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.