Every year, millions of Americans send their hard-earned money to life insurance companies, in return for a promise that it will grow and provide them with regular income in old age. These fixed annuities make up a large part of the nation’s retirement savings — at last count, more than $3 trillion.
They could also become a nexus of the next financial crisis, if regulators don’t act to mitigate mounting risks.
The annuity business should be simple and boring. Invest in high-quality assets that will mature when the time comes to pay policy holders; take a small cut of the returns for your efforts. Thanks to penalties for early withdrawal, insurers shouldn’t have to worry about customers suddenly demanding their money back, as sometimes happens to banks. As long as the company’s owners provide enough equity to cover the occasional bad investment, everyone should be fine.
In recent years, though, insurers have made things more complicated. In pursuit of cheaper funding, they’ve turned to shorter-term borrowing — via wholesale credit markets and Federal Home Loan Banks. They’ve juiced returns in part by investing in collateralized loan obligations, which contain loans to highly indebted businesses. And they’ve channeled billions of dollars through affiliated reinsurers in Bermuda, where tax and other rules are less burdensome.
The transformation has coincided with a big shift in the industry’s ownership. Private investment firms have taken stakes in companies accounting for more than a tenth of all US life and annuity assets. In some cases they might be adding value, by identifying higher-yielding yet hard-to-sell assets — such as corporate vehicle fleets — that serve annuity holders’ interests. But research suggests they’re boosting returns primarily by increasing risks, and by circumventing taxes and capital requirements. Much of the industry — comprising about $2 trillion in annuity liabilities, including transferred corporate pension plans — has adopted similar strategies.