Bank Management of Insurance Industry Risk: Part 1
Devine, Paul, The RMA Journal
This two-part article looks at the management of risk exposure to insurers through the bank's roles as lender and policyholder. The author then sketches out the broader landscape of bank exposure to insurers. An agent bank generally arranges and syndicates each large insurance-industry credit facility, but community and regional banks often participate as well for relationship or diversification reasons. Any institution may benefit from taking on this tough-to-understand but actually pretty-safe secondary-market exposure.
All banks have risk exposure to insurance companies, and the total amount at risk can easily equal a bank's capital. All risk to insurers should be identified, quantified, and managed, both for safety and soundness considerations and as part of enterprise risk management. While banks can readily identify credit exposure to insurers and manage it much like credit exposure in other industries, there are a number of complexities within the analytical and regulatory aspects of the insurance industry. Banks also can readily identify policyholder risk, but its management involves a different set of analytical and regulatory factors. Indeed, the complexity of these factors can lead banks to turn to outside consultants for tools and assistance in prudently addressing policyholder risk.
Other types of insurance-industry credit exposure also can be difficult to identify, quantify, and manage. "Soft" and indirect exposure inevitably arises as the bank provides account and transaction services to insurers, in the course of capital markets transactions, and in a range of other ways. While such soft and indirect exposure poses less risk than credit exposure, the aggregate dollar amounts can be surprisingly large. The breadth and complexity of any bank's relationship to the insurance industry--plus the large dollar amounts involved--mandate that a bank have officers with specialized industry knowledge and responsibility for broad management of insurance-industry exposure.
Credit exposure is probably the first insurance-industry risk that springs to the mind of a commercial banker. Making loans or credit commitments to insurance companies, or issuing letters of credit on behalf of insurers, clearly involves risk, since there is actually money out the door or a contract to lend in circumstances limited only by defined events of default. That risk, however, is in a certain sense easily managed. Credit exposure to insurers can be readily identified and quantified, since every bank has internal policies governing the establishment of credit facilities and the periodic review of credit relationships. The fact that commercial banks are regulated, moreover, leads to a degree of homogenization of banks' lending policies and exposure reporting systems--each bank's individual arrangements must conform to the expectations of its regulators, who iteratively establish a broad set of criteria that define safe and sound lending practices. While credit exposure to insurers involves certain accounting, analytical, and regulatory complexities discussed below, lending to insurers is otherwise similar to lending to other large businesses.
Further, the banking industry's credit exposure to insurance companies is highly concentrated. Large insurance companies need large credit facilities for a number of reasons, such as the following:
* Potential liquidity.
* To back-stop their commercial-paper programs.
* To acquire or otherwise expand.
* To fund portfolio-management transaction timing mismatches.
* To meet various needs for letters of credit.
Generally, those credit facilities are arranged and syndicated by a relatively small number of money-center banks. The agent bank syndicates an insurance transaction among the other money-center banks; large regional banks with treasury management, asset management, or other noncredit product sets used by insurers; and the U. …