The evolution from life insurance to financial engineering

Area of Science:

• Finance
• Insurance Studies
• Risk Management

Background:

• Since the 1980s, US household net worth intermediation has shifted from defined benefit plans to life insurers and defined contribution plans.
• Life insurers' growth is driven by variable annuities, offering longevity insurance, tax advantages, and guaranteed minimum returns.
• These guarantees transform insurers' core function from traditional risk pooling to financial engineering.

Discussion:

• Variable annuity insurers face significant interest rate and equity risks due to potential mismatches.
• The COVID-19 crisis highlighted the vulnerability of these insurers, with notably low stock returns.
• This shift necessitates a re-evaluation of the insurance sector's role and risk exposure.

Key Insights:

• The evolution of financial products like variable annuities introduces complex financial engineering within the insurance sector.
• Guaranteed minimum returns in annuities create financial mismatches, exposing insurers to market volatility.
• The insurance industry's stability is increasingly linked to financial market performance and risk management.

Outlook:

• Enhanced financial disclosure requirements are crucial for monitoring risk mismatches in the insurance sector.
• Standardized stress testing can help assess and mitigate potential systemic risks within insurance companies.
• Regulatory adjustments are needed to ensure the stability and resilience of the insurance sector amidst evolving financial landscapes.