A new commentary released by Morningstar DBRS, highlights that liquidity risk in the insurance industry is gaining more attention because of the growing use of private assets.
Historically, liquidity risk has typically received far less attention in the insurance sector in comparison to other types of financial institutions such as banks.
However, analysts note, that following the U.S. regional bank and the UK pension crises, “greater attention” is now being paid to systemic liquidity issues.
In fact, analysts explained that insurers are exposed to various sources of liquidity risk, including a growing exposure to illiquid assets, as private credit rises in popularity and makes traditional investment strategies less competitive.
During recent years, the growth of alternative asset investment strategies across the insurance sector has enhanced the importance of monitoring liquidity risk.
In most cases, insurers usually allocate a small portion of their portfolio to alternative strategies, including private equity, real estate, or infrastructure, because of the nonguaranteed and higher-risk profile of the return of these asset classes.
But, as Morningstar DBRS points out, with private credit, insurers potentially can build a larger allocation to private
assets while continuing to achieve their asset liability matching and investment risk goals.
As a result, this could lead to significantly higher liquidity risk, especially if certain products become viable only
when supported by private credit assets.
Furthermore, Morningstar DBRS explains that another strategy that is playing a crucial role towards leading to a greater allocation of private assets is the use of reinsurance to transfer insurance liabilities, and their corresponding assets to jurisdictions that have a more “favourable regulatory environment.”
“Liquidity issues in the reinsurance market could potentially spread to direct carriers who rely on timely payments from reinsurance counterparties to pay policyholder benefits,” Morningstar DBRS said.
Patrick Douville, Vice President, North American Insurance Credit Ratings, commented: “Liquidity risk regulatory frameworks in the insurance sector are often less developed than those that apply to banking institutions because of the historically lower concern over liquidity issues with the insurance business model.
“In fact, insurers are exposed to various sources of liquidity risk, including a growing exposure to illiquid assets as private credit rises in popularity. In our view, a consistent, widely accepted approach for quantitatively measuring liquidity risk and liquidity resources is needed.”
