Silicon Valley Bank Collapse Highlights Critical Lessons For The Insurance Industry

U.S. insurers have relatively minimal exposures to SVB bonds

The failure of Silicon Valley Bank, along with the recent shutdown of Silvergate Bank by regulators, has impacted several banks. The ramifications for insurers’ equity portfolios could be more significant than for bond-holdings, as some major bank stocks have already lost significant value. Five US insurers have equity exposures concentrated in the bank and trusts sector greater than their capital, and 17 have exposures totaling at least half their capital (Exhibit 1).

With regard to longer-term holdings, US insurers have relatively minimal exposures to SVB bonds. Only eight companies have bond exposures greater than 2% of their capital & surplus—with the maximum still being less than 5% (Exhibit 2). Whether these bonds will have to be impaired remains to be seen.

SVB Financial Group appears to be a casualty of rising interest rates and of insufficient risk management to address the asset/liability issues because of those rising interest rates. The bank catered primarily to higher-risk tech startups, which have also been hurt by higher interest rates and dwindling venture capital. As interest rates rose the past year, financially strapped venture capital firms found it more difficult to access funding, and many pulled their deposits from the bank. The reported value of SVB’s bondholdings declined, and the bank reported a notable loss after selling approximately $20 billion of its fixed-income portfolio. According to published reports, SVB tried and failed to raise $2.3 billion through stock sales to cover a $1.8 billion loss on the fixed-income sale. As SVB sought to raise equity capital, its clients, which saw this as a move to raise money for losses and started withdrawing funds, caused a run on the bank. Given SVB’s inadequate liquidity and insolvency, the California Department of Financial Protection and Innovation took the bank over the bank on March 10, 2023. The US Federal Deposit Insurance Corporation (FDIC) will be the receiver.

Besides approving plans to backstop depositors and financial institutions associated with Silicon Valley Bank, regulators also took steps to quell the crisis by shutting down New York-based Signature bank, a big lender in the crypto industry, to which the insurance industry also has minimal direct exposure.

Life Insurers Not As Vulnerable To A Run On Banks

Many insurers depend on banks for lines of credit, distribution, hedges, and other operational aspects. However, life insurers are not as vulnerable to a run on banks, although Equitable Life in the United Kingdom in 2001, General American in 1999 and Executive Life in 1991, both in the US, demonstrate the possibility of runs on the bank on insurance companies, however remote, and underscore the importance of enterprise risk management (ERM) in general, and asset/liability management (ALM) and liquidity risk management in particular. Investment managers are navigating an interest rate environment that has not been seen in decades, and lessons from the past can help insulate them from future mistakes. Insurers that conduct robust analysis on the impact of rising interest rates on their asset/liability portfolios and manage their impacts through capital and other risk management tools will fare better than those that are less well managed. Insurers also need to properly account for unexpected liquidity needs due to the material increase in illiquid assets across the industry, although even liquid markets have the potential to seize up in times of financial turmoil.

Many life/annuity insurers have liabilities with less certain cash flows due to embedded market risks, which further demonstrates the importance of sound liquidity management. Companies that have not invested in or responded quickly enough to the need for a robust asset allocation framework will be more pressured than peers that have. As a consequence, they may offer less attractive products for new business growth and face ALM and liquidity challenges owing to greater disintermediation on in-force business (especially if many seasoned policies have no surrender charge protection or market value adjustments). Disintermediation can arise from several aspects of policyholder behavior, including an increase in surrenders, partial withdrawals, 1035 exchanges, as well as increases in policy loan utilization.

A ‘Tech Downturn’

The current crisis can be traced back to a broad-based downturn in tech startups, as well as SVB’s focus on venture capital. As a result its business concentration risk resulted in a larger-than expected deposit outflows. Only a very small percentage of startup venture capital firms survive to become fully mature companies—and they do so only after years of careful management and constant fine-tuning.

The issues that caused SVB’s downfall are not dissimilar to those that have dogged banks financing other, riskier financial propositions such as cryptocurrency-related companies, especially in light of the turmoil in the financial markets the past year. Insurance companies aren’t the only entities worried about the impact of these events on their investment portfolios.

Had the US government not stepped in to make all depositors whole, underwriters of directors’ and officers’ liability insurance for startups and venture capitalists, as well as the financial institution insureds supporting such entities, would face legal claims. The potential for D&O claims for startups would have been significant if the government had decided not to help depositors.

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