A new issues paper from the International Association of Insurance Supervisors (IAIS) indicates that the world’s insurance regulators are increasingly going to be paying attention to the potential risks arising from the increased allocation to alternative assets and to the increasing adoption of cross-border, asset-intensive reinsurance (AIR).
“The paper highlights key supervisory focus areas related to these structural shifts and provides a framework to assist supervisors and insurers in assessing potential financial stability implications,” the association writes in a statement about the publication of the issues paper.
Entitled Issues Paper on structural shifts in the life insurance sector, the paper introduces a definition of alternative assets for the first time that is agreed upon globally. They say the lack of a broadly accepted alternative asset definition has made quantifying the trend difficult. “Regardless of definition, external data shows that both the supply of alternative assets and allocations to these have increased over the past two decades.”
The paper itself incorporates supervisory input and comments from more than 500 stakeholders.
“The primary aim of macroprudential policy for the insurance sector is to ensure that the financial system and insurers can absorb, rather than amplify, adverse shocks,” says IAIS secretary general, JonathanDixon. “Given the continued rapid growth in this area globally, and considering concentrations in certain insurers and markets regionally, it is critical the IAIS and insurance supervisors maintain a close watch.”
Hidden leverage concerns
The paper itself is extensive, looking at the benefits associated with alternative assets, supervisory concerns (in addition to valuation and liquidity considerations, these include hidden leverage concerns, links to private equity firms and potential conflicts of interest, credit risks and information gaps). It also examines the rising adoption of AIR in the sector and at the jurisdictional differences in approaching and managing the associated risks. (The paper notes that regulatory arbitrage could be a concern as different jurisdictions have different approaches and regulatory requirements for reserving, capital requirements and investing.)
The AIR transaction supervisory concerns that the association says are critical include the transactions’ “inherent complexity, recapture risk, concentration risk and the potential exploitation of cross-jurisdictional differences in reserve valuation, capital requirements and investment flexibility,” they write.
Key risks associated with alternative assets, meanwhile, include valuation uncertainty, illiquidity and complexity. They say addressing these requires risk management practices, scenario analysis and liquidity stress testing, strengthened governance and robust and transparent credit risk assessments.
“This paper finds that systemic risk appears limited at the global aggregate level,” they write. “Rapid growth of alternative assets and AIR, as well as concentrated exposures among certain insurers, warrant close monitoring to mitigate emerging vulnerabilities.”
