For a fixed income investor, which security is more safe- Banks or Insurance companies? This is a very complicated subject, but here are few thoughts. There are many factors that affect the credit worthiness of a security. One of the main purposes of Regulation of financial services company is to protect the consumer. I will limit my thoughts on just regulation, affecting fixed income investors and just on capital. Both Insurance companies and Banks are heavily regulated. In United States, Insurance companies are regulated by state regulatory bodies. National Association of Insurance Commissioners (NAIC) has laid down strict guidelines on types of assets that Insurance companies can buy and how capital is to be held by insurance companies against various risks taken by them for assets held in their portfolio and types of insurance policies sold by them. In Europe and everywhere else Insurance companies have laid down guidelines under a regime called Solvency I. There is an updated version Solvency II, which is more stringent in capital requirements as compared to Solvency I.
Banks are regulated by various Regulatory bodies, like FDIC, OCC, Federal Reserve (FED) and others. Some of these regulatory bodies overlap duties in their supervision. Banks have to maintain capital standards as per BASEL guidelines and there are updated versions called Basel II and Basel III. Each version of Basel is more stringent in capital requirements as compared to previous version.
The capital calculation requirements are very complex and often run into hundreds of pages. Higher capital requirements could give extra comfort to investors that their fixed income is safe as institutions have adequate cushion to meet unexpected losses. It could also mean that institution is taking more risk, and therefore needs to have more capital.
FED provides a liquidity option called discount window to the banks. Banks can always go the FED and get cash if they need liquidity by pledging the approved investments with the FED. Insurance companies don't have this liquidity window. They have to go to Banks and tap from their pre-approved credit lines with the banks to withdraw cash in times of crises. Therefore in terms of liquidity availability Banks have much more option than Insurance companies.
Bank deposits up to $250,000 are insured by gold plated guarantee of FDIC. Therefore depositing in the banks up to this 250,000 is as if depositing the money with US government. Insurance companies do have state guarantees up to $100,000, but FDIC guarantees trumps other Guarantees. However these guarantees are not available to Fixed Income investor who invests in these companies Holding companies debt.
So if there are many regulatory guidelines and strict capital guidelines, then all the institutions should be safe from the fixed investor point of view.
Now in the past few years, which banks and insurance companies have failed. Some of the prominent names are Washington Mutual (WAMU), Indy Mac, Wachovia was taken over by Wells Fargo (NYSE:WFC) for partly sum, Countrywide was bailed out by Bank of America BAC, which is regretting that acquisition and they are hundreds of banks which were taken over by FDIC. Amongst the insurance companies', top names that comes to mind is AIG. Federal Government had to come up with ways of lending money to AIG. There were other insurance companies like PMI (PMI Mortgage Insurance co), Land America, Triad Insurance, which were taken over by their regulatory bodies.
So if all these institutions which had strict investment guidelines and capital requirements either from State or Federal Reserve, the question that one is forced to ask is why did they fail? The answer to these questions are quite complex. One thing which is common to all these insurance companies and banks is they had a very significant exposure to US housing market as compared to rest of the competitor institutions.
MetLife is or we should say was both a bank and an Insurance company. This is a classic company which is regulated by both the Banking regulators and Insurance Regulators. Even though Banks have the advantage of having a discount facility with the Federal Reserve, MetLife decided that it is better off being an Insurance company than bank. Met life had access to cheap deposits by having a banking subsidiary.
For the same investments MetLife calculated that by being a bank and by being in the top 19 banks, it was subject to Stress test from FED and it had to hold more capital. This clearly shows that Capital Requirements are significantly stringent in being a banking company as compared to being just Insurance Company. MetLife has stated that the additional capital requirement of being a bank makes it difficult to offer the products at a cheaper price as competition which does not have to hold higher capital.
MetLife is one prominent example that gives a clear comparison that for same investment risk held by a financial institution, banking regulators requires holding more capital than Insurance regulators. This should give more comfort to Fixed Investor, all things being equal, Banking companies have more capital buffer and likely to be safer as compared to Insurance companies.