ICIR-SAFE Research and Policy Workshop
Systemic Risk in the Insurance Sector
Models, Measures and Reality
Systemic risk in the insurance industry is gaining strong attention as the systemic relevance of insurance companies causes controversial debates in the academic literature and policy sphere.
The ICIR-SAFE workshop has addressed the systemic risk topic by shedding light on the most relevant issues: What does systemic relevance in the insurance context mean? How can systemic relevance be adequately measured? Can primary insurers or reinsurers be systemically relevant? The idea of the workshop was to tackle these issues by triggering thought provoking discussions and by raising the awareness for the different perspectives of the stakeholders involved. To this end, the workshop has served as a platform to host a high-level discussion between international regulatory institutions, policy makers, industry and academics.
The first day of the workshop focused on the policy dimension of systemic risk in insurance, with strong interaction between regulatory and supervisory institutions and the industry. Institutions such as the International Monetary Fund (IMF), the International Association of Insurance Supervisors (IAIS), the European Insurance and Occupational Pensions Authority (EIOPA), the European Central Bank (ECB), the European Systemic Risk Board (ESRB), the German Federal Financial Supervisory Authority (BaFin) and the Deutsche Bundesbank contributed to the discussion. In addition, executives from leading insurance companies such as Allianz, AXA, and Munich Re, and from Insurance Europe and the German Insurance Association (GDV) gave an insight into the industry perspective. The second day of the workshop was devoted to a research meeting that discussed high-quality research findings on systemic risk topics.
Summary of the panel discussions
The first panel, “The Global Regulatory Perspective on Systemic Risk in the Insurance Industry”, focused on the question whether regulators are doing too much or too little regarding systemic risk in the insurance sector. It was argued that the generally high level of interconnectedness of the insurance business seems to makes systemic relevance possible. Measuring systemic risk only by means of an entity-based approach, i.e. to evaluate each insurance company's systemic relevance at its firm-level, and finally to generate a list of globally relevant institutions, does not sufficiently reflect the systemic risk potential in the insurance sector. In this context, the role of the “collective behavior”, i.e. the common exposures within the insurance industry due to joint actions of the firms, e.g. fire sales of assets, and their general destabilizing potential, was stressed. To improve the regulatory approach to systemic risk in the insurance sector, the suggestion was to supplement the current entity-based approach by an activity-based approach that would incorporate the effects of insurers' common business activities with regard to systemic risk. This approach might help to detect and reduce the insurance sector's potential for posing systemic risk.
Regarding the appropriateness of the current approach for determining global systemically important insurers, the IAIS' indicator-based model and its underlying different steps and phases were explained thoroughly. Although the approach is partially similar to the banking sector, it was stressed that it is still able to take the special characteristics of the insurance business model into account by means of several unique indicators only aligned to the insurance business. Therefore, the fundamental differences between the banking business model and the insurance business model, and through that the insurance sector's general importance for financial stability, have been emphasized.
Considering the insurance sector’s quantifiable contribution to systemic risk, the academic side reveals that the insurance sector contributes significantly to systemic risk, albeit at a generally lower level than banks. One of the main drivers for the sector's systemic importance can be found in increasing common exposures that are not related to just similar investment and liability portfolio allocations of insurance companies, but are rather caused by duration mismatches and changed market dynamics. Implications for supervisory activities are to focus on a more macro-prudential approach to the sector for the adequate treatment of systemic risk and to pay more attention to smaller insurance companies as well.
Overall, the panel revealed that the current regulatory approaches are not comprehensive enough to cover all the different dimensions of systemic risk in the insurance sector, especially from a global perspective. The discussants reached a consensus about the need for a more sector-wide approach to cope with the insurance companies' contribution to systemic risk, but its exact design, despite the different recommendation of the discussants, finally remained open.
The second panel, “The Industry Perspective”, focused on connecting existing frameworks and measures of systemic risk to the business model of insurers. Several achievements in the process of macro-prudential supervision were acknowledged. These included the identification of potential risks with regard to liquidity needs and spillover effects by means of the systemic risk monitoring report (SRMP) and liquidity risk management plan (LRMP).
However, the discussants also identified a number of shortcomings in the current supervisory framework. In particular, the main differences between the insurance and banking business models were stressed, namely that insurers do not drive credit cycles and rely on a liability-driven investment approach. Thus, it was pled that the current and future regulation should not copy existing banking regulation but take the specificity of the insurance sector into account.
Regarding the measurement of systemic risk in the insurance sector, the discussants clarified a number of critical issues: Since current regulation does not differentiate between different degrees of systemic riskiness to a large extent, systemic importance is more based on a black-or-white decision, while it should rather include a ranking according to the extent of systemic risk. Likewise, many academic approaches miss a lower bound of systemic risk that decides between being systemically important or not.
The panel discussion also revealed a number of questions that do not seem to be answered at the moment, but remain as promising topics for future debates. These include, for instance: “Can there also be a non-activity that is systemically important?” and: “At which point are externalities of insurers’ decisions systemic?”.
The third panel, “The European Regulatory Perspective”, addressed the importance of liquidity and macroeconomic risks as potential drivers for systemic risk in the insurance industry. It was stressed that liquidity risk has complex, intertwined linkages and interrelations. For example, in the life insurance context the combination of the size of surrender values and the potential charges for contract termination may result in different scenarios of possible mass lapses in life insurance. , The resulting effects need to be understood thoroughly. Furthermore, the development of a comprehensive global risk-based solvency regime that includes macro-prudential risk measures within the International Capital Standard would be a valuable evolution of the regulatory frameworks.
Regarding the current regulatory framework for EU-insurers, Solvency II, its link to systemic risk was emphasized by the consequences of the current Ultimate Forward rate (UFR) level for determining the value of technical provisions. The discussants came to the conclusion that the incentive and solvency effects stemming from a gap between the interest rate values based on the UFR and the “true” interest rate level must be carefully analyzed. However, it was also argued that the UFR issue seems to be less important compared to other distortions under Solvency II, especially disregarding credit risk for European sovereign bonds in the first pillar.
The panel closed with a thought provoking statement from the supervisory side:
“Market valuation is like democracy. It is not perfect but it is the best we can do.”