Sources of Liquidity and Capital—
Key Differences Pre- and Post-Crisis
Management
Strategy
Surplus notes
Letters of credit
Pre-Crisis
Available
Available
During Crisis
unavailable
unavailable
Debt issuance Available
Commercial paper Available
Securitization Available
Asset sales Available
Liability fire sale Available
Parental guarantees N/A
Divestiture Available
Reinsurance Available
unavailable
unavailable
unavailable
Limited
Available
N/A
unavailable
unavailable
Post-Crisis
under attack
Relatively
expensive
Available
Returning
Limited
Available
Available
Emerging option
Limited
Returning for
some lines
for insurance companies seeking to
raise cash.
■ ■ securitization deals have reemerged in the past year, with several
companies entering this market.
■ ■ Asset sales have returned as a viable
option for adding liquidity to the balance sheet.
■ ■ Liability fire sales generally are
available to highly rated companies
willing to write business with a lower
expected return on capital.
■ ■ Parental guarantees are emerging
as a capital management tool. Some
states, such as Iowa and Indiana, are
beginning to allow companies to use
them to back redundant reserves.
Federal rules have been enacted to
ensure that reinsurance treaties recognized in a state of domicile also are
recognized on similar terms by other
states.
■ ■ divestitures are once again a viable
strategy as the mergers and acquisi-
tions market has begun to show some
life. Companies need to carefully
consider which blocks to sell as offer
prices for some business lines remain
depressed.
Tracking Liquidity Costs
Insurers setting up a robust liquidity
management program may need to rethink their management accounting and
incentive compensation structures to
reflect more accurately the costs associated with liquidity needs. It’s fortunate
that commercial banks have developed
liquidity transfer pricing structures that
can be adapted for use by insurance organizations. This technique is similar to
ALM transfer pricing techniques that
some insurers have used in the past.
The basic premise is simple: Business
units are charged (or compensated) for
investing in an asset portfolio for which
cash flows do not match those of the
liability they support. In an upward-
sloping interest-rate environment, a
business unit with a 10-year asset portfo-
lio backing a five-year liability would be
assessed an internal charge on its asset
yield. The amount of the charge would
be set so that the asset yield, net of the
charge, would be equal to the yield the
business unit could earn on a five-year
asset portfolio of similar credit qual-
ity. Senior management would decide
if business units would be charged only
for the spread between the risk-free
rates at the five- and 10-year maturities
or if an adjustment for the additional
credit spread also should be applied. A
business unit that is a net provider of
liquidity similarly would receive com-
pensation from the corporate line for
this service.
