Abstract
Insurance regulation, often viewed as a dreary backwater by politicians and economists, is as critical as the banking sector in promoting financial stability, economic growth, and consumer protection. Life insurance and pension plans are almost as ubiquitous as mortgages. Their providers hold $50 trillion worth of assets worldwide. In the last chapter, I argued that financial stability is best achieved through a transfer of risk based on the different risk capacities between short-term funded institutions like banks and long-term funded institutions such as life insurers and pensioners. Banking and insurance stability are simply different sides of the same coin. To view them as two separate endeavors is a grave mistake. The regulation of both banking and insurance must be integrated from a systemic risk perspective.
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- 1.
Bank of England, “Working Party on Pro-Cyclicality” (London: Bank of England: June 2014).
- 2.
Solvency II Directive, European Commission 138 (2009). See also Commission Delegated Regulation 2015/35.
- 3.
Solvency II was initially due to be implemented on January 1st, 2013, but concerns over its impact caused that date to be pushed back. Even post-January 1, 2016 its implementation will only be phased in.
- 4.
There were early concerns that the whole group of a non-EU insurance company with an EU subsidiary would have to comply but that is not the case. US and other non-EU groups complain that having the EU subsidiary comply with Solvency II as a stand-alone entity, with its own capital-adequacy requirement, reduces the scope for its customers to benefit from efficiencies in capital management of the larger group.
- 5.
Whether insurance companies are systemic in the same way as banks is an interesting question but space constraints preclude this from being properly addressed here.
- 6.
The FSB has declared the following insurance companies to be globally and systemically important: Allianz SE American International Group Inc., Assicurazioni Generali SpA, Aviva PLC, Axa SA, MetLife Inc., Ping An Insurance (Group) Company of China Ltd., Prudential Financial Inc., and Prudential PLC.
- 7.
See Charles Goodhart, The Basel Committee on Banking Supervision: A History of the Early Years, 1974–1997 (Cambridge, UK: Cambridge University Press, 2011).
- 8.
Value-at-Risk (VaR) and Daily-Earnings-At-Risk (DEAR) are examples of these risk management approaches.
- 9.
It was not simply good luck for investment banks that regulators adopted this approach. They had a strong hand in making the case. See Avinash Persaud, “Banks Put Themselves at Risk in Basle,” Financial Times, October 16, 2003.
- 10.
The European Economic Area (EEA) is made up of the EU member states plus Norway, Liechtenstein, Iceland and, pending ratification, Croatia.
- 11.
See EIOPA’s website for further details: www.eiopa.europa.eu
- 12.
Ibid.
- 13.
Ibid.
- 14.
Even before the most recent quantitative-impact assessment in 2014, the Economist Intelligence Unit Report for BlackRock conducted a survey looking at 223 insurers with European operations, finding that 97 percent of insurers agree that the equity-risk premium would have to rise to justify them investing in equities given the new capital charges. Ninety one percent agree with the idea that share prices will be lower as a result of Solvency II, and 91 percent agree that corporations will respond by switching from equity to debt issuance. For a simulation exercise on the impact of Solvency II on insurers’ investments, see Andre Thibeault and Mathias Wambeke, Regulatory Impact on Banks’ and Insurers’ Investments (Ghent, Belgium: Vlerick Centre for Financial Services, September 2014).
- 15.
On August 14, 2013, the UK’s Independent newspaper, quoted Mr. Tidjane Thiam, then CEO of Prudential Insurance of the UK, as saying that “the proposed Solvency II regime could prevent insurers from investing in infrastructure and property . . . costing the UK jobs and growth.”
- 16.
EIOPA
- 17.
See Bank of England, June 2014.
- 18.
Hedging of risks means neutralizing or offsetting them so that they no longer have impact. Individuals often hedge risks, like the risk of a motor accident, by buying insurance against that risk.
- 19.
See William R. Cline and Joseph E. Gagnon, Lehman Died, Bagehot Lives: Why Did the Fed and Treasury Let a Major Wall Street Bank Fail? (Policy Brief 13-21, Peterson Institute for International Economics, September 2013).
- 20.
According to Tony Lomas, the Pricewaterhouse Cooper partner leading the administration, as reported in Lehman’s UK Unit Administrators Foresee £5bn Surplus, Financial Times, March 5, 2014.
- 21.
This is one reason why it is inappropriate for these companies to buy bail-in bonds issued by banks; see Avinash Persaud, Bail-In Securities Are Fools’ Gold (Washington, DC: Peterson Institute for International Economics, November 2014).
- 22.
Although the S&P 500 is estimated back to 1928, the original index started form in 1928 as the S&P 90 until 1957 when it became the S&P 500.
- 23.
This is through the futures market. Futures in the S&P 500 (as opposed to funds that hold the component shares) are one of the most liquid financial instruments.
- 24.
Data was provided by CLSA Ltd.
- 25.
Standard deviation is a measure of the distribution of outcomes. In a normal distribution—one that looks like a bell jar—68.3 percent of outcomes are within one standard deviation from the mean, 95.5 percent of outcomes are within two standard deviations from it, and 99.7 percent of outcomes are within three.
- 26.
Ibid.
- 27.
See data of the Federal Reserve database in St. Louis (FRED), http://research.stlouisfed.org/fred2/
- 28.
Returns are calculated with re-invested dividends. The peak-to-trough decline during this ten year period was greater than zero but this highlights my point that more time reduces market and liquidity risk.
- 29.
Even the harrowing period in the stock market from 1929 to 1948 is positive once dividends are reinvested. Today, in the US, where dividends are becoming a rarity, the importance of dividends on equity returns in the past is often forgotten.
- 30.
The real return of an investment, mean returns after inflation has been subtracted.
- 31.
Author’s calculations derived from the FRED data.
- 32.
See Avinash Persaud, “Market Liquidity and Risk Management” in Liquidity Black Holes: Understanding, Managing and Quantifying Financial Liquidity Risk (London: Risk Books, 2002).
- 33.
We all tend to fight the last war and avoiding a repeat of AIG has been a strong motivation for insurance regulators in recent years. But, arguably, AIG was a special case of an institution acting like a bank while in an insurer’s clothes and could be dealt with more specifically.
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Persaud, A.D. (2015). Putting the New Framework to the Test. In: Reinventing Financial Regulation. Apress, Berkeley, CA. https://doi.org/10.1007/978-1-4302-4558-2_6
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