A Dodd-Frank provision regulating derivatives could improve insurers’ risk management and have a minor impact on ratings, according to analysts at Standard & Poor’s.
In response to the financial crisis of 2008, Congress passed the Dodd-Frank Act, officially known as the Wall Street Reform and Consumer Protection Act of 2010. Among the law’s provisions is Title VII, also known as “Wall Street Transparency and Accountability,” which aims to boost transparency in the pricing of derivative transactions —specifically swaps, which insurers and others financial institutions commonly use. Swaps within the scope of this regulation are defined in section 1a of the Commodity Exchange Act and include, but are not limited to, interest rate swaps, credit default swaps, and total return swaps.
According to S&P, insurers employ derivatives primarily to hedge against specific risks in their investment or liability portfolios. Derivatives used to generate income are generally a very small proportion of insurers’ total investment holdings.
In its report, “The Dodd-Frank Act: Title VII Swap-Clearing Requirements Could Lower U.S. Insurers’ Counterparty Exposures,” Standard & Poor’s Ratings Services says that it believes Title VII could improve insurers risk management processes. It also says Title VII could have an impact, albeit it a minor one, on its ratings on the insurance industry.
“We don’t expect these new regulations to have much of an immediate effect on our ratings on insurers, and any rating implications will affect life insurers more than non-life companies,” said S&P credit analyst Maftuna Azizova. “The implementation of these requirements may also affect our views on insurers’ liquidity and financial flexibility.”
The transition from over-the-counter hedging to clearinghouses will potentially enhance the transparency and liquidity of the derivative market in general, the report says. From a credit risk perspective, S&P said it sees this as improvement to an organization’s risk mitigation within its enterprise risk management framework.
“Since derivatives primarily hedge against specific risks within insurers’ investment or liability profiles, and derivatives used to generate income are generally a very small proportion of their total holdings,” Azizova said, “we don’t anticipate the use of such instruments will have a significant impact on our ratings on insurance companies.”