CDS Spreads, Systemic Risk and Global Systemically Important Insurers Designations

Abstract

After the recent court case overturning the Financial Stability Oversight Council (FSOC)’s systemic importance designation of MetLife, the public raises awareness about the robustness of the identification methodology for global systemically important insurers (G-SIIs). As the G-SII identification framework proposed by the International Association of Insurance Supervisors (IAIS) lacks empirical support and relies heavily on historical accounting data, we examine how systemic risk measures constructed from credit default swaps (CDS) data, which are market-consistent and forward-looking, can supplement the IAIS’ identification framework. Using a dataset of insurers’ CDS spreads between 2011 and 2015, we construct three different kinds of systemic risk measures (i.e., MESCDS, networks of CDS spreads and absorption ratio) and assess the G-SII designation results announced by the Financial Stability Board (FSB). We find that: 1) the systemic risk of designated G-SIIs is, on average, higher than other insurers, suggesting that the IAIS’ G-SII identification methodology is, in general, sound and effective; 2) reinsurers should fall within the IAIS’ G-SII assessment exercise, as some of them generate more systemic risk than the designated G-SIIs; and 3) given the non-negligible litigation risk from the designated G-SIIs, the regulators should consider supplementing their G-SII identification methodology with CDS-based systemic risk measures to substantiate their designation decisions in court.