Isn't reinsurance systemically risky? A call for reason and transparency

Nina Arquint, Swiss Re's Head of Group Qualitative Risk Management, explains why reinsurance activities are not a source of systemic risk.

Supported technically by the International Association of Insurance Supervisors (IAIS), the Financial Stability Board (FSB) has designated insurers as systemically important. The first official designation as Global Systemically Important Insurers (G-SII), took place in 2013.  This move was part of the G20 initiative designed to put an end to the too-big-to-fail theory.

In re/insurance, the real source of systemic risk had lain in its pursuit of quasi-banking activities not in the size of the institution in question. Consequently, the IAIS modified the "too-big-to-fail" theory in order to increase the focus on activities and lessen the emphasis on size.  In the case of the re/insurance industry, size is actually a positive attribute, not a negative one, since it enables the industry to absorb risk, including systemic risk.

Early on, when developing the methodology to assess systemic risk, regulators examined whether reinsurance activities could be a source or amplifier of systemic risk.  (FINMA: Assessing the potential for systemic risks in the insurance sector, June 2010; IAIS: Reinsurance and Financial Stability, 19 July 2012).

In our view, reinsurance activities are not a source of systemic risk because:  
1)    reinsurance makes use of transparent, directed risk transfer (as opposed to intransparent networks, as in banking);
2)    reinsurance fully covers liabilities through  technical provisions (as opposed to leveraging); and
3)    reinsurance cession rates average 12% – this is too small to be globally risky.

Prudential regulation of the reinsurance industry ensures adherence to the three aforementioned principles. Our response to the question in the title would therefore be: "No – at least not globally, if provided by a supervised reinsurer".

Systemic risk can occur if there is an institutional or geographical concentration of risk in the reinsurance covers.  However, this risk is local, not global – otherwise global cession rates would be higher.  Surprisingly, the IAIS has proposed introducing these risk aspects into their 2016 revised global designation methodology. However, we are of the view that the proposed "supplementary reinsurance assessment" is inappropriate for the G-SII methodology, which should assess global systemic importance.  Concentration risk assessment is still required of course, but this is covered by regular prudential supervision.    

If there was sufficient transparency concerning the G-SII designation methodology, the concerns (including those regarding reinsurance) could be openly discussed and resolved. When the first designations of insurers were announced in 2013, the IAIS did not disclose its methodology, allegedly to protect the designated companies. Moreover, the IAIS continues to keep both the public and the companies concerned uninformed, and it is is silent on the relative and absolute weight of the indicators involved.

In our view, the IAIS should provide:
1)    Full public transparency on all currently used indicators, 19 in total. They should disclose:
       a.    the weighting (IAIS: reference value) applied in the 2015 and 2016 assessment;
       b.    the level on which each indicator indicates  "systemic risk" according to IAIS;
       c.    the distribution of each indicator for the companies assessed; and
       d.    the threshold for the final score to propose a company for designation to the FSB.
2)    Transparency on its score in all indicators for the assessed company.

The IAIS seems to hide behind the insurance industry when arguing against the need for transparency. However, this body the IAIS serves the public, and consequently public pressure should be brought to bear in this matter.


Published on 22nd April 2016

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