Insurers can use derivative contracts in order to mitigate risks stemming from both sides of the balance sheet, such as those relating to interest rates, foreign exchange, credit or inflation. Despite seeming to be an appealing choice for insurers, according to a recent report by the National Association of Insurance Commissioners (NAIC), only 5% of insurance companies in the United States are making use of derivatives.
Previously, research done in the United States prior to the crisis argues that this low proportion may be attributed to lack of familiarity with both regulations and accounting treatment of derivatives. Since the crisis, there has been a need for improved risk management strategies, in which derivatives can play a significant role; however this may be of greater significance to reinsurers than insurers.
Despite the small percentage of companies using derivatives in the US, it is not surprising that 94% of these derivatives are used for hedging purposes. The majority of the derivative instruments employed being swaps (49%) and options (45%).
Going forward it will be interesting to see what the impact of the SAM framework will have on insurers in South Africa with regard to their strategies involving derivatives and to what extent they are used within the local insurance industry.
Original NAIC statistics:
Research published in the Journal of Risk Finance on how US insurers use derivatives: