Geneva Association: IAIS' G-SII Criteria May Create More Risk, Obstacles to Refinancing

John H. Fitzpatrick, secretary general of The Geneva Association. Photo: Courtesy of the Geneva Association. John H. Fitzpatrick, secretary general of The Geneva Association. Photo: Courtesy of the Geneva Association.

The International Association of Insurance Supervisors (IAIS) should remove traditional insurance activities in determining its methodology for identifying globally systemically important insurers (G-SIIs or G-SIFIs) that may be misclassified, the Geneva Association wrote in comments submitted today to the IAIS.

Traditional insurance features too prominently in the IAIS indicators, creating a situation that could result in non-risky insurers being designated as systemically risky and systemically risky insurers avoiding designation, the Geneva Association warned.

Another big concern is the unintended consequence of the methodology actually creating an obstacle for governments and banks to borrow.

The inclusion of traditional insurance activities in “large exposures” means that the considerable holdings of government bonds and bank-issued securities owned by insurers would be subject to one of the indicators of systemically risky institutions.

An IAIS G-SII assessment judges large concentrations of risk in the investment portfolios. 

Insurers are big investors in government bonds, bank debt, and other bank securities. One unintended consequence: Insurers seeking to avoid the systematically risky designation would reduce their bank-issued securities, government bonds and investments in bank securities, John H. Fitzpatrick, secretary general of The Geneva Association, tells National Underwriter. The reduction would contribute toward instability, he warned, noting that there all indicators, when final, will trigger actions by insurers to reduce their risk profile.

“The criteria that is settled on is very important because whatever criteria is finally agreed to will cause actions by companies to mitigate their exposure, says Fitzpatrick, a Chicago-based American who will be heading up the association from its headquarters in Geneva, and who spoke today to NU from Munich. Fitzpatrick, who is also a non-executive member of the board of AIG, is helping the company to repay its debt to the U.S. Treasury.

Fitzpatrick warned that the IAIS methodology, if not changed, could result in behaviors to reduce systemic risk that would not be beneficial for the financial system. For example, to manage their systemic risk ranking, insurers may seek to adjust their holdings in important assets, making it harder for banks and governments to refinance.

The Swiss-based Geneva Association membership comprises a statutory maximum of 90 chief executive officers from the world’s top insurance and reinsurance companies. The U.S. company CEOs involved in this report include those from Prudential, MetLife, New York Life, Liberty Mutual, AIG, RGA and The Hartford, as well as, in Bermuda, Ace, Arch, Axis, Renaissance and XL. 

MetLife is trying to sell its bank so as not to be classified a domestic systemically important financial institution, or SIFI, under the Dodd-Frank Act, by the Treasury-led Financial Stability Oversight Council.

Companies such as Prudential Financial (Baa2 positive), MetLife (A3 stable), and AIG are likely to be on what Moody’s predicts will be a very short (G-SII) list, states Moody’s analyst Laura Bazer, a senior credit officer with the rating agency. These companies all are large, have significant insurance business abroad, and are likely candidates for non-bank SIFI designation in the U.S as well, Bazer wrote in June. 

The IAIS’s Assessment Methodology for the Identification of Global Systemically Important Insurers, was issued May 31, 2012, with an 18-point methodology system for identifying G-SIIs. The project is part of a G-20 initiative to better supervise the global financial system after the AIG event that roiled the world markets in 2008.

The 18 indicators were grouped into five weighted categories which the Basel-based global insurance supervisory body will use to assess insurers to determine whether they are systemically risky.

The largest consideration will be given, by far, not to size but to nontraditional insurance activities and interconnectedness, according to a breakdown of all factors. 

The IAIS proposed assessment methodology for identifying global systemically important insurers, or G-SIIs (loosely referred to as G-SIFIs in the States) is part of a long process to reduce the risk of a financially cataclysmic insurance failure.

The Geneva Association says that its research shows that the best way to identify risk in insurance is to focus on activities rather than institutions, and pointed to two nontraditional insurance activities in particular. They are speculative derivatives trading on non-insurance balance sheets and the mismanagement of short-term funding.

“Geneva Association research, in particular the research report Systemic Risk in Insurance (March 2010) has demonstrated that traditional insurance activities do not create systemic risks,” the association states.

The IAIS earlier accepted this, for example in Section A of the consultation paper and an earlier financial stability paper in November 2011, the Geneva Association states. 

“The insurance business is based on the law of large numbers, that as the number of risks in a portfolio increases, the riskiness of the portfolio decreases,” Fitzpatrick states. “Also, as the lines of business and geographies increase, it diversifies further, reducing the risk of the overall portfolio. Several of the indicators penalize this natural risk reduction rather than reward it.”

The IAIS surprised some insurers because its general comments were supportive of the points that size and diversification reduce risk. But in respect to indicators of systemic risk, the IAIS began using size and diversification /geographic reach as an indicators of what is systemically risky. 

Fitzpatrick says he believes the more diversified the risks are, and the lines of business, all within traditional insurance, the less risky an insurer profile will be.

The Geneva Association also recommends that companies be involved early on in assessment process to avoid misunderstandings or misreading of data. The association also advises that the supervisory assessment process enable a company’s management to undertake transactions with an understanding of how it may affect its current status. For example: Whether mergers, acquisitions or disposals will affect their ranking. 

The paper was endorsed by the Financial Stability Board (FSB), which is coordinating measures to reduce the moral hazard posed by G-SIFIs. Supervisors, insurers and other interested parties are encouraged to submit comments on the proposed methodology through 31 July. 

At the request of the G20 Leaders and FSB, the IAIS has been developing the G-SII assessment methodology and policy measures. 

The IAIS calls itself a global standard setting body whose objectives are to promote effective and globally consistent regulation and supervision of the insurance industry. Its membership includes insurance regulators and supervisors from over 190 jurisdictions in some 140 countries.

“We believe that the development and promotion of effective supervisory and regulatory policies to reduce systemic risk and address information gaps is for the benefit of all concerned, including the insurance sector,” comments Dr. Nikolaus von Bomhard, chairman of The Geneva Association and chairman of the board of management, Munich Re.

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