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Leading Insurers Call for Careful Consideration of Unintended Consequences Emerging from IAIS Proposals on Systemic Risk
IIF responds to the IAIS regarding its Proposed Policy Measures for G-SIIs, calling for sector-specific and proportionate regulation.
Washington D.C., December 17, 2012 — The debate on systemic risk regulation in insurance is at a critical point. The International Association of Insurance Supervisors (IAIS), in collaboration with the Financial Stability Board (FSB), is developing a methodology to identify potential Global Systemically Important Insurers (G-SIIs) and is elaborating proposed policy measures. The IIF endorses the objectives and goals of this work, and emphasizes the importance of assessing the extent to which the activities of insurance firms may be a source of systemic risk. Correctly drawn up and implemented, a new framework for systemic risk in insurance can reinforce financial stability. However, as currently designed, there is a high risk of detrimental unintended consequences. The IIF therefore exhorts the IAIS to undertake a comprehensive study to assess the potential impact of its proposals on the wider economy, and the ability for insurers to provide their services to the economy, similar to that undertaken by the Basel Committee on Banking Supervision and the BIS at the time of their proposals to address systemic risk in the banking sector.
Insurance plays a vital role in society. It brings benefits such as the pooling of risk, the provision of transparent pricing to a wide range of risks, offers financial protection for individuals, and bolsters the resilience of businesses and governments. “It is therefore essential to develop a regulatory framework that is properly tailored to the insurance business model, one that takes full account of its intrinsic characteristics and does not threaten to undermine its social and economic benefits,” said Mr. Charles Dallara, Managing Director of the IIF. He added: “In our view the proposed IAIS G-SII methodology and policy measures borrow excessively from those developed for the banking sector, without taking into proper consideration the unique characteristics of the insurance business model.”
The IAIS acknowledges that there is little evidence of traditional insurance and reinsurance either generating or amplifying systemic risk within the financial system or the real economy. This view is shared by the IIF, and should be clearly reflected in the IAIS G-SII methodology and policy measures. Traditional insurance groups provide important benefits to the economy – as shock absorbers and long-term investors – but they are not sources of financial turbulence. Consequently, regulators should focus their attention on non-traditional and non-insurance activities which might be potentially systemically risky, in order to address systemic risk concerns. Only insurance groups that engage significantly in such activities without proper prudential oversight and adequate risk governance may become vulnerable to financial market developments, and therefore might be considered to potentially pose systemic risk.
Mr. Martin Senn, Chairman of the IIF Insurance Regulatory Committee, a member of the IIF Board of Directors and CEO of Zurich Insurance Group, noted: “In our view, the current methodology does not provide an effective measure of systemic risk. Instead it creates a simple ranking of insurers, which is insufficient to address such a complex matter. The methodology and corresponding policy measures need to reconcile with the consensus understanding that traditional insurance does not generate systemic risk.”
The IIF is particularly concerned over the potential introduction of blanket capital requirements. In insurance, capital requirements must not punish size or global activity, as that would be a disincentive for effective risk pooling. Increasing the size and global activity of an insurer permits the pooling of risk, thereby contributing to greater financial stability and welfare. A blanket capital surcharge on large global insurers would reduce the efficiency of risk pooling and lead to more expensive insurance, less risk capacity and, ultimately, greater reliance on state protection.
Mr. Steven A. Kandarian, Vice Chair of the IIF Insurance Regulatory Committee and CEO and Chairman of MetLife, said: “Because the traditional insurance business is not a source of systemic risk, it is important that any additional policy measures are specifically designed to focus only on those non-traditional and non-insurance activities that pose systemic risk. A blanket capital surcharge may raise the cost of offering traditional insurance products and result in reduced availability of products currently meeting social needs.”
The IAIS also proposes targeted capital increases on separated activities that have the potential to generate or aggravate systemic risk. The IIF encourages the IAIS to regard separation and targeted capital surcharges as measures of last resort, only to be considered after a specific assessment and identification of systemic relevant activities, and only after taking into account risk mitigation activities. Most non-traditional and non-insurance activities are closely linked to traditional insurance and complement each other without being systemically risky. A separation may eliminate the benefits resulting from such diversification.
Regarding the proposed measures for a potential recovery and resolution of a G-SII, it is vital to recognize that characteristics such as maturity mismatches, illiquid assets and leverage, which can result in precipitate failure with systemic consequences, are not features of traditional insurance. It is intrinsically part of the nature of the insurance business that it permits a prolonged time to react to developing stress situations. A more tailored approach regarding recovery and resolution measures is therefore necessary for insurance.
The IIF believes that comprehensive group supervision for global insurance groups should be the primary measure to address potential systemic risk in insurance. Such an approach should allow supervisors to monitor all group-wide activities on a consolidated basis, with particular focus on non-traditional and non-insurance activities, and to detect and adequately mitigate any potentially systemic relevant activities. Group supervision should therefore play a major role in any potential set of G-SII policy measures.