04 October 2012

Risk.net: Systemic risk methodology continues to worry insurers

The US bailout of American International Group (AIG) in 2008 has been consistently presented as an example of why some insurers need to be considered for inclusion as global systemically important financial institutions (G-SIFIs) and face closer supervision from regulators. And the argument has gathered momentum. With the group of 20 major economies (G20) urging progress on insurance reform, the International Association of Insurance Supervisors (IAIS) published a proposed assessment methodology for identifying global systemically important insurers (G-SIIs) in May this year.

However, the methodology faces opposition from many in the insurance industry who say traditional insurance business is no threat to global financial stability. They argue it is non-traditional insurance business, such as that undertaken by AIG, which demands greater scrutiny and control. Additionally, they fear that applying policy measures designed primarily for the global banking industry to insurers fails to understand the intrinsic differences between these two sectors. A failure to recognise the distinctive characteristics of the insurance industry could even result in further instability for the insurance industry, it is claimed.

“The primary concern is that the proposed methodology, which is based on the approach applied by the Basel Committee, needs greater fine-tuning to capture the specifics of the insurance industry and the differences in business models with the banking sector, in order that the assessment captures only insurers whose distress or disorderly failure would cause significant disruption to the global financial system”, remarks Gideon Pell, chief risk officer at New York Life in New York.

A report by the Financial Stability Board (FSB) in October 2010 announced that the framework for dealing with SIFIs would also be extended to cover insurance companies. Initial responses from the insurance industry were not positive. The Geneva Association stated that while it did support the introduction of supervisory and regulatory policies to reduce systemic risk within the global financial system, the traditional insurance business model was fundamentally different to that of banks.

The Geneva Association highlighted the fact that insurers pool risk and use probability theory, including the law of large numbers, to manage risks. In a presentation to the FSB in October 2010, Raj Singh and Axel Lehmann, the chief risk officers of Swiss Re and Zurich Financial Services Group respectively, spoke on behalf of the Geneva Association on this front. The speakers argued that a SIFI designation upon insurers might actually add, rather than reduce, systemic risk by creating market distortions and decreasing the risk capacity of the industry. Higher capital requirements for insurers would, they argued, impair their role as risk-mitigation agents in the wider economy.

Later, on October 27, 2010, Adair Turner, chairman of the UK’s Financial Services Authority (FSA), expressed his own concerns with the proposals during the IAIS annual conference. He said: “We cannot simply read across regulatory reforms designed for banks and assume that they should apply to insurers. In respect to both capital and liquidity risks, we clearly need different approaches.”

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