AM Best warned that underwriters of directors and officers insurance for startups and venture capitalists, as well as the financial institution insureds supporting them, narrowly avoided financial distress thanks to US Government intervention around the collapse of Silicon Valley Bank.
The potential for D&O claims for startups in particular would have been significant if the government had decided not to help depositors, analysts at the rating agency have suggested.
“Since startups are by nature much more agile and less risk-averse than other companies, their directors and officers often make decisions quickly,” said David Blades, Associate Director for Industry Research and Analytics at AM Best.
“Therefore, the potential for D&O claims for startups would have been high in the case government had decided not to help the depositors.”
SVB, which was the preferred bank for the technology sector, saw a rise in demand for its services throughout the pandemic, with many firms using the bank to hold cash for payroll and other business expenses. As the deposits grew, SVB invested a large portion, which is typical for banks.
As widely reported in the mainstream media, the issue began when SVB invested heavily in long-dated U.S. government bonds, including those backed by mortgages. While these bonds were perceived to be safe, the rapid rise in interests rates by the Federal Reserve to tackle inflation, saw the prices of these bonds fall, in turn leading to a significant drop in value of SVB’s bond portfolio.
The bank’s customers began drawing on their deposits and SVB didn’t have sufficient cash on hand, so it started selling some of the bonds at large losses, which in turn spooked investors and customers, ultimately leading to the collapse of the bank on March 10th, 2023.
But despite US insurance companies’ minimal exposure to bonds issued SVB, the rating agency argues that the failure highlights for insurers the importance of managing enterprise, asset-liability and liquidity risks.
Just eight US insurers have bond exposures greater than 2% of their capital and surplus, with the maximum being less than 5%, although whether these bonds will become impaired remains to be seen.
The ramifications for equity portfolios could be more significant, according AM Best, as some major bank stocks already have lost significant value. Five U.S. insurers have equity exposures concentrated in the broader bank and trust sector greater than their capital, and 17 have exposures totaling at least half their capital.
“Many insurers depend on banks for operational aspects, but generally are not as vulnerable to bank run-on scenarios, although they can occur as we’ve seen in the past and emphasize the importance of a robust risk management structure, especially for annuity writers in a rising interest rate environment,” said Jason Hopper, associate director, industry research and analytics, AM Best.
“Insurers that conduct detailed analysis on the impact of rising interest rates on their asset-liability portfolios and manage their impacts through capital and other risk management tools will fare better in those events than those that are less well-managed.”
AM Best asserts that the current crisis surrounding SVB can be traced back to a broad-based downturn in tech startups, as well as SVB’s focus on venture capital, which meant its business concentration risk resulted in a larger-than-expected deposit outflows.
“Only a very small percentage of startup venture capital firms survive to become fully mature companies—and they do so only after years of careful management and constant fine-tuning,” the rating agency concluded. “The issues that caused SVB’s downfall are not dissimilar to those that have dogged banks financing other, riskier financial propositions such as cryptocurrency-related companies, especially in light of the turmoil in the financial markets the past year.”