Capital Markets Bureau
Regulatory Alert
  • Equity Markets’ Volatility and U.S. Insurance Industry Exposure

    Stocks around the world continued to be volatile as September began, on the heels of their worst month in more than three years. Driving the sell-off were continuing concerns that China’s slowdown will weigh on the global economy, along with investor uncertainty with regard to the timing and magnitude of an anticipated increase in interest rates by the Federal Reserve. Coming off a steep decline in August, the Standard & Poor’s (S&P) 500 Index fell 2.96% to 1,913.85 on Sept. 1, the third-worst drop this year, possibly setting a sour tone for September — historically the worst month of the year, in which the index has fallen 1.1% on average going back to 1927 — although stocks staged a partial rebound in the following session. Equities in Asia also were volatile, as the Shanghai Composite index dropped nearly 5% intraday after manufacturing reports pointed to a deepening Chinese economic slowdown, but then recovered on news of additional government intervention.

    Table 1 shows the recent performance of major stock markets around the world, as measured by benchmark indices. The data show that all major markets are in a so-called correction, typically defined as a decline of 10% or more from their prior peak, except the U.S., which has been wavering near the edge of correction territory. Further, the data show that stocks in Hong Kong and mainland China are down 26% and 39%, respectively, from their prior peaks, signifying bear markets (typically a 20% or greater decline).

    World Stock Market Indices' Performance as of Sept. 2, 2015
    Index QTD YTD 1 yr. 3 yr. Peak to
    Peak to
    Peak Date
    S&P 500(U.S.) -5.5% -5.3% -2.7% 38.6% -12.5% -8.7% 5/20/2015
    S&P TSX Composite(Can.) -6.9% -7.4% -13.3% 13.4% -19.0% -13.6% 9/3/2014
    Financial Times 100(U.K.) -6.7% -7.4% -10.9% 6.5% -19.0% -14.6% 4/27/2015
    DAX(Eur./Ger.) -8.2% 2.5% 5.7% 44.1% -24.6% -18.9% 4/10/2015
    Euro Stoxx 600(Eur.) -9.5% 0.7% 0.6% 29.6% -20.0% -16.9% 4/15/2015
    Nikkei 225(Jap.) -10.6% 3.7% 15.5% 104.7% -15.5% -13.6% 6/24/2015
    Hang Seng Index(H.K.) -19.3% -10.3% -14.4% 8.7% -27.0% -25.9% 4/27/2015
    Shanghai Composite(China) -26.1% -2.3% 39.5% 54.3% -44.9% -39.0% 6/12/2015

    Because most U.S. insurers’ common stock holdings are U.S.-based, it is reasonable to estimate the potential mark-to-market impact of the stock market decline on U.S. insurers’ capital and surplus using the 12.5% peak-to-trough decline in the S&P 500 Index. Table 2 shows the unaffiliated common stock exposure of U.S. insurers in relation to their total capital and surplus as of year-end 2014 and as of June 30, 2015. It also shows the hypothetical percentage impact on capital and surplus of the decline in stocks from their peak to the August market trough. Because insurers’ aggregate exposure to common stocks is relatively modest compared to other assets such as bonds, the expected impact of a significant stock market sell-off on insurers’ capital and surplus is modest, even in the case of property/casualty (P/C) insurers, which are the most heavily exposed to stocks. The common stock exposure of individual insurance companies relative to total capital and surplus varies greatly, however, depending on investment allocations and capital structure; it significantly exceeds total capital and surplus in a relatively small number of cases.

    U.S. Insurers' Common Stock Exposure Relative to Total Capital and Surplus
    U.S. $ mil., as of 12/31/14 Fraternal Life P/C Health Title Total
    Unaffiliated Common Stock 2,774 29,506 245,717 8,537 639 287,174
    Total Capital and Surplus 12,580 429,509 862,810 116,419 4,251 1,425,570
    Unaffiliated Common Stock as Percentage of Total Capital and Surplus 22.1% 6.9% 28.5% 7.3% 15.0% 20.1%
    U.S. $ mil., as of 6/30/15 Fraternal Life P/C Health Title Total
    Unaffiliated Common Stock 2,853 27,777 249,369 8,516 800 289,314
    Total Capital and Surplus 13,034 433,540 865,254 116,007 4,451 1,432,287
    Unaffiliated Common Stock as Percentage of Total Capital and Surplus 21.9% 6.4% 28.8% 7.3% 18.0% 20.2%
    Estimated Mark-to-Market Impact on Total Capital and Surplus of a 12.5% Decline in Market Value of Unaffiliated Common Stock -2.7% -0.8% -3.6% -0.9% -2.2% -2.5%

  • Greece and Puerto Rico Turmoil – Minimal Impact on U.S. Insurer Investments(6/29/2015)

    Over the weekend, two announcements were released with negative implications relative to sovereign and municipal debt: one pertaining to Greece and the other Puerto Rico. While neither topic is new to the capital markets, both news releases were significant in that they carry negative implications in the ongoing turmoil within each area of focus.


    After the Greek government’s negotiations with creditors came to an impasse, it announced that Greek banks would close for six days and impose capital controls for the next week, until a national referendum scheduled to take place on July 5th. The referendum will determine whether the Greek government will accept austerity measures demanded by the country’s creditors in exchange for additional aid. Furthermore, on Sunday, June 28, the European Central Bank froze emergency loans to Greek banks at their current level of €89 billion, and Athens is expected to default on a €1.55 billion (USD 1.73 billion) payment due to the International Monetary Fund, as it has lost international rescue loans for the first time in more than five years.  The U.S. insurance industry’s year-end 2014 exposure to Greece was modest, at $117.3 million ($7.3 million in bonds and $100 million in equities), with only $0.2 million in Greek sovereign debt. The exposure had been larger until 2011, at just over $1 billion, when the Greek government restructured significant portions of its debt, exchanging old bonds for newer ones at about 25 cents on the dollar. Greece’s long-term sovereign debt rating is currently CCC/Caa3/CCC by Standard & Poor’s (S&P), Moody’s Investors Service (Moody’s) and Fitch Ratings, respectively.

    Besides direct Greek sovereign exposure, there is also potential concern for secondary impacts. Exposure to banks, especially European banks that are exposed to Greek sovereign debt, is one example. The total bond exposure of U.S. insurers to European banks was not substantial, at approximately $6.8 billion as of year-end 2014. The largest three exposures to non-U.S. banks were with Credit Suisse, HSBC Holdings PLC, and Deutsche Bank. In addition to direct investments in these aforementioned banks, U.S. insurers may also have some exposure to those banks as counterparties in derivatives transactions. The three largest European bank exposures based on notional value include Deutsche Bank, Credit Suisse and Barclays, however, the actual exposure to these banks is much smaller (i.e. due in part to netting, etc.), and should be well-collateralized.

    Puerto Rico

    The governor of Puerto Rico also announced over the weekend that the commonwealth’s debt is unpayable.  At $72 billion, Puerto Rico’s debt load represents more than 70% of GDP. The island’s economy has been suffering since 2006 with the closure of U.S. military bases, followed by the elimination of tax incentives that caused pharmaceutical companies and other manufacturers to leave. The resulting problem with unemployment (currently at 12%) has led the country’s younger population to immigrate to the U.S. mainland, further shrinking the country’s tax base and in turn exacerbating the situation. Puerto Rico’s population has fallen 4.7% since 2010. Puerto Rico’s municipal bonds had been considered attractive because they are exempt from federal, state and local income taxes in the U.S. The largest holders of Puerto Rico’s bonds are municipal bond mutual funds. Direct ownership of bonds by U.S. insurers was $1.4 billion as of year-end 2014. In addition, bond guarantors are estimated to have exposure of approximately $14 billion in par value of bonds. In general, U.S. insurer exposure to Puerto Rican bonds has been declining as the commonwealth’s financial struggles have increased. The long-term debt ratings on the Commonwealth of Puerto Rico are currently CCC+/Caa2 by S&P and Moody’s, respectively.

  • Moody's Lowering City of Chicago Debt Rating to 'Junk' Status Has Small Impact on Overall Insurance Industry Holdings (5/15/2015)

    Moody's Investors Service (Moody's) on May 12 lowered the credit rating on the city of Chicago's $8.1 billion outstanding general obligation (GO) bonds to Ba1 from Baa2, along with the credit ratings on approximately $800 million tax revenue debt and authorized motor fuel tax revenue debt. The downgrade is a consequence of a ruling by the Illinois Supreme Court last week that limited Chicago and the state of Illinois' ability to handle unfunded pension plans. It also includes Moody's expectation that the city's elevated unfunded pension liabilities will continue to grow.

    In addition, according to Moody's, "The Ba1 rating on the sales tax and motor fuel tax debt reflects the absence of legal segregation of pledged revenue from the general operations of the city. This lack of separating caps the ratings at the city's GO rating." Moody's has also kept a negative outlook on the revised rating. Moody's currently has a long-term rating of A3 on the state of Illinois with a negative outlook.

    Notwithstanding, Standard & Poor's (S&P) and Fitch Ratings (Fitch) both maintain an investment grade rating on Chicago's GO bonds. S&P on May 14 lowered Chicago's GO bond ratings to A- from A+ and placed the ratings on CreditWatch with negative implications. According to S&P, the rating action reflects the city's short-term liquidity pressures. S&P also warned that it could lower Chicago's long-term GO debt rating further "if the city does need to access its own internal liquidity at levels we feel compromise its overall liquidity strength." Fitch has an A- credit rating assigned to Chicago's GO bonds, with a negative outlook.

    As of year-end 2014, the U.S. insurance industry had approximately $7.2 billion in Chicago municipal debt outstanding (not including the exposure of financial guarantors), a large proportion of which was held by property/casualty (P/C) companies. In the event S&P or Fitch lowers the rating on Chicago's GO bonds to below investment grade, the result would be an NAIC Designation below NAIC 2. In turn, P/C and health insurers would have to hold these bonds at the lower of cost or fair value. Given the relatively small exposure of Chicago municipal debt compared to the industry's approximate $5.5 trillion in total invested assets, this exposure does not result in significant cause for concern. However, individual company exposures may be significant as a percent of capital and surplus.

  • Implications of Currency Policy Change by Swiss National Bank (1/29/2015)

    On Thursday, Jan. 15, the Swiss National Bank announced an end to the Swiss currency peg of $1.20 to the euro, a policy adopted in September 2011. The policy change was prompted by the continued devaluation of the euro due to anemic to negative economic growth in the region. On Thursday, Jan. 22, 2014, the European Central Bank (ECB) announced a €60 billion per month government bond purchasing program in hopes of stimulating growth in the Eurozone. The stimulus program would push up government bond prices, thus making it more expensive for the Swiss National Bank to continue the $1.20 peg policy.

    Following the announcement of an end to the peg policy, the Swiss franc jumped about 18%. The currency increase benefits some but not others. Anyone receiving francs are beneficiaries because of the increased value. In global trade, Swiss exporters do not benefit, as their products are now more expensive relative to other currencies.

    As of year-end 2013, U.S. insurers reported total holdings of about $9.4 billion in book/adjusted carrying value (BACV) of securities issued by companies domiciled in Switzerland. The $9.4 billion in BACV consisted of about $6.7 billion in bonds and $2.7 billion in stock. About $158 million of the bond holdings, or less than 2.5%, was denominated in Swiss francs. About 97% of the total Swiss bond exposure was allocated to corporate bonds. Based on the direct exposure of $158 million to the Swiss franc relative to total cash and invested assets of about $5.5 trillion, there is no major direct risk to U.S. insurers.

    Due to the rising Swiss franc, Credit Suisse, whose U.S. subsidiaries were counterparties for $113 billion in notional value of derivatives transactions with U.S. insurers, announced it expects a drop in profits for the first three quarters of 2014, but the company suffered no “material trading losses” from the rise in value. Other large multinational corporations are expected to experience a similar strain on profits. The contagion will affect companies outside of the financial sector, including (among others) Glencore International (commodities), Nestlé (food and beverage) and Novartis (pharmaceuticals). In addition, U.S. companies, including insurers, engaged in derivatives transactions may face increased counterparty risk as a result. Collateral posting, a standard requirement in derivatives transactions, should offset the counterparty risk. Approximately 127 U.S. insurers have Swiss-domiciled corporate parents. Given the negative pressure on earnings and profits, a Swiss parent company is incented to take possession of U.S. dollar-denominated assets held by subsidiaries. Another concern is that earnings not denominated in Swiss francs are now worth less, creating a desire, or need, to increase dividends to offset the currency valuation loss. Such an action by a U.S. insurer’s Swiss parent may jeopardize the capital position of the insurer.

    The NAIC Capital Markets Bureau will continue to monitor trends in the Swiss franc and report as deemed appropriate.

  • Recent Economic Trends and Volatility in Major Foreign Currencies (1/13/2015)

    As the euro area economy continues to struggle, growth in China begins to slow, and oil prices(per the West Texas Intermediate, WTI) dipped to their lowest intraday level of $46.83 a barrel on Jan. 7, 2015(since April 2009), certain foreign currencies –particularly the euro, the Canadian dollar (loonie) and the yen– have experienced significant declines.

    The U.S. insurance industy’s direct exposure to foreign currency risk remains modest. As of year-end 2013, translated into U.S. dollars, the U.S. insurance industry had approximately $47.7 billion in foreign currency exposure, of which the largest five currency exposures were: $21 billion in Canadian dollars, $10 billion in Japanese yen, $8 billion in the euro, $5.5 billion in the British pound and $1.6 billion in Australian dollars. In Canada, unemployment was an unexpected 6.6% in December 2014, which was also the second straight month of job losses for the country, suggesting its economic progress is flailing. The loonie has dropped 12.1% since mid-June 2014, reaching its lowest level in January 2015 (since May 2009). The Japanese yen decreased 12% in all of 2014, and despite some upticks and the Bank of Japan stating it will buy at least 1.25 trillion yen, the value of the yen is expected to continue to decrease in 2015; it has been on a declining trend for three years. The value of the yen dropped 17% from early July 2014 to early January 2015. A weak economy persists in the euro area, with poor industrial data reported from three large Eurozone economies (Germany, France and Finland) suggesting recovery is far off and faltering. Political uncertainty (particularly related to the upcoming Jan. 25 Greek elections) and deflation risk further put economic recovery at risk in this area; however, additional economic stimulus by the European Central Bank may be on the horizon in the form of sovereign bond purchases (in particular, €500 billion of investment-grade assets). On Jan. 8, 2015 the euro reached its lowest level since December 2005, down 15% from May 2014. Lastly, the value of the Australian dollar and British pound also experienced relatively large decreases from July 2014 to early January 2015, at 14.1% and 11.8%, respectively.

    The NAIC Capital Markets Bureau will continue to monitor trends with foreign currencies in general and report as deemed appropriate.

  • U.S. Insurance Industry Investment Exposure to the Energy Sector and Oil-Exporting Countries is Modest as Oil Price Plunge Continues (12/17/14)

    Bloomberg News reported on Dec. 16 that the global price of crude oil plunged through $60 a barrel for the first time in five years. New York-traded West Texas Intermediate, the world's most liquid forum for crude oil trading, dipped below $55 on Dec. 16 for the first time in five years. From its mid-June peak, crude oil has slumped nearly 50% through mid-December this year. The stocks and debt securities of oil-producing companies are coming under pressure—high-yield exploration and production and oil-service companies in particular—while oil-exporting countries such as Russia (where the ruble has declined precipitously to record lows), Nigeria, Iran and Venezuela have also been hard-hit.

    Figure 1: Price of Crude Oil (WTI), Last 30 Years

    Energy stocks have come under pressure: The S&P 500 Energy Index is down about 10% over the past 12 months, despite the broad index’s 14% positive 12-month return. Energy sector high-yield corporate bonds have also sold off. As of Dec. 16, the Energy component of the Markit CDX HY CDS Index had widened to 676 basis points (bps) after ranging from 250 bps to 300 bps for most of the year, while the overall CDX HY index widened to 404 bps after trading between 300 bps and 350 bps for most of 2014. Due to investor fear of “contagion,” ripples have spread, causing emerging markets around the world to sell off. Through mid-December, stock markets in Colombia, Brazil, Mexico and Chile are down 13% to 30% in the past 12 months on a currency-adjusted basis, and Russia’s MICEX Index is down 52%. Emerging market debt has followed suit, as the emerging market CDX Index widened to 419 bps on Dec. 16 after trading between 250 bps and 350 bps for most of the year.

    At present, the global demand for oil is low because of weak economic activity, as well as increased energy efficiency, and a steady shift away from oil to alternative energy sources. Despite ongoing economic recovery in the U.S., economic activity in Europe remains sluggish. In addition, Asian economic growth remains under pressure, with Japan stagnant and China’s growth continuing to decelerate. On the supply front, geopolitical tensions have not disrupted oil, and the market seems relatively unconcerned about geopolitical risk. At the same time, the shale oil boom in the U.S. has enabled it to become the world’s largest oil producer. This has allowed the U.S. to sharply reduce its dependence on imports, thereby freeing up global supply. OPEC, led by Saudi Arabia and other Gulf countries, has maintained production levels to preserve market share. According to The Economist magazine, Saudi Arabia can easily handle lower oil prices, given its $900 billion of reserves and its ultra-low production cost ($5 to $6 per barrel).

    The fallout from the oil price plunge is worst for the players in the industry who have high cost structures (i.e., deep-water or Arctic drilling) that make them the most vulnerable to lower prices. The hardest hit countries are those dependent on a high oil price to fund their fiscal imbalances. The two most prominent countries are Russia (already suffering due to Western sanctions following its annexation of Crimea and continued interference in Ukraine) and Iran (which is supporting the Assad regime in Syria). The Russian ruble has plummeted more than 50% through mid-December despite massive efforts by the Russian central bank (an 11.5 percentage-point increase in rates and more than $80 billion of intervention), igniting market fears that capital controls may be imminent. The latest 6.5 percentage-point rate hike was the largest since the 1998 Russian sovereign default.

    As of year-end 2013, the U.S. insurance industry had modest exposure to the key oil-exporting countries around the world, with a combined $169 billion of debt and equity exposure, or 3.0% of total cash and invested assets. Drilling down to specific country exposures, the majority, or 78%, was to Canada, whereas exposure to Russia and Venezuela was $882 million and $1.6 billion, respectively. There was minimal to no exposure to Iran or Nigeria. The U.S. insurance industry’s worldwide oil-and-gas-related bond and stock exposure totaled $226 billion, or 4.1% of total cash and invested assets. Note that the country exposures and the energy sector exposure are not mutually exclusive.

    The NAIC Capital Markets Bureau will continue to monitor events within the energy sector and the regions affected and will report as deemed appropriate regarding any potential impacts to the U.S. insurance industry’s investments.

  • U.S. Insurance Industry Exposure to Argentine Sovereign Debt is Small as Default is Possible (7/30/14)

    Argentina is at risk of defaulting on interest payments due today, July 30, on $13 billion in sovereign debt maturing in 2033. The default is expected to occur because of a ruling by the U.S. District Court, which blocked the country’s attempt to transfer $539 million in interest on the 2033 bonds to investors because it did not set aside amounts owed to “holdout” creditors related to Argentina’s previous 2001 debt default.

    Argentina, the third-largest Latin American economy, last defaulted on $95 billion in sovereign debt in 2001, most of which was swapped for new bonds in 2005 and 2010. Investors took a 70% loss on the principal, but 7% of the holders (the “holdout” creditors, or hedge funds) rejected the restructuring terms and won a U.S. District Court ruling to reclaim 100% of all principal and unpaid interest. July 30 is the last day of a 30-day grace period for Argentina to pay interest due on the 2033 bonds. Based on default provisions in the bond indenture, a default on the interest payments could trigger a cross-default clause that allows other investors to demand return of the principal and unpaid interest immediately (provided, however, that holders of at least 25% of the debt demanded their money returned).

    Argentine government officials and the holdout creditors are in talks today aimed at avoiding default, which could occur if Argentine President Cristina Fernández de Kirchner either agreed to settle the suit filed by the creditors, compensate them in full, or obtain a delay on the U.S. court ruling that prohibits Argentina from servicing the 2033 debt before paying the holdout creditors.

    As of July 29, and according to Bloomberg, the bonds due in 2033 were trading at 82% of par, which was above their 74% of par average for the past five years. The morning of July 30, the bonds were trading at 92.2% of par. In addition, average yields on Argentine debt were 9.7% as of July 28.

    As of year-end 2013, the U.S. insurance industry had a modest exposure to Argentine debt, at $172 million, 73% of which was sovereign debt. Within this sovereign debt exposure, approximately $56 million was in the bonds maturing in 2033. In addition, the industry had approximately $15 million in exposure to Argentine equities. The long-term sovereign debt ratings for Argentina are currently CCC-/Caa1/CC by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, respectively.

    The NAIC Capital Markets Bureau will continue to monitor events within this region and report as deemed appropriate regarding any potential impacts to the U.S. insurance industry’s investments.

  • U.S. Insurance Industry Exposure to Ukraine is Minimal, Mitigating Concern Over Prime Minister Departure and Continued Political Uncertainty (7/25/14)

    The crisis in Ukraine continues, with the most recent news of Prime Minister Arseniy Yatsenyuk’s resignation on July 24, triggered by dissolution of Ukraine’s ruling coalition. Yatseynuk’s resignation must be approved by parliament according to Ukraine’s constitution. In the meantime, the existing cabinet remains in place until a new coalition is formed, likely after elections that are expected to occur in late October.

    Yatsenyuk’s administration commenced in Ukraine in February 2014 after street protests caused former President Viktor Yanukovych to flee. Since then, the eastern part of Ukraine has fought a pro-Russian rebellion that is believed to be supported by the government in Moscow. Remember that, in March, Crimea, the former Ukrainian peninsula, was annexed by Russia.  Yatsenyuk is credited with leading Ukraine’s economy during the crisis, implementing tough measures that resulted in the country receiving a $17 billion loan from the International Monetary Fund (IMF). To qualify for the next loan tranche from the IMF, Ukraine is expected to implement social spending cuts and army spending increases.

    The yield on the 10-year Ukrainian U.S. dollar-denominated bond has been extremely volatile, ranging from 8.1% on July 23 to more than 11.0% in February 2014. After reaching a year-to-date low on July 23, the yield on the sovereign bond widened approximately 15 basis points to 8.2% on the news of the Ukrainian premier’s resignation. These yields equate to prices ranging from $96 to $79, with the current price at $95.

    According to Bloomberg data, the Ukrainian hryvnia has depreciated almost 30% against the U.S. dollar since the beginning of 2014 and remained relatively unchanged at 11.7 per dollar on the news.

     As of year-end 2013, the U.S. insurance industry had a modest exposure of $85.2 million in Ukrainian bonds, $70.5 million of which was in sovereign debt. Ukrainian U.S. dollar-denominated long-term sovereign debt is rated CCC/Caa3/CCC by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, respectively. Other former USSR exposures include an aggregate of approximately $667 million with Georgia, Kazakhstan, Latvia, Lithuania and Slovenia as of year-end 2013. Despite the small exposure, the situation bears close monitoring until a resolution is reached, which is not expected to occur anytime soon. Further volatility is expected, as is economic and financial damage with the continued hostility between Ukraine and Russia.

    The NAIC Capital Markets Bureau will continue to monitor events within this region and report as deemed appropriate regarding any potential impacts to the U.S. insurance industry’s investments.

  • U.S. Insurance Industry Exposure to Thailand is Minimal, Mitigating Concern Over Military Coup(5/23/14)

    The ouster of the civilian leaders of Thailand and seizing of government control by military leaders could potentially increase the market risk of related investments in the portfolios of U.S. insurers. The potential risk is mitigated by the small concentration of Thai securities held by insurers.

    As of the 12 months ended May 23, 2014, the Thai baht depreciated 9.17% against the U.S. dollar. The price stood at 32.6. On Jan. 6, 2014, it reached a high of 33.08. The yield on the 10-year Thai U.S. dollar-denominated bond has experienced some volatility over the past three months, ranging from approximately 3.37% to more than 3.78%. On May 23, 2014, the ask price on the 10-year Thai bond was 107.68 and the bid was 105.88. Thai government credit-default swaps (CDS) reached almost 180 in early 2014, indicating a market-perceived increase in risk. The CDS have since fallen to a May 23, 2014, close of 138.8.

    As of year-end 2013, the U.S. insurance industry had a total exposure of $478 million in book/adjusted carrying value (BACV) in Thai securities, of which 98% were in bonds and 2% in equity. Life insurers had the greatest exposure to Thai bonds at $418 million, representing about 89% of the bond exposure. About 60% (or $281.8 million) of the energy sector investments were in PTT PCL (BBB+, Standard & Poor's) and 16% (or $76.3 million) of the financial sector investments were in Bangkok Bank (Baa1, Moody's Investors Service). P/C insurers had the greatest exposure to equities at $9.6 million (or about 88%) of the equity exposure.

    Table 1: Sector Breakdown of Bond Investments (BACV)

    Table 2: Sector Breakdown of Equity Investments (BACV)

    Thai U.S. dollar-denominated long-term sovereign debt is rated A-/Baa1/A- by Standard & Poor's, Moody's Investors Service and Fitch Ratings, respectively. While this exposure is small, the situation bears closer monitoring until a resolution is reached.

    The NAIC Capital Markets Bureau will continue to monitor events within this region and report as deemed appropriate regarding any potential impacts to the U.S. insurance industry's investments.

  • U.S. Insurance Industry Exposure to Ukraine and Former USSR Countries is Minimal, Mitigating Concern Over Political Uncertainty(3/5/14)

    The current crisis in the Ukraine, particularly the recent intervention by Russian militia in Crimea, has triggered volatility in global financial markets, including stock losses in the U.S., Europe and Asia. U.S. Treasuries, however, have rallied because of investors’ flight-to-quality instinct. While the Russian economy has been struggling, it could benefit from the current turmoil in the form of higher prices for oil and gas, two of its main exports.

    Recently, the Russian ruble has dropped to a record low against the dollar and the euro, and Russian stocks have decreased by 10% since the beginning of the year. In addition, the yield on the 10-year Ukrainian U.S. dollar-denominated bond has been extremely volatile, ranging from approximately 9.0% to more than 11.0% in February 2014, closing on March 4 at 9.5%. This equates to prices ranging from $80 to $91, with the current price at $88.50.

    According to JPMorgan Asset Management, the Ukraine desperately needs financial support — a situation that existed prior to the current turmoil. While the Ukraine’s current interim government has been negotiating with the International Monetary Fund (IMF) about a bailout agreement, its foreign reserves have dropped to record lows along with its currency, the hryvina. That said, the possibility of a Ukrainian sovereign default cannot be ruled out. And the market price of insuring against Ukrainian default has increased 300 basis points since the summer of 2013.

    As of year-end 2012, the U.S. insurance industry had a modest exposure of $94 million in Ukrainian bonds, of which 84% was in the form of government bonds. There were no Ukrainian equity investments. Taking a broader view, exposure to all of the former Union of Soviet Socialist Republics (USSR) totaled $1.6 billion in book/adjusted carrying value (BACV). The majority of former USSR exposure was with Russia at $1.1 billion, the majority of which (72%) was also sovereign debt.

    Ukrainian U.S. dollar-denominated long-term sovereign debt is rated CCC/Caa2/CCC by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, respectively. Russian U.S. dollar-denominated long-term sovereign debt is rated BBB/Baa1/BBB by the three aforementioned nationally recognized statistical rating organizations. Other former USSR exposures included an aggregate of $410 million with Georgia, Kazakhstan, Latvia, Lithuania and Slovenia. While this exposure is small, the situation bears closer monitoring by regulators until a resolution is reached. Further volatility is expected, as is economic and financial damage if there is a continued “standoff” between the Ukraine and Russia.

    The NAIC Capital Markets Bureau will continue to monitor events within this region and report as deemed appropriate regarding any potential impacts to the U.S. insurance industry’s investments.

  • Leveraged Bank Loans: Increased Demand, Deteriorating Underwriting and Revised Regulatory Guidance (4/2/13)

    New issuance of leveraged bank loans has been increasing post-financial crisis, including among nontraditional lenders. Consequently, bank regulators are concerned over the quality of these loans due to signs of weakening standards. To the extent insurers consider investing in leveraged bank loans either directly or through collateralized loan obligations (CLOs) — particularly in this current low interest rate environment — thorough analysis, including a review of appropriate documents and models associated with the investment, will identify the risks involved and whether the proposed investment is prudent based on the insurer's strategy and investment guidelines. Having the appropriate infrastructure within an insurer's portfolio management division can help identify and monitor these risks. This includes having experienced analytical professionals within the portfolio management and credit analysis team, in addition to appropriate systems and monitoring processes in place with respect to operations and administration (as well as for business continuity plans). In addition, how the bank loans are sourced and the insurers' relationships with traders or agent banks, along with whether the bank loans are first or second lien, and how they are priced (i.e., marked-to-market, and by which vendor(s)) are also factors to be considered by insurers when investing directly in bank loans. Note that with respect to syndicated bank loans, the lead agent bank usually has (limited) authority to act on behalf of the syndicate regarding any amendments to the bank loan terms. This, therefore, emphasizes the need for insurers, and all investors for that matter, to understand the nature of their investments.

    Leveraged bank loans are attractive in the current low interest rate environment because they are high-yielding with floating interest rates that increase as rates rise. Though they are typically rated below investment grade by the rating agencies, they are also senior debt within a company's capital structure, meaning that they take priority with respect to interest and principal over other classes of company debt. According to Standard & Poor's, the average yield on a leveraged loan was 5.44% in January 2013 compared to 2.75% on an investment grade corporate bond (according to Barclays U.S. Corporate Index). Leveraged loan issuance for all of 2012 was $42 billion, compared to a high of $160 billion in 2007, according to S&P Capital IQ Leveraged Commentary and Data.

    In addition to a primary market for new issuance, there is an increasingly liquid secondary market for investing in leveraged bank loans, which has attracted additional institutional investors. Insurance companies invest in bank loans; however, historically, direct exposure has been minimal. Insurers are exposed to bank loans indirectly through investments in CLOs, which were approximately $22 billion as of year-end 2011. A resurgence of new issuance in CLOs post-financial crisis has played a role in the increased demand for leveraged loans.

    Leveraged lending decreased during the financial crisis but has been on a rebound since 2009. Non-bank lenders, as well as non-regulated investors, entered the market and were willing to accept looser bank loan terms. Consequently, underwriting standards have deteriorated; for example, meaningful maintenance covenants were being excluded. These "covenant-lite" loans do not have the safeguards — such as limits on how much debt a company can add to its balance sheet — that traditional leveraged bank loans carry. According to S&P, for the first two months of 2013, $25 billion of covenant-lite loans were issued, which is almost the same amount that had been issued at their peak in February 2007.

    On March 21, banking regulators (that is, a joint effort between the Federal Reserve Board, The Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency) released updated supervisory guidance for banks regarding leveraged lending due to concerns over looser underwriting standards and banks increasing risk. The revised guidance primarily focuses on having banks establish sound risk-management practices; underwriting standards with clearly defined expectations; valuation standards that include established policies and procedures; pipeline management such that exposure can be measured timely; and reporting and analytics that include appropriate management information systems for monitoring loan characteristics and to perform stress testing.

    Consequently, the Capital Markets Bureau believes it is important for state insurance regulators to be aware of the potential risks that bank loans as investments might carry, particularly if they reach high concentrations, and to be alert for significant investments by any one insurer.

  • Reaching for Yield with Structured or Esoteric Investments (8/7/12)

    In the current environment of a relatively flat yield curve and low interest rates — and with the expectation that low interest rates will persist at least through late 2014 — investors in general and insurance companies specifically may seek investing in assets that generate a higher yield than the more traditional, "plain vanilla" investments, such as corporate bonds or U.S. Treasuries. Alternatives that would add incremental yield, though sometimes only nominal, would be structured or esoteric investments. The concern with a structured or esoteric investment is not necessarily that the probability of default would be higher than that of a more traditional investment, but rather, that other key factors — such as loss given default, predictability of income streams, market value volatility, liquidity and counterparty risk — could negatively impact the investment and, therefore, the overall investment portfolio.

    For example, in the case of residential mortgage-backed securities and commercial mortgage-backed securities, recent Capital Markets Special Reports have highlighted that some structures have significantly higher downside volatility in more conservative loss scenarios than the majority of the insurance industry's holdings. In addition, income streams might fluctuate dramatically for leveraged interest rate products; that is, bonds whose coupon is not only dependent on the performance of an economic or market variable such as the Consumer Price Index, the London Interbank Offered Rate (LIBOR) or the Standard & Poor's 500 Index, but which can also be leveraged to exaggerate volatility. In some structures, if the economic or market variable does not meet a specified target, no interest payment is due. So, although the repayment of principal is not directly affected, the income stream of the bond can vary dramatically from one period to another. Finally, with synthetic structured securities — which are created through a credit default swap or other derivative whereby the synthetic aspect allows the investor access to investments that might not otherwise be available — investors might incorrectly identify the investments' relevant risks, including counterparty risk, because of the complex structure of these investments. The complexity of the cash flows of some of these structures can often make it difficult for investors to fully understand the drivers behind cash flows. Synthetic structured securities, which include credit-linked and different kinds of equity-linked securities, have existed for quite some time but tend to be much more prevalent when there is limited new issuance.

    Aside from the concerns discussed above, the market for highly structured and esoteric investments is not necessarily liquid. That is, they are not traded frequently, and their market prices are not always readily available. These investments, therefore, cannot be relied upon to support unexpected, short-term cash flow needs that would require the immediate sale of the securities. Although there does not appear to be significant exposure in the insurance industry of these securities, there is considerable discussion in the marketplace about developments in these areas. Therefore, the Capital Markets Bureau believes it is important for state insurance regulators to be aware of the potential risks that these types of investments might carry, particularly in high concentrations, and to be alert for significant investments by any one insurer.

Regulatory Alert

Capital Markets Special Reports archive and subscription


Capital Markets Daily Regulator Newsletter (includes subscription to Special Reports)

Request for an Investment Analysis Report

The Capital Markets Bureau is located in the NAIC's Capital Markets & Investment Analysis Office in New York City. Its mission is to support state insurance departments and other NAIC staff on matters affecting the regulation of investment activities at state regulated insurance companies.

The Capital Markets Bureau monitors developments and trends in the financial markets generally, and specifically with respect to the insurance industry.

  1. Issues that are of interest to state insurance regulators are reported periodically through regularly scheduled publications and through ad hoc reports.
  2. State insurance regulators can request independent research on investment issues.
  3. The group assists in examinations, through analysis of investment portfolios, discussions with examiners and, as requested, participates in on-site examinations.
  4. The staff provides training, education and analysis support through on-site seminars and webinars. This is coordinated through the NAIC's Education and Training Department.

The Capital Markets Bureau supports Financial Regulatory Services and Insurance Analysis & Information Services, to identify potentially troubled insurers and market trends that may have a material impact on the investment profile of the insurance industry. The group works collaboratively with Government Relations staff developing comment letters, briefings and related materials; serving as a technical resource to Congressional/federal/state officials regarding NAIC policy positions on financial regulation and capital markets. The staff also participates in international discussions on issues of macro-prudential surveillance.

The Capital Markets Bureau takes an active role with respect to issues concerning the Valuation of Securities Task Force and the Capital Adequacy Task Force, along with their respective working groups including the Invested Assets Working Group and the Investment Risk-Based Capital Working Group. In addition, the group supports the Statutory Accounting Principles Working Group, the Emerging Accounting Issues Working Group, as well as the work of other NAIC committees and subgroups impacted by investment issues.

The Capital Markets Daily Newsletter & Special Reports:

Capital Markets Special Reports available to regulators and the public, these reports focus on detailed and specific analysis of issues that have the potential of impacting insurance company investment portfolios.

The Capital Markets Daily Newsletter is a REGULATOR ONLY email distributed at the conclusion of each day. It provides brief summaries of financial market performance and the developments that impacted it. It is occasionally supplemented with additional summaries that aggregate significant items affecting insurers and regulators. Regulators receiving this newsletter will also receive the Capital Markets Special Reports.

Capital Markets Conference Calls for REGULATORS ONLY are held on a quarterly basis, or as needed. This provides an open forum for discussion of recent research or topical issues of the day.  Registered participants receive Continuing Education credits.

Investment Portal is another REGULATOR ONLY tool provided by the NAIC.  The secure website is available to state insurance regulators that request access.  The Capital Markets Bureau maintains the website with current market information and reports from various sources.

Investment Analysis: As requested by state insurance regulators, the Capital Markets Bureau provides a number of services – (1) Preliminary Investment Analysis and detailed Investment Analysis Reports; (2) Detailed Asset Reviews; (3) Derivatives Use Plan Reviews; and (4) On-Site Examination Support. Any state insurance department that is interested in such support should contact the Capital Markets Bureau by sending an email to Edward Toy at









Capital Markets Bureau
One New York Plaza
Suite 4210
New York, NY 10004
Phone: 212.398.9000
Fax: 212.382.4204