A life insurer can face liquidity risk if it needs more cash or readily saleable assets than expected to meet near-term obligations. That possibility does not mean a policyholder should assume a payment problem based on a market headline, a management change, or one financial ratio. To prepare this guide, our editorial team reviewed the Bank of Canada’s analysis of life-insurer liquidity, OSFI’s explanation of the Life Insurance Capital Adequacy Test, OSFI’s guide to intervention for federally regulated life insurers, and Assuris’ policyholder-protection levels.
Can My Life Insurer Face Liquidity Risks?
Yes. The distinction between liquidity and solvency is important. The Bank of Canada lists two main liquidity risks for Canadian life insurers: 1) unexpected cash requirements due to policyholder behaviour, and 2) margin calls on derivative positions.
Insurers address liquidity risks through asset-liability management, credit facilities, liquidity buffers of cash and liquid assets, stress testing, and other risk management practices to cope with unexpected cash requirements.
Liquidity refers to the ability to meet cash requirements as they become due, while solvency refers to having enough assets or capital to meet liabilities. Although related, solvency is not a substitute for liquidity. Even with lots of assets, you still need a plan to handle unexpected cash needs.
Why Liquidity Matters for Life Insurers
Life insurers invest customer premiums and must make policy payouts for decades. Assets can be invested accordingly; for example, liabilities have a long duration, so it makes sense to invest in longer-dated bonds.
However, insurers still need cash at various points, such as to pay out on deaths, make annuity payments, pay out on surrenders and loans, cover running costs, and pay collateral on derivatives, although the precise timing and amounts cannot be known for certain.
Managing liquidity risk is not simply about total asset value, as the timing and amounts of cash flows are also very important.
How Market Stress Can Create Liquidity Pressure
Stress can lead to changes in asset values, lapse or surrender behaviour, and margin calls occurring simultaneously.
Market volatility does not necessarily indicate payment stress for life insurers. Bank of Canada research on four large Canadian life insurers during certain stress periods found that lapses and surrenders remained within normal historical ranges during the COVID-19 crisis. Margin calls did not deter the three largest insurers in the data from buying bonds during the first half of 2022. However, these results do not necessarily generalize to all life insurers or all periods of market stress.
Read More: Read How Canadian Life Insurers Operate Globally
Tools Insurers Use to Manage Liquidity
- Match the expected timing of asset cash flows with policy and other obligations.
- Hold cash, government securities and other assets that can be sold or pledged in stress.
- Test surrender, mortality, interest-rate, currency and collateral shocks over more than one time horizon.
- Maintain committed funding sources and operating plans for a disruption.
The Bank of Canada reports that insurers in its interviews used internal liquidity coverage ratios. Unlike banks, life insurers do not follow one standardized regulatory liquidity coverage ratio, so ratios disclosed by different companies may use different definitions.