07 April 2003

IAIS study on credit risk transfer

The paper focuses on the use and extent of credit risk transfers, issues for financial stability and for risk management within insurance firms, and supervisory and regulatory issues.

Credit risk transfers increase substantially Although the paper concludes that it is very difficult to gather definitive global data on credit risk transfer transactions, the information shows that there has been a substantial increase in credit risk transfer activities, albeit from a very low base. It appears that credit derivatives are only a relatively small proportion of insurers’ investment activities, even though the industry, particularly the reinsurance industry, is a significant player in the global market.

Issues for financial stability Credit risk transfers potentially provide a stabilising mechanism, enabling risks to be spread amongst a greater pool of players. However, this effect is likely to be limited by the small number of 15-20 specialist players from the insurance sector who seem to be involved. The paper highlights that regulatory arbitrage does not appear to be the main driver for credit risk transfer activities, but that they are driven more by general commercial reasons, such as insurers seeking increased yields and diversification of portfolios. But still more consistent data information is needed to definitely judge the risks (re)insurers are exposed to in this area.

Issues for risk management within insurance firms The paper points out that credit risk transfer straddles both the investment and the underwriting activities of insurers and raises potentially difficult issues for implementation of risk management systems within insurance firms. Firms need to acquire new skills and techniques before they participate in the credit risk transfer market.

Supervisory and regulatory issues The IAIS urges that regulatory standards should not encourage or facilitate regulatory arbitrage. Regulatory frameworks should ideally result in similar capital charges and risk management requirements for 'like' risks in the different financial sectors. Furthermore, supervisory staff need to have sufficient skills and tools to assess firms’ risk management systems and controls in the area of credit risk transfer.

Background In 2001 the Financial Stability Forum asked both the International Association of Insurance Supervisors (IAIS) and the Committee for the Global Financial System (CGFS) to consider the issues and the possible implications for financial stability. The focus of the work carried out and the conclusions are broader than just implications for stability, and focus in particular on issues for both insurance firms and insurance supervisors as a result of growth of credit risk transfer activities.

Full study

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