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THE INSURANCE SECTOR TRENDS AND SYSTEMIC RISK IMPLICATIONS
Based on Global Financial Stability Report, IMF, April 2016
Nico Valckx Workshop on Systemic Risk in Insurance
Columbia Business School, October 28, 2016
Motivation and Main Findings
Motivation (1)
Relative Size of Financial Intermediaries(Percent of GDP)
Insurance sector: Big player in financial markets Important economic functions
0
50
100
150
200
250
300
350
400
450
2005 2015 2005 2015 2005 2015 2005 2015 2005 2015 2005 2015
United States Canada Euro area United Kingdom Japan Korea
Insurance Banks OFIs Pension funds
• Two views on systemic risk
Individual insurers
System of insurers
Largecomplex
interconnected
Default,stop
funding, stop
lending, securities.
Correlated sales, fire
sales, stop/reduce
funding.
Distress?…
……
Shock to asset prices
Counter-party
stress …risks to
real activity
Common exposures
Domino View Tsunami View
Motivation (2)
Questions answered in GFSR
Has insurance sector’s systemic importance changed over time/countries?
What explains changes in systemic importance?• Investment
behavior• Maturity
mismatches• Business models• Broader market
dynamics
Implications for insurance regulation?
• Increased, esp. life, but lower than banks• More homogenous, higher commonalities• Increased market risk and interest rate sensitivities
Systemic importance
• Insurers transmit shocks across financial system• Especially in Europe and North AmericaSpillovers
• No major shift towards “riskier” assets • But assets have become “riskier”• Search for yield among weaker, smaller firms
Life insurers’ assets
• Macro-prudential approach needed• International capital and transparency standards • Focus on smaller and weaker firms
Regulatory implications
Main findings
Insurance Sector: Systemic Importance
Increased price comovement among insurers
Time series clustering(Number of clusters)
Insurers’ Equity Return Due to First Principal Component (Percent)
0
20
40
60
80
100
I II I II I II I II I II
Life Nonlife Life Nonlife Mixed
United States Europe
Systemic Risk – rising CoVaR and capital shortfalls
CoVaR Indices (Normalized, 2006=100)North America Europe Advanced Asia
Conditional capital shortfall (USD trillions)
0.0
0.5
1.0
1.5
2.0
2001 2004 2007 2010 2013 2016
Life insurers
Nonlife insurers
Banks
0.0
0.2
0.4
0.6
0.8
2001 2004 2007 2010 2013 2016
Life insurers
Nonlife insurers
Banks
0.0
0.4
0.8
1.2
2001 2004 2007 2010 2013 2016
Life insurers
Nonlife insurers
Banks
0
50
100
150
200
250
300
350
2006 2009 2012 2015
Banks
Nonlife insurers
Life insurers
0
50
100
150
200
250
300
350
2006 2009 2012 2015
Banks
Nonlife insurers
Life insurers
0
50
100
150
200
250
300
350
2006 2009 2012 2015
Banks
Nonlife insurers
Life insurers
0
2
4
6
8
10
12
14
16
18
20
Nov-01 Mar-07 Aug-08 Dec-14
Top 25 Top 50 Top 100
-16
-12
-8
-4
0
4
8
Nov-01 Mar-07 Aug-08 Dec-14
Top 25 Top 50 Top 100
A +10 percent value for the top 100 indicates that there are 10 percent more insurance firms among the top 100 than justified by their sample share.
Life insurers Non-life insurers
Forward-Looking Default Correlation Networks(Percent; over- or underrepresentation of insurers)
Systemic RiskDefault Correlation Networks rank Life high
Systemic Risk Spillovers:Insurance is shock transmitter
Systemic Importance Drivers
Investment behavior
• Take on greater asset risk in low interest rate environment? Across asset categories true only for weaker, smaller firms
• Increased similarity in asset composition? Not apparent
• Greater procyclicality in investment behavior? Mixed evidence
• But greater common exposure toaggregate riskinterest rates
1. More risky investments: at lower cap, smaller firms and those with more annuity/min.return products
-4
-2
0
2
4
6
High interest
Low interest
High interest
Low interest
High interest
Low interest
All
United States Canada Netherlands Germany
With low interest rates, the propensity of lower-capitalized firms to hold riskier assets is strengthened.
-5
0
5
10
15
High interest
Low interest
High interest
Low interest
High interest
Low interest
Guaranteed interest
United States Canada Netherlands Germany
With low interest rates, the propensity of firms with higher annuity product shares to hold riskier assets is strengthened.
Firms with higher guaranteed interest
rates on life insurance offerings
have larger risky asset portfolios.
-15
-10
-5
0
5
10
15
High interest
Low interest
High interest
Low interest
All All All
United States Canada Netherlands Germany Korea
With low interest rates, the propensity of smaller firms to hold riskier assets is strengthened.
1 2
3
In low interest environments, factors that contribute to higher exposure to riskier assets are lower-capitalization ….
… a higher share of annuity products in total liabilities …
… and the size of the firm , with smaller being more exposed
2. Procyclicality 3. Duration mismatches- Mixed evidence - Higher i-rate sensitivity
U.S. insurers acted countercyclically in 2008 and contributed to stability
US and European Insurers' Equity Returns‘ Interest Rate Sensitivity Increases…and so does their net duration mismatch
But… turnover at firm level did not increase in recent years
-0.80-0.70-0.60-0.50-0.40-0.30-0.20-0.100.000.10
Life Nonlife Life Nonlife Mixed Life Nonlife
U.S. insurers European insurers Asian insurers
Precrisis Postcrisis
Note: For a negative (net) duration, insurers’ liabilities are longer than their assets. Insurers’ future business prospects get better (worse) when interest rates increase (fall).
4. Liability side developments may also contribute to riskiness…
Life Insurers’ Unit-Linked Products (Percent of assets)
0
10
20
30
40
50
60
70
80
2004 2006 2008 2010 2012 2014
United States Netherlands
Germany United Kingdom
Korea Scandinavian countries
Switzerland Canada
0
5
10
15
20
0
10
20
30
40
50
60
70
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015:H
1
Catastrophe bondsSidecarsIndustry loss warrantiesCollateralized re and otherShare alternative capital (right scale)
(Billions of U.S. dollars) (Percent)
Unit-linked products are a form of long-term insurance whereby the policyholder chooses the investment strategy. These products can, but do not necessarily have to, include guarantees.
Alternative Insurance Risk Capital Instruments
5. Changed Market DynamicsHigher cross-asset correlations post-2010
• Search for yield• Lower risk aversion
Temporary factors
Increase risk of market illiquidityBenchmarking more widespread
Structural changes
Greater similarity
across insurance
firms’ stock prices
Insurance stocks more affected by
common shocks
Implications for Regulation
Recent Regulatory Developments
• Regulations now more risk-based and accounting principles more market-based– valuations more market-sensitive– investment horizons of risky investments shortened – the maturity of safe assets extended
• Wide variations in capital requirements and the use of internal models – These are among the main problems in developing a global
capital framework– But progress is being made
Compliance with ICPs
1. Selected IAIS Core Principles on Regulation 2. Selected IAIS Core Principles on Business Strategies
0
20
40
60
80
100
AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM
Exit M&A Cond. Enforce. PCA Report MaPru. Groups
Observed Unobserved
0
20
40
60
80
100
AE EM AE EM AE EM AE EM AE EM AE EM AE EM
Activity Invest. Liab. Risk Mgt. Cap. Gov. Disclose
Observed Unobserved
Forward looking lessons for Regulation
• Macro-prudential approach– address risks related to common exposures
• Market-consistent valuation standards – enhance transparency– address duration mismatches
• Supervisory follow-up of smaller and weaker firms– Focus should not be restricted to only large firms– Too-many-to-fail problem– Contagion
• Vigilance to avoid regulatory arbitrage
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