Geneva Association: ‘No Systemic Risk from Insurance Core Activities’

February 26, 2010

A newly published report from the Geneva Association, which analyzes the role played by “insurance in financial stability and its systemic relevance,” has concluded “that the core activities of insurers and reinsurers do not pose systemic risks due to the specific nature of the industry.”

The Association listed some of those features as follows:
— Insurance is funded by up-front premia, giving insurers strong operating cash-flow without the requirement for wholesale funding.
— Insurance policies are generally long-term, with controlled outflows, enabling insurers to act as stabilizers to the financial system.
— During the hard test of the financial crisis, insurers maintained relatively steady capacity, business volumes and prices.

The report also concluded that the industry doesn’t fit into the “commonly cited definition of systemic risk,” as defined by the Financial Stability Board (FSB); i.e. none of the industry’s core activities are relevant for at least one of the following reasons:
— Their limited size means that there would not be disruptive effects on financial markets;
— An insurance insolvency develops slowly and can often be absorbed by, for example capital raising, or, in a worst case, an orderly wind down.
— The features of the interrelationships of insurance activities mean that the contagion risk would be limited.

The report, however, did not hesitate to address the resurgent debate surrounding the implementation of the Solvency II regulations on insurers, which is set for 2012. The European Commission’s committee, CEIOPS, which is drafting the regulations, has reopened the possibility of increasing capital requirements and other measures generally opposed by Europe’s insurance industry. The Association advised “supervisors and policymakers” to “focus on activities rather than financial institutions.”

The Association’s study doesn’t absolve the insurance industry completely. The report, without naming names, singles out “quasi banking activities conducted by insurers” as having “either caused failure or triggered significant difficulties.” Without proper risk controls both “derivatives trading on non-insurance balance sheets,” and “mis-management of short-term commercial paper or securities lending” do pose systemic risks.

The industry has therefore come up with five specific recommendations to “address these particular activities and strengthen financial stability.” They are listed as follows:
— The implementation of a comprehensive, integrated and principle-based supervisions framework for insurance groups, in order to capture, among other things, any non-insurance activities such as excessive derivative activities.
— Strengthening liquidity risk management, particularly to address potential mis-management issues related to short-term funding.
— Enhancement of the regulation of financial guarantee insurance, which has a very different business model than traditional insurance.
— The establishment of macro-prudential monitoring with appropriate insurance representation.
— The strengthening of industry risk management practices to build on the lessons learned by the industry and the sharing of experiences with supervisors on a global scale..

The report was presented this morning at the offices of Aviva in London, and those in the industry, who attended the presentation generally, approved the report. Munich Re CEO Dr. Nikolaus von Bomhard, the Chairman of the Geneva Association, Patrick M. Liedtke, its secretary general and managing director, Dr. Stefan Lippe, an Association board member and CEO of Swiss Re, Andrew Moss, also a board member and CEO of Aviva, and Lloyd’s CEO Richard Ward, also a board member, strongly supported the report’s conclusions

Ward commented: “We welcome the Geneva Association’s well-researched and authoritative report on systemic risk in insurance. It recognises that the core activities of insurers and reinsurers do not give rise to systemic risk and explains how the insurance business model has proved to be a source of stability during the financial crisis. Ongoing regulatory debates can only benefit from the report’s publication.”

The full report is available at: http://www.genevaassociation.org/portals/0/Geneva_Association_Systemic_risk_in_Insurance_Report_March2010.pdf

Source: International Association for the Study of Insurance Economics (Geneva Association) and Lloyd’s of London – www.lloyds.com

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