Diversification just became a little more difficult for insurance companies thanks to a correction of an unintentional error on the part of the National Association of Insurance Commissioners (NAIC).
Even before the NAIC policy change went into effect a few weeks ago, prudent insurance company treasurers had already begun turning to money fund alternatives like structured bank products—where cash is liquid, federally insured at very high levels, and offers an attractive yield.
Recently, the NAIC announced that it would be removing U.S. government money market funds (MMFs) that invest in government agency paper (e.g. FHLB, FNMA, and Federal Farm Credit Banks) from its U.S. Direct Obligations/Full Faith and Credit Exempt List. Insurance company treasurers charged with investing their firms’ operating cash are typically limited to funds that appear on the NAIC list otherwise incur a risk-based capital charge, which can significantly impact net yields.
While the NAIC’s original intention was never to include funds with agency paper—which are not deemed to be full-faith-and-credit investments—as part of its exempt list, these funds enjoyed unabated acceptance for several years. Now, that changes.
The remedy started taking place on July 1, 2018, when certain U.S. government MMFs were removed from the exempt list, leaving mostly U.S. treasury money funds and potentially some government funds that have no exposure to agency paper. Insurance companies are still free to invest in government MMFs however they will be subject to a risk-based capital charge of 0.40 percent if they are a life insurance company and 0.30 percent if they are a property/casualty carrier.
This presents an interesting dilemma for insurance companies which now have even less choice when it comes to investing their operating cash. The July 1 change exacerbates a previous move by the NAIC two years ago when it eliminated Class 1 Status for prime money funds, decreasing the pool of investment vehicles on their exempt list. Government money funds have long been a staple for insurers that will now have to carefully refocus on their diversification needs and find alternate liquidity vehicles that ideally do not impose risk-based capital charges, such as treasury-only money funds, insured bank deposits and expanded FDIC-insured vehicles like CDARs or StoneCastle’s Federally Insured Cash Account (FICA)® .
The sky isn’t falling, but many insurance companies are clearly paying attention, and activity started to pick up as we got closer to July 1. The Securities Valuation Office (SVO) originally included approximately 40 money market mutual funds that they have acknowledged should not be on the list. While 40 funds seems like a large number, the SVO estimates that insurance companies in those funds represents approximately $6 billion.
The NAIC nobly functions with a focus on safety of investment, which supports the main objective of insurance treasury professionals. Broadly speaking, according to the 2017 AFP Liquidity Survey, 67 percent of organizations with a written cash investment policy rank their most important objective of cash to be safety; 30 percent said liquidity; 3 percent said yield. While safety will not be compromised, the shrinking universe of qualified cash vehicles from which insurance company treasurers can choose for their operating cash—i.e. Treasuries, Treasury MMFs, collateralized vehicles, bank deposits—has them boxed in a corner and facing potentially marginal or diminished returns going forward. While this can present an issue for some, the larger challenge is in properly diversifying across multiple vehicles as is a common mandate in many investment policies. Most treasury MMFs have significant overlap in underlying investments and while an insurance company may own shares in more than one treasury fund, the diversification utility is marginal.
As the NAIC amends to its original intention, a reinvigorated search for alternate suitable investments will continue. The AFP Liquidity Survey further demonstrates that the use of structured bank products, have grown in use to 43 percent of treasurers surveyed, compared to only 23 percent the year prior, providing treasury professionals with a full faith and credit option to meet the scrutiny of most investment policy mandates. While the NAIC inches toward removing or simply not renewing the funds, its SVO is recommending that they expand the list and keep the funds. Time will tell.
With only a few weeks since the July 1 policy went into effect, market experts are watching closely to see where insurance company treasurers will allocate operating cash dollars, and any affect it may have on U.S. government funds that may experience outflow activity. Insurance companies hold $61 billion in money market funds. The NAIC’s change could have a noticeable impact on where these organizations put their cash.