Mortgage Backed Securities and Capital of Life Insurers: Was the Industry Prepared for the Credit Crunch of 2007-2008?
The Geneva Papers on Risk and Insurance Issues and Practice, Special Competition Edition, July 2008
26 Pages Posted: 12 Aug 2008
Date Written: July 16, 2008
Abstract
In this article we explore U.S. life insurers' exposure to Mortgage-Backed Securities (MBS) and its potential impact on capital should the credit ratings of these bonds be lowered. We analyze two years: 2003 (well before the realization of problems with these instruments) and 2006 (immediately prior). We create five potential scenarios of different severity for recategorizing MBS credit ratings and compute the theoretical impact on measured insurer asset risk, via a proxy for the C-1 component of life insurers' risk-based capital. Under all scenarios we find large increases in assessed asset risk. We then model insurer capital structure as a function of asset risk and other factors to assess whether insurers had prepared their capital structures for the possibility of problems with these instruments. Our findings indicate not only that insurers were unprepared for MBS downgrades, but also that they reduced capital as they accumulated MBS, as though acquiring MBS should raise the overall quality of the investment portfolio. Finally, we analyze possible adjustments to capital to accommodate the now recognized increased risks of MBS. Our models suggest, for example, that an insurer with median MBS exposure might be expected to increase its capital by 10% or more to maintain an historical relationship between capital and risk factors, in the event of a moderate recategorization of MBS risk
Keywords: credit crunch, mortgage backed securities, life insurers, risk based capital, capital structure
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
The Relations Among Asset Risk, Product Risk, and Capital in the Life Insurance Industry
By Etti G. Baranoff and Thomas W. Sager
-
The Obsolescence of Capital Controls? - Economic Management in an Age of Global Markets
By Louis W. Pauly and John Goodman
-
By Louis W. Pauly and Simon Reich
-
Financing Risk Transfer under Governance Problems: Mutual versus Stock Insurers
By Christian Laux and Alexander Muermann
-
Intangible Assets, Going-for-Broke and Asset Risk Taking of Property and Liability Insurance Firms
By Tong Yu, Bing-xuan Lin, ...
-
Financial Systems and Industrial Policy in Germany and Great Britain: The Limits of Convergence
-
By Sigrid Quack and Christel Lane
-
Variable Annuities with Guaranteed Living Benefits: A Capital Structure Impact for Life Insurers?
By Etti G. Baranoff, Thomas W. Sager, ...