18 April 2013

Risk.net: Systemic risk debate hots up over variable annuities and ILS

What makes an insurance company a risk to the global financial system? This is the question posed by the International Association of Insurance Supervisors (IAIS) and the Financial Stability Board (FSB) as they prepare to unveil a new regulatory framework for the supervision of global systemically important insurers (G-Siis). As yet, there is no simple answer. Insurers, policy-makers and other stakeholders have expressed numerous opinions but have so far failed to reach a consensus.

The pressure is now on to reach an accord. By the end of the second quarter, the FSB will have published its first list of designated G-Siis, and the IAIS should have finalised its policy proposals for the heightened regulation of these higher risk groups. But time is running out for the major insurance groups in the regulators’ spotlight, such as MetLife, Allianz, Axa and Prudential Financial, to make their case.

The debate is most heated on the treatment of so-called ‘non-traditional, non-insurance activities’ (NTNIA) under the proposed framework. This is the umbrella term given to some products sold by insurers as well as some internal processes that the IAIS and FSB consider go beyond plain-vanilla insurance business. Such non-traditional, non-insurance activities, it is argued, boost a firm’s systemic riskiness, and have subsequently been targeted by both regulators and policy-makers for the imposition of stricter regulatory and capital requirements.

Current IAIS proposals place a high weighting on the participation in such activities in determining whether an insurer poses a systemic risk (a 40–50 per cent indicator weighting in the current G-Sii assessment methodology). This means insurers with significant interests beyond core insurance are more likely to attract the dubious honour of being labelled systemically important.

In practical terms, G-Siis will need to ring-fence their NTNIA and place them in separate entities to eliminate the threat of these risky activities inflicting losses on the insurer’s core balance sheet. They may also find themselves subject to an additional, higher loss-absorbency capital charge.

The fundamental purpose of identifying such activities and loading additional regulatory requirements onto the insurers that engage in them is to avoid a repeat of the shock collapse of AIG in 2008, and discourage firms from dabbling in the dark art of shadow banking. However, in the eyes of insurers NTNIA is too broad a term that threatens to capture practices that have become commonplace among insurers in recent years. While the industry readily admits that some of these can be plausibly termed ‘non-traditional’, it argues there is little reason to classify them as ‘non-insurance’, and no justification for singling them out for punitive capital charges and increased supervisory scrutiny.

Two widespread activities in particular are in regulators’ sights: the sale of variable annuities (VAs) and use of insurance-linked securities (ILS). Both are under consideration by the IAIS and FSB as potential non-traditional, non-insurance activities. Neither is considered as such by the industry.

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