Our regular readers might remember that we wrote about a paper that the International Association of Insurance Supervisors (IAIS) had published in November which provided their thoughts on how the re/insurance industry interacts with the wider financial markets. The paper discussed systemic risk from re/insurers and identified insurance-linked securities and catastrophe bonds as instruments that increased that risk. Now the IAIS are proposing a methodology to identify insurers who are systemically important or too big to fail.
Today the IAIS has released its proposed assessment methodology for identifying globally systemically important insurers and reinsurers, something they are dubbing G-SII. The paper has been endorsed for consultation by the Financial Stability Board (FSB), which is coordinating this effort to put in place a set of measures to reduce the moral hazard posed by global systemically important financial institutions. The IAIS calls on supervisors, insurers and other interested parties to submit any comments they have on the proposed methodology through 31st July.
“This proposed methodology results from intensive and thorough discussion within the IAIS based on the expertise from supervisors around the world,” said Peter Braumüller, Chair of the IAIS Executive Committee. “Based on a recommendation by the G20 Leaders and the Financial Stability Board, the IAIS has accomplished an important piece of financial sector reform.”
The proposed methodology uses an indicator system, similar to the one that the Basel Committee uses to identify global systemically important banks, with a few differences which reflect the nature of insurance business. There are three steps in the process; collection of data, an indicator-based assessment of the data, and a process of supervisory judgment and validation. It uses 18 indicators in five categories; size, global activity, interconnectedness, non-traditional insurance and non-insurance activities, and substitutability.
See non-traditional insurance activities? That includes insurance-linked securities, catastrophe bonds and likely industry-loss warranties and catastrophe derivatives as well. It could also include hedge fund, or investor backed insurance entities s well, given that they are likely more interconnected with the wider financial markets than a traditional insurer. Mr. Braumüller explains; “The potential for systemic risk within the insurance sector needs to be considered where insurers deviate from the traditional insurance business model and more particularly where they enter into non-traditional insurance or non-insurance activities.”
As a result, the IAIS are proposing significantly higher weighting be applied to the on-traditional and non-insurance activities and interconnectedness categories when assessing an insurers score.
48 large insurers and reinsurers are going to be assessed to see whether they should be classified as globally systemically important. Names put forwards as potential candidates include Generali, AIG, Axa, Allianz and Prudential. It’s thought that the results of this process would be some form of disincentives to put insurers off engaging in riskier non-traditional or non-insurance activities. That is likely to include derivatives trading such as CDS (credit default swaps). They hope that within five years we could see measures beginning to be put in place to restrict any activities which increased systemic importance.
We feel it’s unlikely that the type of non-traditional activities we are concerned with here at Artemis will be affected as they are a very small part of the overall market. Of course, if the ILS, cat bond and ILW market were to grow significantly then they may have more impact on assessments of systemic importance, but at the moment they will be a very small piece of the balance sheet of any re/insurer who is being assessed.
There are a number of associated documents available on the IAIS website here, including a consultation document and some FAQ’s on the proposal. There is also a mechanism for submitting any comments you may have at the same address. We suggest you read the documentation and if you have any concerns make sure your comments are heard and you input your thoughts on this proposal.