Insurers as Systemically Important Financial Institutions (SIFIs)? Exploration and Methodology

Abstract

This paper focuses on developing a methodology for identifying potential Systemically Important Financial Institutions (SIFIs) in the insurance sector. While many contend that insurers do not cause systemic risk, regulators asked to include insurers in the SIFI designation. In order to operationalise the identification process for potential SIFIs, the methodology suggested in this paper uses the definitions of the Financial Stability Board (FSB) and the International Association of Insurance Supervisors (IAIS) for systemic risk. The categories are: 1. Size, 2. Interconnectedness, 3. Substitutability, and 4. Timing, in combination. With these categories in mind, we adopt the results of the seminal report of the Geneva Association “Systemic Risk in Insurance” (2010) which regards the activities of insurers as the key for the analysis. The report concludes that core or traditional insurance activities do not fit into the definition of systemic risk. Activities that are quasi banking or non-core thus may fit into potentially systemically risky activities (pSRAs). Thus, the first step of our proposed methodology is a discovery of pSRAs in insurance. PSRAs are not indicators to insolvency. They are used in the second phase for a discovery of those insurers that engage in pSRAs. Briefly, Phase I is the methodology to discover pSRAs, and Phase II is the methodology to find which insurers are engaged in pSRAs and determine whether they meet SIFI status. Only such insurers are to be scrutinized for a potential designation as SIFIs. Such insurers’ engagement in pSRAs will be measured and examined based on benchmarks indicators in Phase II. If their exposure to the pSRA is above the indicators’ benchmarks, those insurers will be a “pSRA insurer.” Further studies are expected since the IAIS is calling for data collection. The engagement in a pSRA over a specified benchmark should not lead automatically to a SIFI designation of an insurer. As long as the insurer can carry the activity, it should not cause a systemic problem to the economy. Therefore, the current regulatory system is engaged to additional measures of such a “pSRA insurer.” Key is the institutional engagement in pSRAs. The pSRAs is the added dimension above the solvency regulation system. Examples of pSRAs we use here are: derivatives for speculations and mismanagement of short term investments. Indicators in Phase II are provided as well.