Regulatory Pressure，Regulatory Forbearance and the Risk-Taking of Nonlife Insurers

Abstract

An effective insurance supervision system is to exert the supervisory authority to take prompt corrective actions when the financial situation of insurers is deteriorating, the probability of bankruptcy is increasing, or the solvency is below the statutory standard. Prompt Corrective Action plays a defensive role in the Risk-Based Capital System, which ensures the regulatory agencies take timely and effective action to reduce the adverse impact of troubled insurers on the financial system. However, regulatory forbearance is not uncommon in practice. For example, when insurers do not satisfy the solvency requirement, in order to avoid public panic, the regulatory agencies may not promptly punish them. Regulatory forbearance allows a distressed financial institution to continue to operate rather than liquidation immediately. Classified regulation in China’s insurance regulation system allows regulators to flexibly decide the disposal method. Since the selective” regulatory measure may give problematic insurers a chance to speculate and delay the disposal time, the regulators may fall into the regulatory forbearance” trap and the disposal cost is expanded. In this paper, using the panel data of China’s property insurance companies from 2009 to 2016, we test whether regulatory forbearance exists in China’s nonlife insurance market, and what effects it may have on insurers’ risk-taking. We find that the insurers whose solvency is below the statutory standard will replenish capital under the regulatory pressure, but it is not prompt, so there is partial regulatory forbearance in the market. Insurers with insolvency have significantly higher underwriting risk than those with sufficient solvency, but the overall risk and investment risk are not significantly lower than those with sufficient solvency; Insurers falling into the regulatory forbearance zone will underwrite more actively, reduce risky investment significantly, and rely on the debt-driven business model more excessively. In addition, the paper summarizes the insurers whose solvency is lower than the regulatory standard in the period of 2009-2016, and finds that most of them fail to find the best capital replenishment solution when their financial situation deteriorates further. The self-rescuing time is long, and the insurers are in the insolvency state for several consecutive accounting years. Most insurers are forced to replenish capital when their solvency is far below the standard. The conclusions have important policy implications. Specially, the regulatory forbearance in China’s nonlife insurance market is helpful for the execution of CROSS （China Risk-Oriented Solvency System） and the stability of the insurance industry, as it prevents the nonlife insures who lack capital from falling into crisis, while more stringent regulation may make insurers more fragile, especially in poor operating environment.