When buying life insurance in Canada, many policyholders focus on premium costs, coverage amounts, and the insurer’s reputation. An often-overlooked factor is a life insurance company’s liquidity – its ability to meet cash demands on time. Liquidity matters because an insurer needs to pay claims promptly when policyholders face unexpected life events. Liquidity risk is when a financial institution, such as a life insurer, cannot meet short-term obligations without incurring unacceptable losses.
How do life insurance companies manage liquidity? How can you tell if an insurer is having liquidity problems? Read on to learn why liquidity is important when choosing a life insurance provider and what red flags to look out for before taking out a life insurance policy.
Why Liquidity Matters for Life Insurers
Liquidity is essential for any financial institution, but especially for insurance companies whose entire business model revolves around long-term promises made to policyholders. When a policyholder passes away or decides to surrender a policy, insurers must have enough liquid assets to cover that claim. Insurers also need enough cash to pay wages, fund policy loans, and handle administrative expenses. Insurers might struggle to fulfill these obligations promptly without sufficient liquidity, leading to reputational damage and, in extreme cases, insolvency.
Life insurers typically hold substantial assets in bonds and other long-term investments designed to provide stable returns. However, if many policyholders file claims or surrender policies simultaneously, insurers may have to liquidate investments faster than anticipated. In those cases, forced liquidation can cause insurers to realize losses on their investments, weakening their financial positioning or causing payout delays.
As a policyholder, you want the reassurance that if your family ever needs a payout, there’s no question about the availability of your insurer’s funds.
Key Sources of Liquidity Risk for Life Insurance Companies
Canadian life insurers face liquidity risk from multiple angles, including:
What Happens During Market Turbulence?
Market turbulence can act as a stress test for an insurer’s liquidity. Asset prices often become more volatile during a financial crisis or a period of economic instability. Even high-quality, long-term investments can lose significant market value if sentiment turns sour. When this happens, insurers can face pressure from two fronts: policyholders surrendering their policies or taking loans out on the cash value, and a drop in the resale value of the insurer’s assets.
In extreme cases, prolonged market turmoil can erode an insurer’s capital base. Canadian regulatory capital requirements expect life insurers to hold sufficient reserves to weather market fluctuations, but no system is foolproof.
If the company has to sell investments during a market downturn, it could face significant losses that deplete liquidity. An example of this is the 2008 global financial crisis. While Canadian insurers generally fared better than many international peers, the crisis highlighted how quickly liquidity pressures could materialize if risk management measures were inadequate.
Tools Insurers Use to Manage Liquidity
Liquidity is a primary concern for Canadian life insurers, so they employ various strategies and tools to manage and maintain it. These can include:
Red Flags for Policyholders to Monitor
Your family may face unnecessary financial stress if your life insurer can’t pay out on a policy promptly due to liquidity issues. While life insurers in Canada are subject to stringent regulatory oversight, policyholders should watch for indicators of potential liquidity issues, including:
Key Advice from MyChoice
- Before buying a life insurance policy, consider the insurer’s financial ratings, the terms of its policies, and the level of customer service. Choosing a stable insurer can give you peace of mind that your claims will be paid promptly.
- Reputable insurers publish quarterly and annual reports, which you can usually find online. Reading and analyzing these financial statements can inform you about the company’s liquidity position and overall health.
- Look for credit rating downgrades, leadership changes, regulatory actions, or other legal issues to determine whether a life insurance provider is stable with little liquidity risk.