25 January 2016

Financial Times: Banking can learn from insurance on systemic risk

Removal from the nine-strong list of insurers, deemed systemically important financial institutions (Sifis), meant a huge administrative problem evaporated. So did the prospect of tougher Sifi capital requirements from 2019. Generali’s secret had been to shrink and simplify its business.

MetLife, the biggest US insurance company by assets, has been on a mission to shake off its Sifi label ever since it got it. A year ago, it took legal action against the US regulatory body, the Financial Stability Oversight Council, to challenge the designation. A couple of weeks ago, it announced plans to shrink, by spinning off a unit that generates 20 per cent of profits. This may have been a ruse to ditch a low-margin business but it may also prove a canny way to avoid the Sifi requirements, providing another route map for big rivals.

The black-box exercise that the FSB and FSOC engage in when deciding on Sifi labelling is frustrating for insurance companies and puzzling for everyone else. Generali escaped the designation more than two years after it sold the US business that looked like a principal risk, and only after it had also sold a pretty banal private bank.

Quite why Aegon has suddenly been included is similarly mysterious. The Dutch group only scrapes into the top 20 insurers in the world, ranked by market capitalisation, and is barely a tenth the size of the biggest, China Life, which is not designated a Sifi.

Most illogical of all is the absence of any reinsurers on the Sifi list, particularly the likes of Warren Buffett’s Berkshire Hathaway, Munich Re or Swiss Re.

All the same, the regulators are right in their aims. Basing their assessments on both size and complexity makes sense, and penalises the kind of balance sheet risk — and financial market complexity — intrinsic to, for example, annuity guarantees underpinned by elaborate derivatives contracts.

It is also a useful check on the merger and acquisition fever that gripped insurers — like other hot sectors — last year. Get too big and the economics no longer add up.

The dynamic between insurers, their regulators and their shareholders should be instructive for the banking industry, 30 of whose number are deemed systemically important by the FSB.

Despite the turmoil, and all the talk of banks being under pressure, there has been little sign of the biggest balance sheets shrinking on either side of the Atlantic. With a few blips, JPMorgan has grown consistently since the financial crisis and now has a $2.4tn balance sheet. The same goes for BNP Paribas, with €2.1tn of assets. Over a similar period, HSBC’s assets of $2.5tn are almost unchanged.

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