• David H. Kinder, ChFC

Myth #13: Insurance Companies Engage in Fractional Reserve Lending

Updated: Dec 28, 2019

Today, I got into a strange conversation with someone who *claimed* to teach life insurance in Canada for 10+ years. I say *claimed* because he couldn't make any sense to me.

One of his assertions was that life insurance companies engage in "fractional reserve lending" in order to afford all those buildings with their names on them, just like banks do, and that's why "cash value policies are ripping people off".

I had never heard this, but I do know a few things. Every life insurance company has a regulated legal reserve fund called a general investment account. These general investment accounts are strictly regulated as to how they work and what these companies are allowed to invest in.

Let's reference the ACLI - American Council of Life Insurers for some additional information:


Assets and Investments

Assets held by life insurers back the companies' life, annuity, and health liabilities. Accumulating these assets, via the collection of premiums from policyholders and earnings on investments, provides the U.S. economy with an important source of investment capital.

At the end of 2017, life insurers had $6.5 trillion invested in the U.S. economy - 90 percent of industry assets.

Life insurers' represent one of the largest investors in U.S. capital markets:

  • Life insurers are a major source of bond financing for American business, holding more than 21% of all U.S. corporate bonds.

  • Life insurers invest in American business for the long-term. More than 39% of general account bonds held by life insurers had a maturity of more than 20 years at the time of purchase. At the time of purchase, 72% had a maturity of more than 10 years.

  • Life insurers provide long-term capital to the commercial mortgage market, financing more than $471 billion, or more than one-sixth, of U.S. commercial mortgages.

So that's what's generally in every insurance company's portfolio. Now, let's look at the same reporting entity with their assets and liabilities:

ACLI 2019 Life Insurers Fact Book: Chapter 2 - Assets

I'm going to skip down to page 5 for aggregate totals as of 2018 (originally posted in millions, I'll write out the full number):

  • General Account: $4,500,294,000,000 (that's trillions)

  • Separate Account: $2,492,500,000,000 (again in trillions)

  • Total: $6,992,794,000,000 (nearly $7 trillion in assets)

ACLI 2019 Life Insurers Fact Book: Chapter 3 - Liabilities

Again, let's skip down to page 2 for 2018 combined liabilities and surplus funds:


Surplus and capital amounted to $419 billion for U.S. life insurers at the end of 2018 (Table 3.1). Surplus funds provide extra reserve safeguards for such contingencies as:

  • an unexpected rise in death rates among policyholders,

  • unusual changes in the value of securities,

  • and general protection for policy obligations.

Several factors influence the amount of surplus that a life insurer retains, including:

  • company size,

  • kinds of insurance written,

  • mortality experience,

  • general business conditions,

  • and government regulation.

Capital refers to the total par value of shares of the companies’ capital stock.

You cannot have a $400 billion surplus if you're engaged in fractional reserve lending!!! It cannot be done! Liabilities would FAR exceed assets if engaged in fractional lending!

The reason this kind of stuff comes up, is because people are (rightfully) concerned how safe their money is. After all, life insurance and annuities aren't "FDIC Insured". That's true - they're not. It's better. It's life insurance! So, how safe ARE life insurance companies? Per this reference PDF document:

Under the legal reserve system, a life insurance company must have a policy reserve fund into which a large percentage of each premium dollar goes. This fund is the method by which a legal reserve life insurance company determines the assets it must maintain in order to meet its future commitments under the life insurance policies it has issued.

The policy reserve fund is considered a liability to the company, not an asset of the company. In maintaining its reserve fund liabilities, a life insurance company then has the funds to pay the future living and death benefits guaranteed by life insurance and annuity contracts when they come due.

Legal reserve life insurance companies are regulated at the state level, with the state Departments of Insurance monitoring the financial well-being of the insurance companies headquartered in their state. Life insurance companies must comply with the legal reserve requirements established by the state in which they are headquartered and must submit annual financial statements to the insurance departments of each state in which they do business, as well as undergo periodic examinations. If an insurance company becomes "at risk," it does not simply go out of business, declaring the policies it has issued null and void. Instead, the insurance department steps in to save the company from going bankrupt and oversees the company's liquidation if it cannot be saved.

I hope this helps to show how insurance companies manage their general investment account and how they have the capital for planned amount of claims each year. David H. Kinder | Lifetime Tax & Wealth Educator

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