Press Release - JULY 24, 2018
Best’s Special Report: U.S. Insurers Increasing Use of Derivatives for Liability Risk Management
FOR IMMEDIATE RELEASE
OLDWICK - JULY 24, 2018
The Best’s Special Report, titled, “Growing Use of Derivatives for Liability Risk Management,” states that the notional value (i.e., the total value of options, forwards, futures and foreign exchange currencies) of insurance industry derivatives now tops $2.3 trillion, with roughly 95% held by life/annuity insurers. Swaps account for the largest notional value of insurers’ derivatives—48% in 2017, up marginally from 47% in 2013. Options constituted another 43% in 2017, down from 47% in 2013.
While notional values have increased 27% since 2013, total potential exposure has grown just 16%, to $50.2 billion in 2017 from $43.4 billion. Although swaps account for 48% of the notional value of total derivatives, they account for nearly 90% of potential exposure, while futures account for nearly 9% of potential exposure, compared with just 5% of notional value.
Approximately 13% of life/annuity organizations use derivatives, while less than 2% of the property/casualty and health segments each use them in one form or another. The top 10 users of derivatives account for 66% of total industry notional value, and more than 85% of the industry’s total potential exposure.
Just 17% of rating units have potential exposures exceeding 10% of their capital and surplus, including 10% with exposures greater than 20% of capital and surplus. The report notes that the capital and surplus cushion is important, given that derivative performance tends to fluctuate widely from year to year, and the industry has experienced unrealized losses in four of the last five years.
In terms of notional value, insurers for the most part have been expanding their use of derivatives for all types of risk, with interest rate and equity/index risk being the two main types of risk subject to hedging. However, insurers’ greatest potential exposure is to credit risk, followed by interest rate risk. The main difference between notional value and potential exposure is in the calculation used for potential exposure. The potential exposure for credit risk is 81% of the notional value, whereas every other type of risk is less than 2%. This is driven heavily by credit default swaps, which according to the report is why swaps have the vast majority of exposure while accounting for less than half of total notional value. Credit default swaps account for only 3% of the notional value of all swaps, but nearly 65% based on potential exposure, in contrast to interest-rate swaps. Swaps tend to be insurers’ choice to manage interest rate, credit, duration and currency risks, while options are preferred to manage equity/index risk.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=276044 .
A.M. Best is the world’s oldest and most authoritative insurance rating and information source.