The US Financial Stability Oversight Council (FSOC) has raised concerns about the financial stability of life insurers, citing increasingly complex investment strategies and a growing reliance on offshore reinsurers with less stringent capital requirements.
In its 2024 annual report, FSOC warned that these trends could introduce new risks to the industry.
Established under the Dodd-Frank Wall Street Reform and Consumer Protection Act, FSOC includes federal and state regulators along with insurance industry experts.
According to the council, the life insurance sector has undergone significant structural changes since the global financial crisis, including greater use of alternative investment strategies, an evolving liability composition, and increased involvement of private equity firms and other asset managers.
Offshore reinsurance has been under heavy scrutiny as of late, with regulators across the world examining its effects on the insurance landscape.
In 2024, a report from Moody’s revealed that American insurance regulators are increasingly concerned about US life insurers’ reliance on offshore reinsurance, with the National Association of Insurance Commissioners (NAIC) flagging the issue as critical amid broader discussions about transparency and risk in the insurance industry.
Meanwhile, more recently, the Financial Services Agency of Japan (FSA) has also reportedly started a survey of life insurers to assess potential risks related to the increased use of reinsurance arrangements involving firms backed by global investment companies.
In its analysis, AM Best noted that variations in regulatory frameworks across jurisdictions, limited risk appetites in other financial sectors, and an extended period of low interest rates have influenced these changes. FSOC highlighted two primary concerns stemming from these developments.
One issue is the increasing presence of illiquid assets in life insurers’ portfolios. These include esoteric collateral and loans to smaller, highly leveraged borrowers, whose valuations rely on mark-to-model accounting rather than mark-to-market measures. This valuation method can introduce uncertainty, FSOC said.
Additionally, the growing use of nontraditional liabilities, such as borrowing from capital markets and Federal Home Loan Banks (FHLBs), could challenge insurers’ ability to manage cash flow during periods of financial stress.
The council noted that FHLB loans, for example, allow investors to withdraw funds with little notice, creating potential liquidity risks even for well-capitalized insurers if they do not hold sufficiently liquid investments.
AM Best has observed that insurers' reliance on nontraditional funding sources has grown alongside their use of offshore reinsurers. FSOC reported a significant increase in the use of offshore reinsurance, particularly among Bermuda-based reinsurers that are wholly owned by the same insurance group.
These offshore jurisdictions often have lighter regulatory oversight, more favorable tax policies, and different accounting standards compared to the US.
According to AM Best, more than 40% of ceded life annuity reserves from U.S. life insurers were transferred to offshore entities in 2023, marking a 26% increase since 2016. Approximately 40% of life annuity reserves were ceded to Bermuda that year, up from under one-third in 2021.
When considering only 2023 transactions, nearly 60% of reserves flowed through Bermuda, indicating significant growth within a single year.
While the practice has been criticized due to a re/insurance holding firm’s financial issues that bled to several major sports divestments, Bermuda’s premier, David Burt, has defended the strength of the island’s life and offshore reinsurance sector.
The premier said that while not all problems can be prevented, the focus should be on how issues are addressed.
FSOC noted that offshore reinsurers often operate with fewer reserve requirements than US-based counterparts. This could create regulatory arbitrage, in which insurers transfer reserves offshore to benefit from less stringent oversight, potentially weakening policyholder protections.
In response to these trends, federal and state regulators are evaluating a proposal that would require asset adequacy testing for offshore assets ceded in reinsurance transactions. The proposal also includes enhanced disclosure requirements to better track credit, counterparty, liquidity, and market risks associated with offshore reinsurance.
AM Best and FSOC both suggest that these regulatory efforts could help address concerns related to offshore reinsurance and its impact on financial stability. FSOC said that increased transparency and oversight may provide greater confidence in the expanded use of offshore reinsurance while helping mitigate potential risks in the life insurance sector.
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