of rising interest rates. In the period from 2005 to 2007, BOLI crediting rates rose in concert with the general rise in interest rates. One would expect crediting rates to respond accordingly again. Insurers adjust investment portfolios to be more proactive and take advantage of market opportunities. Rising interest rates also bring other insurers into or back to the market while simultaneously expanding capacity by the traditional carriers as they introduce new products at increased crediting rates. By all accounts, BOLI was poised to be an attractive investment for banks heading into 2023 and, with prospects for rising interest rates, solid for several years into the future.
But then, a perfect storm of increased interest rates, declining bond values, a rating downgrade, and a cooling of technology start-ups impacting liquidity needs led to accelerated withdrawals fueled by social media at SVB. On March 10, the second-largest bank failure in US history occurred. Two days later, federal regulators also closed Signature Bank, one of the few traditional banks closely partnered with crypto companies. Despite the significant differences in the underlying causes of the banking failures between the two periods, the government quickly responded to stem a repeat banking crisis similar to 2008. Within a few weeks, however, the ten largest US banks had lost nearly $200 billion in market value. On a global level, in a deal engineered by Swiss regulators, UBS agreed to take over Credit Suisse, a bank that had little in common with SVB. As the calendar turns from March to April, instability and anxiety in the banking sector remain and likely will for some time.
The insurance industry monitors asset-liability risks through sophisticated capital and risk management tools. Insurance policies and annuity contracts have different liquidity hurdles than immediate liquidity in bank accounts. Insurance regulators demand significant reserves to support the benefit obligations of the insurance products. The insurance industry is, therefore, better positioned to weather these financial market storms than the banking industry. Both Fitch and AM Best analyzed the insurance industry’s exposure to the bank failures and noted very modest investment exposure in the failed banks. Recent events would not appear to produce any concerns regarding Institutional Life Insurance capacity appetite on behalf of insurers.
Uncertainty is often the biggest obstacle to sales, especially as it applies to long-term investment decision-making, and BOLI is a long-term investment, more of an illiquid asset. Because cash flows from a BOLI policy are tax-deferred income, the bank maximizes its return by holding the policy to its full term. Of course, a bank can surrender the policy at any time for its cash surrender value, but then taxes are due on all gains built up over the policy since it was first issued, decreasing the net cash flows.
When short-term liquidity concerns invade the market, long-term decisions are often deferred. The industry witnessed a decline in BOLI during the ‘08 crisis. If SVB becomes a news cycle story rather than a deeper drag on the banking industry, BOLI sales may regain strength in the second half of 2023. Otherwise, the industry could experience a significant decline in 2023 BOLI premiums.
While product and capacity may be positive positions for the Institutional Life market, the headwinds of liquidity needs and uncertainty will likely tamper down product demand. It is likely that Institutional Life sales will be steady but less robust in 2023 than in the past several years.
With the latest banking crisis upon us, 2023 continues a multi-year season where uncertainty and pace of change are the normal operating conditions. In times of foggy conditions, it is important to reduce speed, maintain a good lookout, and manage risk by dealing with the reality that it’s sometimes better to get to your desired destination later rather than sooner.