Turning to life insurance, a potential concern is that the shift towards direct investments might in future lead to a concentration of exposure to UK property. Excluding unit-linked business, UK insurers’ property-related 9  exposures grew significantly over the course of 2016 to stand at 11% of non-linked assets. The most rapid growth has been in mortgages and loans secured on property, particularly equity release mortgages. Our analysis of insurers’ equity release exposures suggests that a stress roughly aligned to the FPC’s banking system stress test (a 30% fall in house prices and 0-0.5% growth per annum thereafter) could lead to industry-wide losses of £ billion (see table and chart below). 10  The Prudent Person Principle in Solvency II is an important safeguard against concentration risk . It requires insurers to invest only in assets whose risks they can “properly identify, measure, monitor, manage, control and report”. Moreover, assets must be “properly diversified” so as “to avoid excessive reliance on any particular asset, issuer or group of undertakings or geographical area and excessive accumulation of risk in the portfolio as a whole”. Assets not admitted to trading on a regulated financial market are required to be kept to “prudent” levels. The illiquid direct investments I described earlier would typically fall into this category. Later this year, we plan to set out in a supervisory statement our expectations of how UK insurers should invest their assets in accordance with the Prudent Person Principle.
First, such a facility should enable the Federal Reserve to improve its control over the level of money market rates. By offering a new, essentially risk-free investment, one would expect that anyone with access to such a facility would generally be unwilling to lend instead to someone else at a rate below that posted for the facility. This should help to establish a floor on the level of overnight rates. Right now, most short-term rates trade between 0 and 25 basis points, but occasionally T-bill and repo rates go negative, for example at quarter-end or when financial stresses increase the demand for very safe assets. The full allotment element of the reverse repo facility would increase the availability of a risk-free asset, satisfying the demand when the appetite for safe assets increases. This should help tighten the relationship between these and other money market rates. These reverse repos would be available to an expanded set of counterparties that includes many of the money market lenders who are ineligible to earn the interest on excess reserves (IOER), such as GSEs and a number of money market funds. Depending on the facility rate, these lenders who cannot earn the IOER rate might get a better rate by investing in the overnight RRPs compared to lending to banks or to broker dealers. This competitive effect could, in and of itself, put a stronger floor on money market rates. Second, this new facility is also likely to reduce the volatility of short-term interest rates.