Bank for International Settlements: Insurance and financial stability: a Basel view

08 April 2013

BIS General Manager Jaime Caruana speaks about the importance of the work that the IAIS and the supervisory community are undertaking. He highlights three major challenges: cooperation among different supervisors; the conceptual challenge of coping with systemic risk; and the economic environment.

Cooperation among different supervisors

He said a few words about what we call the Basel Process. The Process is based on various features. One is the physical proximity of independent financial stability committees, such as the BCBS, the IAIS and the FSB, hosted by the BIS, and the resulting synergies among them. Each standard setter brings its expertise in different business models and its own independent governance process. BIS contributions are also important in terms of research and banking experience. Yet another important aspect of the Basel Process is the dissemination of financial stability work to the broader public. By putting together all these elements, we can generate synergies and better coordination in a flexible environment. The BIS is very happy to host the IAIS and to ensure its full participation in the Basel Process.

The conceptual challenge of coping with systemic risk:

• a first lesson is that we know much less than we thought we knew. Moreover, the financial system is constantly, and rapidly, evolving;
• a second lesson relates to SIFIs he understands that there are important differences between the business models of banks and insurers, but he is convinced that the same rationale can be adapted to other industries;
• a third lesson of the crisis is that regulation itself is not sufficient if it is not properly enforced in a timely and consistent way across all jurisdictions. Actual implementation of the standards had a great bearing on the severity of the crisis across countries; and
• a last lesson is that we need a regulatory approach that is consistent across the main jurisdictions and sectors, as financial firms are becoming more and more interconnected.

The economic environment, including the deterioration of the creditworthiness of many sovereigns and the protracted low rate environment, known as "low for long"

As regards the first issue of sovereign risk, it has to be recognised that, as financial firms with long-duration liabilities, insurers and pension funds need long-duration assets:

• they have long looked to government bonds as their core holdings to match liabilities;
• in addition, they have raised returns, typically at shorter maturities, through investment carrying considerable credit risk;
• insurers benefited from governments taking on debt during the crisis in order to limit private credit risk - think of insurers' holdings of bank bonds - but they now face the consequences of high and still rising government debt; and
• thus, risk managers in insurance companies are re-examining their basic business model. In particular, they are asking awkward questions about insurance companies' ability to survive the distress of any sovereign to which they are exposed.

A second threat to insurers' business model is "low for long" bond yields. This threat has several aspects:

• low rates for long can put solvency pressure on those life insurers that have committed to delivering too-high returns for policyholders;
• there is a risk that competitors will simply reach for yield and not adjust their pricing of annuity-type products sufficiently, and that business will shift to those most willing to take risks;
• and even if the industry does adjust its pricing appropriately, customers may go elsewhere, hurting revenues while leaving operating costs; and
• but if customers do go elsewhere, who will provide the long-term financing needed by the real economy? Any cutback in such financing would undermine long-term growth prospects and financial stability.

 

Full speech

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