A spinning top on its point

Financial stability and insurance

Since the financial crisis broke in earnest in mid-2008, the financial sector has been engaged in debate regarding financial stability and the regulations that enforce it. These reforms are taking place in a very challenging and uncertain macro-economic environment, increasing the importance of taking a coordinated approach that considers the cumulative and cross-sectoral impact of new regulation.

Regulatory, corporate and macro-economic flaws were revealed by the financial crisis. This prompted central bankers, finance officials and regulators to devise schemes to strengthen oversight and prevent such a crisis from happening again. At first many of the new initiatives were focused on the banking sector, however, it soon became clear that the insurance industry, despite the resilience it had displayed throughout the crisis, would be swept up in the rearrangement of the global financial architecture and the measures to be introduced.

As a result, along with the new regimes aimed at addressing the roots of the crisis, insurers are now faced with a new dimension of macro regulation and new institutions not familiar with the sector. Given the fundamental differences between insurance and banking business models, as well as their fundamentally different risk profiles, it is essential that this is understood and taken into account by those reforming regulations.

Re/insurers do not cause financial instability

In fact, the question must be asked whether insurers, and indeed reinsurers, are causes of financial instability and should be scrutinised in the same manner as banks. According to a 2010 study by The Geneva Association – which applied the Financial Stability Board (FSB), International Monetary Fund (IMF) and International Association of Insurance Supervisors (IAIS) criteria for identifying systemic risk to the insurance sector – traditional insurance activities are not a source of systemic risk. Indeed, for reinsurers, a Group of Thirty study (2006, updated in 2010) found that interconnectedness between reinsurers and the underlying insurance market is low. The G-30 also concluded that, had a large reinsurer failed in the crisis, there would have been no knock-on effect for the global insurance market, total capital market or total banking sector.

Ensuring effective reform

While the insurance sector believes that ensuring financial stability is undoubtedly the right thing to do, steps must be taken to maximise the effectiveness of such reform and to avoid negative and/or unintended consequences and market distortions. This argument was taken up in an important 2011 study by the Institute of International Finance, The Implications of Financial Regulatory Reform for the Insurance Industry. The report, to which Swiss Re was a key contributor, calls for greater cross-sectoral coordination between banking and insurance in regulatory reform. It emphasised the important role that insurers play as long-term investors in the real economy, and highlighted the challenges currently experienced by the sector as a result of financial market volatility. The report warned that uncoordinated regulatory reforms will be less effective in promoting financial stability and will undermine the ability of insurers and banks to undertake their core functions in supporting economic activity and recovery.

Speed of reform and economic uncertainty

Compounding the pressure insurers face in adequately addressing and assessing the large number of new reforms, is the fact that they are being implemented at a fast speed in a challenging and uncertain macro-economic environment. Current uncertainty emanates from several different sources: the continued lack of a full resolution to the European sovereign debt crisis; fiscal constraint and political infighting in the US; dwindling effective options available to the Fed and European Central Bank; disappointing economic data; and unknown implications from regulatory reforms. We are facing a severe crisis of faith in economic policy, which is undermining business confidence. In times like these, it becomes even more important that economic and fiscal policy be appropriate, stable and credible.

Swiss Re continues to be actively involved in addressing these issues

Published 26 March 2012

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