Regulators' Response To Systemic Risk In Life Insurance

The life insurance sector has become more systemically important across advanced economies, with the near-collapse of AIG during the Global Financial Crisis prompting a rethinking of the sector's systemic riskiness. Regulators have responded by taking a more macroprudential approach to the sector. For example, the Financial Stability Board (FSB) published a list of global systemically important insurers and intends to implement policy measures for these institutions by January 2019. Similarly, the US regulatory reform, the Dodd-Frank Act, imposed a new form of regulation on non-bank holding companies, including insurance companies, deemed to be Systemically Important Financial Institutions.

However, most insurance regulation remains microprudential in nature. The challenge for regulators is to effectively monitor systemic risk in the insurance sector, which has become more complex with the growth of private markets and the bundling and selling of derivative securities by a variety of institutions.

Prudential regulation and the role of supervisors

Prudential regulation and supervision are critical in mitigating systemic risk in the life insurance sector. Prudential regulation aims to ensure that insurance companies hold enough capital and introduce a risk-based approach to their operations. This involves setting capital requirements, regulating investment portfolios, and managing liquidity and interest rate risks. Supervisors play a crucial role in monitoring and enforcing these regulations to protect consumers and maintain financial stability.

In recent years, the life insurance sector has become more systemically important, particularly due to growing common exposures and insurers' rising interest rate sensitivity. This increased systemic risk has prompted a re-evaluation of the sector's regulatory framework. Supervisors and regulators are now encouraged to adopt a more macroprudential approach, which considers the potential impact of insurers on the broader financial system.

The International Monetary Fund (IMF) and the International Association of Insurance Supervisors (IAIS) have played key roles in assessing and addressing systemic risk in the insurance sector. The IMF's Financial Stability Report and the IAIS's Global Insurance Market Report (GIMAR) provide valuable insights and recommendations for supervisors and regulators.

To effectively manage systemic risk, supervisors should focus on several key areas. Firstly, they need to ensure that insurance companies have adequate capital buffers to absorb losses and shocks. This can be achieved by setting higher solvency ratio requirements and implementing stress-testing scenarios to determine capital needs accurately. Secondly, supervisors should monitor liquidity positions and encourage insurers to maintain strong liquidity buffers to withstand market downturns. Thirdly, supervisors should closely scrutinise dividend extractions to protect policyholders and ensure the long-term sustainability of insurance companies. Finally, corporate governance and potential conflicts of interest within complex organisational structures should be a key area of focus to prevent systemic risks arising from improper decision-making.

Additionally, supervisors should pay close attention to the increasing involvement of private equity (PE) companies in the insurance sector. PE firms bring new challenges and opportunities, and their impact on systemic risk must be carefully assessed. Supervisors should monitor the creation and functions of captive insurance companies, which may be used to lower insurance costs or distribute risk within a pool of affiliated insurers. Regulators should also encourage transparency in ownership structures and partnerships to prevent gaps in the financial value chain and the misuse of insurance for pseudo-insurance purposes.

Overall, the role of supervisors is critical in managing systemic risk in the life insurance sector. By implementing prudential regulations, conducting rigorous monitoring, and providing guidance to insurance companies, supervisors can help mitigate systemic risks and contribute to the stability of the global financial system.

Systemic risk and the insurance sector: a network perspective

The insurance sector's contribution to systemic risk has been a growing area of focus for regulators and supervisors in recent years. While the insurance sector has traditionally not been considered a source of systemic risk, the near-collapse of AIG during the Global Financial Crisis prompted a re-evaluation of the systemic riskiness of the sector. This paper aims to contribute to the ongoing debate by examining the role of insurance companies in the financial system, the interconnections between insurance operators, and the vulnerability factors that increase institutions' exposure to systemic risk.

The International Association of Insurance Supervisors (IAIS) highlights how systemic risk in the global insurance sector is still moderate overall, but with an upward trend due to increased illiquid exposures and assets, over-the-counter derivatives, short-term loans, and intra-financial assets. The insurance sector is significant in the network of financial relations and the global economic system, where a crisis can have systemic effects and repercussions due to highly interconnected financial activities.

Recent attention to systemic risk in the insurance sector has been driven by:

• International insurance groups focused on non-traditional businesses, which are often connected by complex reinsurance and retrocession relationships, acting as vectors of systemic risk.
• Investments of assets that increase the degree of interconnection with banks, such as investing directly in their capital or in securitized credit products.
• The close interconnection with the banking system, originating from bancassurance and accentuated by the development of IT innovations and the spread of financial conglomerates.
• The increasingly widespread offer of certain product categories (in the life sector) where the purely financial component takes on decisive importance.

These phenomena inevitably increase the transmission channels of systemic risk. The role of regulators and supervisory authorities is crucial in this context. Regulatory and supervisory interventions should focus on both macro- and micro-systemic supervisory tools.

The possible concentration of systemic risk should be considered at the level of individual insurers as well as the Insurer Pool. The aggregate systemic risk score has been increasing over the past five years, driven primarily by the interconnectedness and asset liquidation categories. A cross-sectoral analysis comparing the systemic footprint of insurers and banks showed that banks have significantly higher total cross-sectoral scores.

The European Systemic Risk Board (ESRB) is responsible for supervising the EU financial system and preventing and mitigating systemic risks. In its 2022 annual report, the ESRB reviewed and updated its assessment to consider new systemic risks, including increased political and economic uncertainty due to Russia's war in Ukraine. The ESRB's macroprudential mandate covers banks, insurers, asset managers, financial market infrastructures, and other financial institutions and markets.

The ESRB's contribution to this debate includes a discussion paper, "Systemic Risk and Macroprudential Policy in Insurance", which provides a comprehensive approach to the following questions:

• Does insurance create or increase systemic risk?
• If yes, what instruments are currently in place within the framework of Solvency II, and how do they contribute to mitigating these sources of systemic risk?
• Is there a need for additional tools, and if so, which ones could be encouraged?

To address these questions, the ESRB has published several documents, including "Systemic Risk and Macroprudential Policy in Insurance" (2017), "Solvency II Tools with Macroprudential Impact" (2018a), and "Other Potential Macroprudential Tools and Measures to Enhance the Current Framework" (2018b).

The ESRB's approach to systemic risk in insurance companies identifies five main transmission channels:

• Exposure channel
• Asset liquidation channel
• Failure to provide insurance products
• A channel similar to that of banks
• Expectations and information asymmetries

The ESRB's preliminary analysis shows that while the instruments with a direct macroprudential impact under Solvency II provide a significant contribution to limiting procyclicality, several sources of systemic risk are not sufficiently addressed by the existing tools. Therefore, there is room for further tools and measures to enhance the framework.

To enhance the current framework, the ESRB identifies the following potential macroprudential tools:

• Additional capital buffer to enable resistance to shocks and prevent deterioration and insolvency.
• Adoption of a sequential approach to liquidity risk, including improving reporting, monitoring liquidity risk, and introducing liquidity requirements.
• Restrictions on dividend extractions in the context of long- and short-term strategies to protect the policyholder.
• Corporate governance monitoring to avoid conflicts of interest within complicated structures.

In conclusion, this paper offers insights into the systemic dynamics within the insurance sector and reflects on regulatory developments aimed at preventing a systemic crisis. It is crucial to promote prevention measures, monitor all activities and risks, and establish organizational and management structures that enable insurance companies to maintain resilience within the system as a whole.

Systemic risk and insurance sector policies and financial connections

Systemic risk in the life insurance sector has been a growing concern for regulators and supervisors in recent years. The near-collapse of AIG during the Global Financial Crisis of 2007-2009 brought attention to the sector's potential for systemic risk. While traditionally, insurance companies were not viewed as posing systemic risks due to their longer-term liabilities, greater diversification of assets, and fewer interconnections with the financial system compared to banks, this perception has changed.

The life insurance sector's contribution to systemic risk has increased due to growing common exposures and insurers' rising interest rate sensitivity. This has led to a greater focus on the role of regulators and supervisory authorities in managing systemic risk in the insurance sector.

Regulators have responded to this challenge by adopting a more macroprudential approach, which involves looking at the system as a whole rather than just individual financial institutions. The Financial Stability Board (FSB), for example, has published a list of global systemically important insurers and plans to implement special policy measures for these institutions. The US Dodd-Frank Act also imposed new regulations on non-bank holding companies, including insurance companies deemed "Systemically Important Financial Institutions."

In Europe, the European Systemic Risk Board (ESRB) is responsible for supervising the EU financial system and addressing systemic risks. The ESRB's macroprudential mandate covers banks, insurers, asset managers, financial market infrastructures, and other financial institutions and markets. The European Insurance and Occupational Pensions Authority (EIOPA) has also published discussions and papers on systemic risk and macroprudential policy in insurance, identifying potential sources of systemic risk and evaluating the effectiveness of existing tools and measures.

To further mitigate systemic risk, regulators have proposed and implemented various policies and instruments. These include additional capital buffers, improved liquidity positions, restrictions on dividend extractions, and enhanced supervision and monitoring of liquidity risk and stress testing.

Overall, the response to systemic risk in the life insurance sector has been a work in progress, with regulators and supervisors continuously evaluating and adapting their approaches to address the evolving nature of systemic risk and its potential impact on the financial system.

Systemic risk and the role of the FSB

The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system. It was created by the G-20 in April 2009 to monitor the finance industry and make recommendations to address systemic risk. The FSB's decisions are not legally binding on its members; instead, it operates by moral suasion and peer pressure to set policies and minimum standards that its members commit to implementing at the national level.

The FSB has taken an active role in addressing systemic risk in the insurance sector. In 2011, it published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs). In 2013, it identified an initial list of global systemically important insurers (G-SIIs) and the policy measures that should apply to them. However, in 2022, the FSB decided to discontinue the annual identification of G-SIIs and instead utilise assessments available through the IAIS Holistic Framework to inform its considerations of systemic risk in the insurance sector.

The FSB will continue to receive annual updates from the International Association of Insurance Supervisors (IAIS) on the outcomes of its Global Monitoring Exercise, including the assessment of systemic risk in the global insurance sector, possible concentration of systemic risks at an individual insurer level, and the supervisory response to identified risks. The IAIS will also continue its annual data collection from individual insurers and supervisors to support its assessment of sector-wide trends and its annual reporting on the outcomes of its assessment and progress in implementing the Holistic Framework supervisory policy measures.

Should circumstances warrant, the FSB may, in consultation with the IAIS and national authorities, publicly express its views on whether any individual insurer is systemically important in the global context and the appropriate application of the Holistic Framework supervisory policy measures it deems necessary to address such systemic importance. The FSB will also aim to develop further guidance regarding approaches to determine the scope of application of the Key Attributes of Effective Resolution Regimes for Financial Institutions (KAs).

In addition to its work on systemic risk in the insurance sector, the FSB is also addressing vulnerabilities in the non-bank financial intermediation (NBFI) sector and structural vulnerabilities related to digitalisation, cyber incidents, and the use of artificial intelligence. It is also working to address climate-related financial risks and is conducting a stocktake of regulatory and supervisory initiatives on nature-related financial risks at the request of the Brazilian G20 Presidency.

Systemic risk and the role of the ESRB

The Entertainment Software Rating Board (ESRB) is a self-regulatory body that assigns age and content ratings to consumer video games in Canada, the United States, and Mexico. The ESRB was established in 1994 by the Entertainment Software Association (ESA) in response to criticism of controversial video games with excessively violent or sexual content. The ESRB's primary mission is to help parents make informed decisions about the video games their children play.

The ESRB rating system is an unbiased, standardized way to help determine whether a game is appropriate for children. Ratings are based on a game's content, using a combination of age-based levels and "content descriptors" that detail specific types of content present in a game. The ratings are designed to help parents make informed decisions about purchasing games for their children.

The ESRB has three main functions:

• Rating Categories: These suggest age appropriateness, with ratings ranging from "Early Childhood" to "Adults Only 18+".
• Content Descriptors: These indicate specific types of content that may be of interest or concern, such as violent actions, sexual content, drug use, or gambling.
• Interactive Elements: These highlight online features or interactions with other users that may be of interest or concern but do not influence the rating assignment.

The ESRB also enforces industry-adopted advertising guidelines and provides certification services for online privacy on websites and mobile apps. The ESRB has an enforcement system that allows for sanctions, fines, and corrective actions on publishers for non-compliance with its guidelines.

While the ESRB operates independently of the ESA, its ratings are enforced on a self-regulatory basis by the video game and retail industries in subscribing countries. Most stores require customers to present photo identification when purchasing games with the highest age ratings and do not stock unrated games. Console manufacturers will not license games for their systems unless they carry ESRB ratings.

The ESRB has been praised by the Federal Trade Commission as the "strongest" self-regulatory organization in the entertainment sector. However, it has faced criticism from politicians and watchdog groups for its structure and operations, particularly regarding its handling of sexually explicit or violent content in certain games.

In summary, the ESRB plays a crucial role in providing information about the content and age appropriateness of video games, helping parents make informed decisions. Through its rating system and enforcement of industry guidelines, the ESRB contributes to addressing systemic risk by ensuring that consumers, especially children, are protected from inappropriate content.

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