Life insurers and systemic risk

Life insurers and systemic risk

The IMF’s latest Global Financial Stability Report argues that life insurers’ portfolios may have become more similar in their exposures to market risk. In particular, interest rate sensitivity may have increased as a result of more pronounced negative duration gaps (maturity of liabilities longer than that of assets), an increase in products with minimum guarantees and higher cross-asset correlations. As a result, life insurers’ investment behaviour may have become more procyclical and they may reinforce shocks rather than absorb them. A common negative shock affecting life insurers (for example, a downward shift in government bond yields) could be compounded by insurers selling corporate bonds.

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The IMF’s latest Global Financial Stability Report (PDF 4.27 MB) devotes a chapter to the contribution of life insurers to systemic risk.

The main findings are:

First, although the failure of an individual large life insurer could still have systemic consequences, this potential impact has not increased.

Second, the asset composition of life insurers’ portfolios has not become significantly more similar.

However, there are some growing concerns because:

Third, low interest rates have induced some life insurers (in particular, insurers with higher shares of guaranteed liabilities or with weaker capital positions, and smaller firms) to take on relatively more risk in a “search for yield”.

Fourth, notwithstanding the second point, life insurers’ portfolios may have become more similar in their exposures to market risk. In particular, interest rate sensitivity may have increased as a result of more pronounced negative duration gaps (maturity of liabilities longer than that of assets), an increase in products with minimum guarantees and higher cross-asset correlations.

Fifth, life insurers’ investment behavior may have become more procyclical and they may reinforce shocks rather than absorb them. A common negative shock affecting life insurers (for example, a downward shift in government bond yields) could be compounded by insurers selling corporate bonds.

In response to this, the IMF makes a number of policy recommendations, including: a closer monitoring of sector-wide developments; the use of macro-prudential instruments such as counter-cyclical capital buffers and limits on the use of minimum guaranteed interest rates on new life insurance contracts, to protect against or prevent the growth of systemic risk; more supervisory attention on smaller and weaker life insurers; and an international capital standard to protect against systemic risk and spillover effects.

In many respects, this sector-wide emphasis is similar to the IMF’s approach to systemic risk in the asset management sector – focusing more on systemic risk across the sector than on the systemic importance of individual regulated firms.

Regulatory challenges

KPMG’s Financial Services Regulatory Centers of Excellence can provide insights into the implications of the raft of regulatory change.

 
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