THE INSURANCE SECTOR TRENDS AND SYSTEMIC RISK IMPLICATIONS

Transcription

1 THE INSURANCE SECTOR TRENDS AND SYSTEMIC RISK IMPLICATIONS Based on Global Financial Stability Report, IMF, April 216 Nico Valckx Workshop on Systemic Risk in Insurance Columbia Business School, October 28, 216

2 Motivation and Main Findings

3 Motivation (1) Insurance sector: Big player in financial markets Important economic functions Relative Size of Financial Intermediaries (Percent of GDP) Insurance Banks OFIs Pension funds United States Canada Euro area United Kingdom Japan Korea

4 Motivation (2) Two views on systemic risk Domino View Individual insurers Tsunami View System of insurers Large complex interconnected Distress? Shock to asset prices Common exposures Default, stop funding, stop lending, securities. Counterparty stress risks to real activity Correlated sales, fire sales, stop/reduce funding.

5 Questions answered in GFSR Has insurance sector s systemic importance changed over time/countries? What explains changes in systemic importance? Investment behavior Maturity mismatches Business models Broader market dynamics Implications for insurance regulation?

6 Main findings Systemic importance Increased, esp. life, but lower than banks More homogenous, higher commonalities Increased market risk and rate sensitivities Spillovers Insurers transmit shocks across financial system Especially in Europe and North America Life insurers assets No major shift towards riskier assets But assets have become riskier Search for yield among weaker, smaller firms Regulatory implications Macro-prudential approach needed International capital and transparency standards Focus on smaller and weaker firms

7 Insurance Sector: Systemic Importance

8 Increased price comovement among insurers Time series clustering (Number of clusters) Insurers Equity Return Due to First Principal Component (Percent) I II I II I II I II I II Life Nonlife Life Nonlife Mixed United States Europe

9 Systemic Risk rising CoVaR and capital shortfalls North America Europe Advanced Asia CoVaR Indices (Normalized, 26=1) 35 3 Life insurers 35 3 Life insurers 35 3 Banks Banks Banks Nonlife insurers Nonlife insurers Life insurers Nonlife insurers Conditional capital shortfall (USD trillions) Life insurers 2. Life insurers.8 Life insurers.8 Nonlife insurers Banks 1.5 Nonlife insurers Banks.6 Nonlife insurers Banks

10 Systemic Risk Default Correlation Networks rank Life high Forward-Looking Default Correlation Networks (Percent; over- or underrepresentation of insurers) Life insurers Non-life insurers 2 Top 25 Top 5 Top 1 8 Top 25 Top 5 Top Nov-1 Mar-7 Aug-8 Dec Nov-1 Mar-7 Aug-8 Dec-14 A +1 percent value for the top 1 indicates that there are 1 percent more insurance firms among the top 1 than justified by their sample share.

11 Systemic Risk Spillovers: Insurance is shock transmitter

12 Systemic Importance Drivers

13 Investment behavior Take on greater asset risk in low rate environment? Across asset categories true only for weaker, smaller firms Increased similarity in asset composition? Not apparent Greater procyclicality in investment behavior? Mixed evidence But greater common exposure to aggregate risk rates

14 1. More risky investments: at lower cap, smaller firms and those with more annuity/min.return products In low environments, factors that contribute to higher exposure to riskier assets are lower-capitalization. 1 2 With low rates, the propensity of lower-capitalized firms to hold riskier assets is strengthened a higher share of annuity products in total liabilities With low rates, the propensity of firms with higher annuity product shares to hold riskier assets is strengthened. Firms with higher guaranteed rates on life insurance offerings have larger risky asset portfolios High Low High Low High Low All -5 High Low High Low High Low Guaranteed United States Canada Netherlands Germany United States Canada Netherlands Germany 3 and the size of the firm, with smaller being more exposed With low rates, the propensity of smaller firms to hold riskier assets is strengthened. High Low High Low All All All United States Canada Netherlands Germany Korea

15 2. Procyclicality 3. Duration mismatches - Mixed evidence - Higher i-rate sensitivity U.S. insurers acted countercyclically in 28 and contributed to stability US and European Insurers' Equity Returns Interest Rate Sensitivity Increases and so does their net duration mismatch Precrisis Postcrisis Life Nonlife Life Nonlife Mixed Life Nonlife U.S. insurers European insurers Asian insurers But turnover at firm level did not increase in recent years Note: For a negative (net) duration, insurers liabilities are longer than their assets. Insurers future business prospects get better (worse) when rates increase (fall).

16 4. Liability side developments may also contribute to riskiness Life Insurers Unit-Linked Products (Percent of assets) United States Germany Korea Switzerland Netherlands United Kingdom Scandinavian countries Canada Unit-linked products are a form of long-term insurance whereby the policyholder chooses the investment strategy. These products can, but do not necessarily have to, include guarantees. Alternative Insurance Risk Capital Instruments (Billions of U.S. dollars) 7 Catastrophe bonds Sidecars 6 Industry loss warranties Collateralized re and other 5 Share alternative capital (right scale) :H1 (Percent)

17 5. Changed Market Dynamics Higher cross-asset correlations post-21 Temporary factors Search for yield Lower risk aversion Greater similarity across insurance firms stock prices Structural changes Increase risk of market illiquidity Benchmarking more widespread Insurance stocks more affected by common shocks

18 Implications for Regulation

19 Recent Regulatory Developments Regulations now more risk-based and accounting principles more market-based valuations more market-sensitive investment horizons of risky investments shortened the maturity of safe assets extended Wide variations in capital requirements and the use of internal models These are among the main problems in developing a global capital framework But progress is being made

20 Compliance with ICPs 1. Selected IAIS Core Principles on Regulation 2. Selected IAIS Core Principles on Business Strategies Observed Unobserved Observed Unobserved AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM AE EM Exit M&A Cond. Enforce. PCA Report MaPru. Groups Activity Invest. Liab. Risk Mgt. Cap. Gov. Disclose

21 Forward looking lessons for Regulation Macro-prudential approach address risks related to common exposures Market-consistent valuation standards enhance transparency address duration mismatches Supervisory follow-up of smaller and weaker firms Focus should not be restricted to only large firms Too -many-to-fail problem Contagion Vigilance to avoid regulatory arbitrage