Systemic Risk Metrics for Insurers

The US and Global banking regulators have been tasked with regulating systemic risk.  One area where they admit that they are unprepared is with the insurance sector.  In the recent Global Financial Crisis, several insurance companies played a pivotal role, specifically AIG and the US Financial Guarantee insurers.  Most insurers do not consider their activities that helped to build up the bubble and precipitate the crisis to be insurance activities and therefore persist in saying to regulators that insurance is not a systemically important sector.  However, the political facts are that AIG and the Financial Guarantors are/were insurers and the idea of leaving insurance completely out of the efforts to prevent a future systemic crisis is simply not a possible.

Last week, the American Academy of Actuaries provided a letter to the US Financial Stability Council titled, “Metrics to Enable FSOC to Monitor Insurance Industry Systemic Risk”.  That letter provides a good starting point for discussion of the issues involved in bringing the insurance sector into the discussion. For example, the letter provides the following list of ways that an insurer might have systemically significant risks:

  1. Risk assumption services provided to the insurance companies through reinsurers, foreign and domestic (e.g. mortality risk in excess of a company’s risk management limit).
  2. Risk assumption services provided by the non-insurance financial services companies to the insurance industry, (e.g. hedging of financial risk, catastrophe bonds).
  3. The interconnectedness of the insurance industry when part of a financial services group.
  4. The interconnectedness of a U.S. insurance company that is owned by a foreign financial services company.
  5. The insurance industry as a lender to the US economy (e.g. through its purchase of corporate bonds).
  6. The interconnectedness of risk assumption services external to the insurance industry when part of a financial services group.

Riskviews cautions the participants in this discussion to realize that it is most likely that the next systemic crisis will take a different form than the past crises.  So setting up measures and regulatory structures that will prevent a recurrence of past crises is no guarantee of preventing a future crisis.

This letter, with its emphasis on setting down broad principles for Systemic Risk in the insurance industry is a good step in the right direction.  Much broad based discussion is needed to take this further to produce a truly dynamic, principles based monitoring and regulating structure that will be imaginative and flexible enough to actually be of future good, not just short term political cover.

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One Comment on “Systemic Risk Metrics for Insurers”

  1. Robert Arvanitis Says:

    Take a step back for a moment.
    Banks transform money over time. They borrow short and lend long, creating ‘liquidity.” Of course they have (credit) tools to manage this risk, but that is in fact the risk that they take/create.

    Insurers transform money over space. They collect from 100, and pay the ONE who has the loss. Of course they have the (actuarial) tools to manage this risk, but that is in fact the risk that they take/create.

    There is far more systemic risk in banking. There, in a crisis, all correlations converge to one. In contrast, neither insurers nor insureds can influence the correlations of (properly understood low-beta) risks.

    Now a gloss: Insureds wish to sell a negative lottery ticket. In virtue of real operations, they have the 1% risk of losing 100. The pure price of that negative lottery ticket is $1. But to be in business, insurers require $1.50, for administrative costs PLUS the capital necessary to guarantee the transformation.

    Consequence (1): Risk transfer is not free.
    Consequence (2): Risk must only be transferred when the risk aversion exceeds the margin,
    Consequence (3): The social value of insurance is the discovery of the cost of risk.


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