February 27, 2021

Warning Raised on European Union Plan to Change Rules for Insurers’ Investments

A report by the Institute of International Finance, which represents more than 400 of the largest financial firms, criticized incentives provided to banks and insurers under different sets of international regulatory plans to place more emphasis on holding sovereign debt in their capital buffers.

“Given the current instability in several government bond markets, blanket incentives under the new regulatory regimes for banks and insurers to increase their holdings of sovereign debt may be questionable,” the group said.

Specifically, the report said, incentives that are likely to be created by impending European rule changes, known as Solvency II, to encourage insurers to shorten the maturity of their corporate bond holdings “may run counter to the precepts of good risk management and asset-liability management principles by encouraging insurers to shorten the tenor of their asset portfolios while their cash-flow profiles remain generally long term.”

Given the current turmoil in financial markets, coordination of regulation of insurers and banks is more important than ever, the report asserted.

The Solvency II rules are still being completed by Brussels. They aim to establish revised capital requirements and risk-management standards for insurers in the European Union to replace the current solvency requirements.

The European Commission, the executive arm of the union, says that the new rules “will be more risk-sensitive and more sophisticated than in the past, thus enabling a better coverage of the real risks run by any particular insurer.” A European Union spokesman could not be reached Wednesday for comment on the report.

A partner at the consulting firm that co-wrote the report said that the proposed changes could actually increase risk in insurers’ capital bases by encouraging them to hold riskier assets.

“Changes in the regulatory treatment of different asset classes will inevitably have implications for insurers’ asset allocation decisions,” said Matthew Leonard, a partner at the consulting firm Oliver Wyman. “This and other aspects of the reforms to banking and insurance regulation may have consequences that are unintended.”

The institute’s managing director, Charles H. Dallara, cautioned that, contrary to market expectations, insurers might be reluctant to add sovereign debt to their portfolios because of concerns about the volatility and liquidity of those assets. “Assumptions regarding the willingness and ability of the insurance sector to provide a ready market for new capital and funding may be overstated,” Mr. Dallara said.

Current estimates, including those of the Basel Committee on Banking Supervision, suggest that banks will have to raise $750 billion of capital to meet the new requirements for capital ratios, known in the industry as Basel III. But, Mr. Dallara added, the need for additional longer-term financing will be much greater than that.

Under planned rule changes, it is assumed that regulators will expect insurers to be major investors in new bank capital and to invest more of their cash in sovereign debt. But given the continuing fiscal crises in Greece, Portugal, Ireland and more recently Italy, as well as the recent volatility of banking shares, the insurers appear less than enthusiastic.

“Even if insurers were willing to increase their exposure to bank assets, sound risk management practices and new insurance regulation will tend to militate against any further increase, particularly of long-term funding,” Mr. Dallara said.

“The formulation of Basel III,” he added, “may be based on assumptions about the role that insurers may play in this process that are not supported by the experience of the insurers to limit their exposure to banks, nor the evolution of the regulatory framework for that sector.”

The report said it was important for regulators to understand the linkages between banking and insurance, and between different national and regional approaches.

“Uncoordinated reforms will be less effective in promoting financial stability and will undermine the ability of insurers and banks to undertake their core functions in supporting economic activity and recovery,” said Walter B. Kielholz, a member of the institute’s board and the chairman of the reinsurer Swiss Re. “The long-term investment function of insurers in the real economy needs to be preserved through appropriate regulatory incentives.”

Martin Senn, a board member of the institute and the chief executive of Zurich Financial Services, said, “Banking regulation affects the activities of insurers and vice versa, and both will be less effective if these spillover effects are insufficiently recognized. Regulatory reform does not need to be harmonized across sectors, but it definitely needs to be coordinated.”

Article source: http://feeds.nytimes.com/click.phdo?i=c73b704d50f20d934d63b008cab2a0c3

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