Britain AIG, courtesy AP

There is little evidence of traditional insurance either generating or amplifying systemic risk within the financial system or in the real economy if they keep close to their traditional insurance business model, according to a comprehensive report from the International Association of Insurance Supervisors.

The report found that the insurance business model worldwide withstood the financial crisis of 2008 because insurance liabilities are not generally correlated with financial market losses, and they are very different from the more vulnerable banking model.

Moreover, there is scant evidence, the IAIS paper stated, that insurers could cause systemic risk, although the benign record thus far won’t keep IAIS from scrutiny of insurers and the role of reinsurers in amplifying risk to the global financial system.

“Based on information analyzed to date, for most lines of business there is little evidence of traditional insurance either generating or amplifying systemic risk within the financial system or in the real economy,” the IAIS found, adding that it is an imperfect science and that “empirical assessments about the systemic importance of insurers and insurance groups may change over time.”

To the extent that there is risk, it comes from non-insurance activities like credit default swaps (CDS) transactions used fornon-hedging purposes or leveraging assets to enhance investment returns, the paper noted.

“The recent financial crisis has revealed that even financially strong insurance groups and conglomerates  operating on a core of traditional lines of business may suffer significant distress and become globally systemically important when they expand significantly in non-traditional and noninsurance activities. In this context, it is important to distinguish between those activities that are regulated as insurance and those that are not,” The IAIS said, perhaps warning that when insurers do stray too far from their traditional lines, there may be the potential for systemic issues.

The paper, Insurance and Financial Stability, is significant in that it demonstrates that insurers did not cause or contribute to the financial crisis and generally do not pose a systemic risk due to their business model, noted Dave Snyder, general counsel for public policy for the American Insurance Association.

To understand the difference in systemic risk between banks and insurers, the IAIS says, the insurance model — with its “disciplined implementation of a predominantly liability-driven investment approach…the nature of insurance claims that in many cases allow the management of cash outflows over an extended period of time…and in the high degree of substitutability, allowing for a comparatively ease of market entry into most lines of  business”– deserves close consideration.

In the case of systemic risk, the IAIS found that enhanced supervision, not more capital, is the answer, Snyder said.

Many insurers have long pleaded the difference between systemic risk in banks versus insurers.

“Insurers are not subject to a ‘run’.  Even life insurers with cash value policies or variable annuity writers have a much lesser degree of liquidity risk,” said one former regulator, now with a global insurance company.

However, at an Insurance, Housing and Community Opportunity Subcommittee of the House Financial Services Committee hearing today in Congress, Daniel Schwarcz, a consumer advocate and professor at the University of Minnesota Law School, repeatedly told lawmakers that there could indeed be a run on life insurance companies.

Schwarcz described the potential for a “calamitous situation” where there would be “a massive loss of confidence in a life insurance company,” negative press, concern, and then a scenario where people would start taking out cash to the extent they could from their policies, and then state guaranty funds would not be able to cover all the extant exposure.  

Spillover, or contagion, is not an issue for insurers, according to the IAIS, although the issue was raised during the separate hearing on systemic risk, and AIG’s supervision. IAIS described an event study looking at the interlinkages between UK banks and life insurers at a time of stock market distress in the 2001 to 2003 period concluded that, in general, there was no materially significant contagion between insurers and banks. However, to the extent that minor contagion was observed, it turned out to be linked to concentrated bank investments in the life insurance sector and to direct ownership of life insurance businesses by UK bank, the report stated.

The conclusions would lend themselves to a determination that there are few, if any, insurers that could be classified as G-SIFIS, Snyder said, referring to Global-Systemically Important Financial Institutions, or too-big-to-fail institutions. G-SIFIs are to be identified and named by the Financial Stability Board. A final report from the FSB is due next year. Domestically, in the U.S., there is a similar effort to identify U.S. SIFIs, and it is unclear how much overlap there will be. Many interests do want a coordinated global-domestic determination, though.

The IAIS paper notes that the two major impairment factors for life and non-life insurers are deficient loss provisioning and inadequate pricing, not investment losses and reinsurance failures.

This means that regulators should not artificially suppress rates, as inadequate rates affect a company’s solvency, Snyder pointed out.

The U.S. state regulatory body and the Federal Office of Insurance at the U.S. Treasury chose not to comment on the report.