Market Overview

Best's Special Report: U.S. Insurers Increasing Use of Derivatives for Liability Risk Management

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U.S. insurance companies are increasing their usage of derivatives in
hedging and portfolio management to manage risks or to achieve
objectives for their asset-liability portfolios, according to a new A.M.
Best
report.

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. For more information, visit
www.ambest.com.

Copyright © 2018 by A.M. Best Rating Services, Inc. and/or its
affiliates. ALL RIGHTS RESERVED.

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