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Understanding the relationship between life insurers and theFederal Home Loan Banksby Anna Paulson, vice president and director of nancial research, Richard J. Rosen, senior nancial economist and researchadvisor, Kyal Berends, associate economist, and Robert McMenamin, team leader, Insurance Initiative

This article describes the growing relationship between life insurance companies andthe Federal Home Loan Banking (FHLB) system. Given the important role that bothplay in the U.S. financial system, it is important to understand how they are connected.

Chicag o Fed Letter

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK JANUARY 2014 OF CHICAGO NUMBER 318

The FHLB system

The Federal Home Loan Banks wereestablished in 1932 to support the hous-ing market by providing low-cost fundingto nancial institutions that make loansto homeowners. The FHLB system com-prises 12 regional banks and the Ofceof Finance. The banks are organized ascooperatives of mortgage lenders with-in a geographical region that can apply

for loans called advances from theirregional FHLB. FHLB advances aresecured by collateral, which can rangefrom mortgages to U.S. Treasury bonds.

To be eligible for FHLB membership,a company must be engaged in hous-ing nance, dened as purchasing ororiginating long-term home mortgageloans or holding mortgage-backed se-curities. Insurance companies play animportant role in housing nance andas of 2012, approximately 15% of theinsurance industrys assets supportedhousing nance. 1 Insurance companies(and banks) must apply for member-ship to the relevant regional FHLB, basedon their principal place of business.Belonging to an FHLB is attractive toinsurance companies because FHLBadvances are a low-cost, exible sourceof funding. Insurance companies mayuse advances to diversify their sourcesof funding, access liquidity in timesof nancial disruptions, or enhance

investment yields through more robustliquidity management. 2

A growing relationship

The percentage of all FHLB advancesthat were provided to insurance com-panies quadrupled between 2007 and2012, growing from 3% in 2007 to 12%and a total of $52 billion in 2012 (seegure 1). While these gures include

advances to both life and property ca-sualty companies, life insurers accountedfor more than 85% of FHLB advancesmade to insurance companies in 2012. 3 The total dollar value of advances to in-surers peaked during the nancial crisisin 2008 when other sources of liquiditybecame more difcult to nd; it has re-mained relatively constant since then. 4

For the FHLBs, the relative importanceof insurance companies as clients varies

widely across banks. While two-thirdsof FHLBs had less than 10% of total out-standing advances to insurance compa-nies at the end of 2012, the Des Moinesand Indianapolis banks both had over45% (see gure 2). This variation isinuenced by the geographical distri-bution of insurance companies, the in-dividual FHLBs appetite for extendingadvances to insurance companies, anddifferences in state law.

The use of FHLB advances by life insur-ance companies is fairly concentrated.

As of 2012, approximately15% of the insuranceindustrys assets supportedhousing finance.

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2. FHLB advances to insurance companies, by FHLB region

Insurance Total Percentage ofadvances advances total advances

($ billions) ($ billions)

Atlanta N/A 87.5 N/A

Boston 1.5 20.8 7

Chicago 1.0 14.5 7Cincinnati 3.0 53.9 6

Dallas 0.4 18.4 2

Des Moines 15.2 26.6 57

Indianapolis 8.4 18.1 47

New York 17.2 75.9 23

Pittsburgh N/A 40.5 N/A

San Francisco 0.0 43.8 0

Seattle 0.0 9.1 0

Topeka 3.4 16.6 20

Total 51.6 425.8 12

N OTES : Includes both life and property and casualty insurance companies. Insuranceadvances were not available for the Atlanta and Pittsburgh FHLB regions separately, butcombined they equaled $1.5 billion.S OURCE : 2012 Regional FHLB 10K filings.

1. FHLB advances to insurance companies

N OTE : Includes both life and property and casualty insurance companies.S OURCE : FHLB annual reports, available at www.fhlb-of.com/ofweb_userWeb/pageBuilder/fhlbank-financial-data-36.

par amount, $ billions percent outstanding

The top 15 life insurance borrowersaccounted for 90% of FHLB advances tothe industry in 2012. However, even forthese companies, FHLB advances are asmall share of total general-account lia-bilities. 5 Among the three large life in-surersAIG, Prudential, and MetLifethat were recently classied as globalsystemically important insurers (G-SIIs)by the Financial Stability Board, MetLifes

relationship related to the resolutionprocess for insolvent insurance compa-nies. When an insurance company be-comes nancially distressed and cannotmeet its obligations, a state insurancecommissioner takes control of the com-

panys operations and places it into re-ceivership. 9 If the company cannot berehabilitated, it is declared insolvent andthe commissioner liquidates the company.The commissioners primary responsi-bility is to convert the insurance com-panys assets to cash and to distributethis cash to policyholders and creditors,according to the priority of their claims.

There is some uncertainty surroundingthe FHLBs claim to collateral on out-standing advances made to insurance

companies in the case of an insurancecompany failure. In addition to potentiallegal uncertainty, insurance companyfailures happen very infrequently, so thelife insurance resolution process is an un-familiar and largely untested process formany FHLBs. While FHLBs have a longrelationship working with the FederalDeposit Insurance Corporation, whichhandles the division of assets for bankinsolvencies, they may not have the samefamiliarity with state insurance com-missioners. One concern for FHLBs isthat these factors could lead to a lengthysettlement process that might preventthe timely liquidation of the collateralbacking FHLB advances.

The case of Standard Life InsuranceCompany of Indiana provides a usefulexample of successful cooperation amongan FHLB, state insurance regulators, andan insurance company. Standard Life wasplaced into receivership in 2008. TheFHLB of Indianapolis worked closely withStandard Life and their rehabilitator toensure that Standard Lifes advances re-mained fully collateralized, while alsoallowing the struggling company exibilityin the type of collateral posted. Ultimately,the rehabilitation process was successful,Standard Life was able to avoid insolvency,and the FHLB of Indianapolis did notexperience any losses on its advances toStandard. 10 This experience led to the

The top 15 life insurance borrowers accounted for 90% of FHLBadvances to the industry in 2012.

use of FHLB advances across its life insur-ance subsidiaries is the largest at $15.6 bil-lion. 6 However, this accounts for just 5%of MetLifes total general-account liabil-ities. AIGs subsidiaries had $82 millionin outstanding advances (or 0.05% of

general-account liabilities) at the end of2012, and Prudential had outstandingadvances of $2.3 billion across its life in-surance subsidiaries (or 1.2% of general-account liabilities). 7 Of the top 15 FHLBlife insurance borrowers, only three hadFHLB advances that accounted for morethan 5% of their general-account lia-bilitiesGuggenheim Capital, CNO,and OneAmerica. Guggenheim Capi-tals life insurance subsidiaries had thelargest share, with advances equal to

14% of total general-account liabilitiesat the end of 2012. 8

Uncertainty during insolvencyproceedings

Insurance companies represent an impor-tant area of growth for FHLBs, but theFHLBs and their regulator, the FederalHousing Finance Authority (FHFA) haveraised some concerns about this growing

2006 2007 2008 2009 2010 2011 20120

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Insurance companyadvances(left-hand scale)

Insurance companies aspercentage of total advancesoutstanding (right-hand scale)

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Charles L. Evans, President; Daniel G. Sullivan, Executive Vice President and Director of Research ; Spencer Krane, Senior Vice President and EconomicAdvisor; David Marshall, Senior Vice President , nancialmarkets group; Daniel Aaronson, Vice President , microeconomic policy research ; Jonas D. M. Fisher, Vice President , macroeconomic policy research ; RichardHeckinger, Vice President , markets team ; Anna L.Paulson, Vice President , nance team ; William A. Testa,Vice President , regional programs , and Economics Editor ; Helen OD. Koshy and Han Y. Choi, Editors; Rita Molloy and Julia Baker, Production Editors ; Sheila A. Mangler, Editorial Assistant.

Chicago Fed Letter is published by the EconomicResearch Department of the Federal Reserve Bankof Chicago. The views expressed are the authorsand do not necessarily reect the views of the

Federal Reserve Bank of Chicago or the FederalReserve System.

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passage of laws in Indiana and Michigan(the two states in the district of the FHLBof Indianapolis) clarifying the FHLBsstatus as a secured creditor. 11

While Michigan and Indiana have takensteps to add clarity to the FHLBs rightsin insolvency proceedings, there is still

This number is an approximation calculatedfrom the insurance industrys aggregateholdings of agency mortgage-backed securi-ties (MBS), nonagency MBS, mortgageloans, and real estate. These categories maycontain a small number of nonresidentialloans. Data are from insurance companystatutory lings from SNL Financial.

See www.fhlbc.com/Members/Pages/federal-home-loan-bank-chicago-members-insurance-companies.aspx.

The percentage of FHLB insurance advancesmade to life insurance companies was cal-culated using total life insurance FHLBliabilities as of 2012 from SNL Financialand total advances made to the insuranceindustry as reported in the 2012 FHLBannual statement; see www.fhlb-of.com/ofweb_userWeb/resources/12yrend.pdf.

4 See www.naic.org/documents/committees_e_rfhlbl_sg_related_docs_fhlb_memo_130619.pdf.

5 Life insurers segregate their assets (and, byextension, their liabilities) into two indepen-dent accounts on their balance sheetsthe general account and the separateaccount. General-account assets supportliabilities that feature guaranteed returnsto customers from the insurer. In contrast,separate-account assets support pass-through products, in which investmentgains and losses are passed on to the cus-tomer and no more than a minimum return

may be guaranteed. Only $2.17 billion ofindustry FHLB liabilities (or 5% of totalFHLB life insurance liabilities) are inseparate accounts.

6 See www.nancialstabilityboard.org/publications/r_130718.pdf.

7 AIGs and Prudentials outstanding FHLBadvances were obtained from their 2012SEC lings because FHLB liabilities are notalways reported consistently by all insur-ance companies on their statutory lings.

8 Unless otherwise noted, all numbers inthis paragraph are based on authors cal-culations using statutory lings data fromSNL Financial.

9 Federal bankruptcy law specically ex-cludes insurance companies from bank-ruptcy proceedings.

10 See www.iair.org/assets/InsuranceReceiver/the%20insurance%20receiver-%20summer%202013.pdf.

See www.naic.org/documents/committees_e_rfhlbl_sg_related_docs_fhlb_memo_130619.pdf.

See www.fhlbi.com/about/documents/FedHomeLoanBankFundingFigures2013.pdf.

See www.fhlb-of.com/ofweb_userWeb/resources/lendingqanda.pdf.

14 See www.naic.org/documents/committees_e_rfhlbl_sg_related_summary_state_survey.pdf.

15See www.naic.org/documents/committees_e_rfhlbl_sg_related_fhlb_exec_summary.pdf.

is important and growing. While FHLBadvances are small relative to total general-account liabilities for most insurance com-panies, FHLB membership can providethem with an important source of liquidityin times of need. The share of FHLB ad-

vances going to insurance companies

quadrupled from 2007 to 2012, and many

Of the top 15 FHLB life insurance borrowers, only three hadFHLB advances that accounted for more than 5% of theirgeneral-account liabilities.

considerable uncertainty for other FHLBs. As a result of this uncertainty, FHLBs mayrequire insurance companies to providemore collateral for advances than theyrequire from banks. This practice varies by

FHLB region. FHLBs are also more likelyto take actual possession of collateral post-ed by insurers, and some FHLBs may placelimits on lending to the insurance indus-try.12 In contrast, when FHLBs lend tonancially strong banks, they typically donot take actual possession of the collateral.

For their part, insurers have raised the con-cern that an FHLB might require an in-surer to post additional collateral for anadvance if the insurance companys nan-cial performance deteriorates. 13 This

could potentially limit the exibility ofFHLB advances and make them moreexpensive at the very time they couldbe most useful. 14

Both insurers and the FHLB system couldpotentially benet from uniform and clearrules about FHLBs rights in insolvencyproceedings. The FHFA, which regulatesthe FHLBs, would like to clarify theirstatus as a secured creditor with a pro-tected rst priority security interest in thecollateral on their advances to insurers. 15 This would give FHLBs protection fromlegal delays that could prevent them fromaccessing collateral in a timely fashion inorder to recoup their losses. Legal claritymight also benet insurance companiesif it leads to more favorable collateralpractices in FHLB lending, similar tothe treatment banks currently receive.

Conclusion

The relationship between insurance com-panies and Federal Home Loan Banks

FHLBs have expressed a desire to expandtheir insurance company membership.These trends have led to an increasedfocus on reducing any uncertainty regard-ing the treatment of FHLB advances and

the collateral that backs them in the res-olution process for insolvent insurancecompanies. Given the signicant rolethat both life insurers and the FHLBsplay in the U.S. nancial system, and inhousing nance in particular, it is impor-tant to understand their relationship

with one another.