Insurers call on regulators to recognise minimal systemic threat

Unlike banks, the core activities of insurance and reinsurance companies do not represent a systemic risk, according to the industry think tank the Geneva Association. Rather, insurers and reinsurers play an important role in supporting the global economy, a new report from the association says.

The report’s findings have led industry leaders to question capital requirement proposals contained in the latest draft of the Solvency II directive.

The Geneva Association report examined the differing roles of insurers and banks in the global financial system and their impact on the crisis. It concluded that the insurance industry does not represent a systemic risk for three important reasons:

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Insurance is funded by up-front premiums that give insurers strong operating cash flow without the need for wholesale funding;

Insurance policies are generally long-term with controlled outflows that enable insurers to act as stabilisers to the financial system;

During the worst of the financial crisis, insurers maintained steady capacity, business volumes and prices.

The report said that, in a worst case scenario, an insurance insolvency develops slowly and can often be absorbed by raising fresh capital or an orderly run-off. Plus, the interrelationships between insurance activities means that contagion would be limited.

INSURERS ARE DIFFERENT

The report underlined pointedly that supervisors and policymakers should focus on activities rather than generalise over financial institutions when they introduce new regulation.

Dr Nikolaus von Bomhard, Chairman of the Geneva Association and CEO of Munich Re, said that, in the public debate, the business model of insurance is unfortunately not always sufficiently separated from the business models of banks.

At a conference in Munich called ‘Assekuranz im Aufbruch’ and organised by German financial newspaper Handelsblatt, Mr. von Bomhard said that insurers are better capitalised than banks and that their balance sheets have lower leverage.

“For insurers, growth in size is a way of reducing and diversifying risks, unlike for banks, which accumulate risks when growing,” Mr. von Bomhard added. Planned Europe-wide tougher capital requirements should take into account the different business models of insurers and banks, he concluded.

The Geneva Association report has added to the growing sense of unease around the solvency capital requirements envisaged under the Solvency II directive due to be transposed into national legislation in 2012. Specifically, the European insurance industry is worried about the ‘excessively prudent’ recommendations made by the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS).

The CEA, the European insurance and reinsurance federation, says the current proposals would be bad for consumers, bad for Europe’s economy and bad for the insurance industry (see news story on front page).

Alberto Corinti, the CEA’s Deputy Director General, told Commercial Risk Europe that the Solvency II proposals could undermine the industry’s financial stability.

“To the extent that the regulatory requirements could affect the business model of insurers then we could see uncertainty in the sector. Looking at the wider picture, if insurers are restricted in their investment policies—for instance in equities or corporate bonds—then their support of the economy is diminished,” Mr. Corinti said. “Further, a lack of good incentives for diversification in investment could make the sector more fragile.”

Other business leaders have expressed concern that the new stringent capital regulations could lead to concentration in the industry through mergers and acquisitions, itself promoting systemic risk by a reduction in the number of insurers.

Commenting on the Geneva Association report Swiss Re CEO Stefan Lippe said in a statement that large insurers and reinsurers play an important role in supporting the global economy. “They are shock absorbers as they have long-term investment strategies. In this respect they contribute significantly to financial stability,” Mr. Lippe said.

The authors of the Geneva Association report acknowledged that the quasi banking activities conducted by some insurers caused failure or triggered problems. So the report identified two activities which have the potential for posing systemic risk when conducted on a widespread scale without proper risk control frameworks. These are derivatives trading on non-insurance balance sheets and the mismanagement of short- term funding from commercial paper or securities lending.

ACTION PLAN

The industry has proposed five recommendations to address these particular activities:

• The implementation of a comprehensive, integrated and principles-based supervision framework for insurance groups in order to capture any excessive non-insurance activities, such as use of derivatives
• Strengthening liquidity risk management, particularly to address potential mismanagement issues related to short-term funding
• Enhancement of the regulation of financial guarantee insurance, which has a different business model compared to traditional insurance
• Establishment of macro-prudential monitoring with appropriate insurance representation
• The strengthening of industry risk management practices and sharing experiences with supervisors on a global scale.

When he introduced the report for the Geneva Association, Aviva CEO Andrew Moss said: “These recommendations will enhance the regulatory framework, strengthen consumer protection and support the industry’s capacity to provide investment to the real economy.”