Insurers May Not Pose A Systemic

Risk, So Do The G-SII Designation's

Costs Outweigh Its Benefits?
Primary Credit Analyst:
Rob C Jones, London (44) 20-7176-7041; rob.jones@standardandpoors.com
Secondary Contacts:
Rodney A Clark, FSA, New York (1) 212-438-7245; rodney.clark@standardandpoors.com
Connie Wong, Singapore (65) 6239-6353; connie.wong@standardandpoors.com
Volker Kudszus, Frankfurt (49) 69-33-999-192; volker.kudszus@standardandpoors.com
Tracy Dolin, New York (1) 212-438-1325; tracy.dolin@standardandpoors.com
Dennis P Sugrue, London (44) 20-7176-7056; dennis.sugrue@standardandpoors.com
Ron A Joas, CPA, New York (1) 212-438-3131; ron.joas@standardandpoors.com
Matthew A Walker, New York (1) 212-438-9375; matthew.walker@standardandpoors.com
Table Of Contents
Can Insurers Be "Too Big To Fail"?
The G-SII Designation's Consequences Are Unfolding
The Global Capital Standard May Be Beneficial In The End, But The Lead
Time Is Short
So Far, G-SII Designations Have Had No Direct Rating Impact
Related Criteria And Research
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Insurers May Not Pose A Systemic Risk, So Do
The G-SII Designation's Costs Outweigh Its
Benefits?
Nine large global insurers are learning to operate as global systemically important insurers (G-SIIs) after the Financial
Stability Board (FSB) assigned them this designation last July, and we should hear in November whether the FSB will
add any reinsurers to the list. While being a G-SII comes with additional oversight and potentially higher capital
requirements, no rating actions (in either direction) have resulted from the designation thus far. But Standard & Poor's
Ratings Services believes that classification as a G-SII may have longer-term credit consequences for these insurers,
both positive and negative.
We recognize that large insurers are systemically important because of the role they play in the financial system.
However, we question whether their potential failure poses a systemic risk in the same way that most large banks'
would. As such, the question becomes whether naming certain insurers as G-SIIs enhances financial stability and
warrants the resulting costs to insurers and their regulators.
Overview
The merits of the G-SII designation for global financial stability are not clear, in our view, and may not
outweigh its costs for insurers and their regulators.
Some of the consequences of being a G-SII are known and some are emerging; some of the proposals are
worthy, in our view, but some may be unnecessary.
We view the global capital standard, a requirement for the G-SII regime, as a positive development for the
industry as a whole in terms of leveling the competitive playing field, but we believe the timetable is
aggressive.
The G-SII designation has had no direct rating impact on insurers thus far, but we see the potential for both
positive and negative longer-term rating implications for G-SIIs.
Can Insurers Be "Too Big To Fail"?
We acknowledge that large insurers are systemically important to the financial system. In particular, their willingness
and ability to hold investments to maturity and avoid forced selling means that they dampen volatility in the financial
markets. But in light of this role, we question whether insurers pose a systemic risk in the way of most large banks. It
may be that the FSB would never have pursued the G-SII regime were it not for AIG's failure--a failure that resulted, in
our view, from its shadow banking activities, which other insurers largely avoided.
Insurers generally weathered the financial crisis well (see "What May Cause Insurance Companies To Fail--And How
This Influences Our Criteria," published June 13, 2013), as our ratings on the nine G-SIIs' core operating subsidiaries
reflect: These ratings fell by just over one notch, on average (see table 1). Generali's rating transition also incorporated
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the subsequent sovereign rating downgrades on Italy.
Table 1
Rating Changes For The Nine Global Systemically Important Insurers' Core Operating Subsidiaries
G-SII Jan 1, 2007 Low point May 20, 2014
AIG AA+/Stable A/Negative* A+/Stable
Allianz AA-/Stable AA-/Negative AA/Stable
Generali AA/Stable A-/Watch Neg A-/Negative
Aviva AA-/Stable A+/Stable A+/Stable
Axa AA-/Stable A+/Stable A+/Stable
MetLife AA/Stable AA-/Watch Neg AA-/Stable
Ping An Not rated A/Watch Neg A/Negative
Prudential Financial AA-/Positive AA-/Stable AA-/Stable
Prudential PLC AA+/Stable AA/Watch Neg AA/Stable
Ratings relate to the core operating subsidiaries of these groups. *Core P/C subsidiaries only, core life subsidiaries 'A+'. Ping An Property &
Casualty Insurance Co. of China Ltd. G-SII--Global Systemically Important Insurer. P/C--Property/casualty.
In our view, the G-SIIs generally aren't too big to be allowed to fail because we believe it's possible to resolve their
liabilities post-failure without disrupting the financial system and without the injection of taxpayers' money. Capital
injections generally aren't necessary when resolving insurers because, relative to banks, they have low financial
leverage, lower liquidity risk, low interdependency, and extensive use of subsidiaries (rather than branches). The
infrequency of insurer bailouts historically bears this out.
We believe that systemic risk was more evident in insurance at a national, rather than global, level during the financial
crisis, when U.S. bond and mortgage insurance and trade credit insurance in some European markets posed systemic
concerns. We further believe that the creation of G-SIIs could divert regulatory resources toward these entities while
more risk accumulates at the non-G-SIIs.
The insurance industry did persuade the FSB that the traditional insurance business model was not systemically risky.
However, the G-SII assessment framework, which the International Association of Insurance Supervisors (IAIS)
designed on the FSB's behalf, emphasized insurers' interconnectedness with the financial sector as well as
nontraditional noninsurance (NTNI) activities that were broad in scope and included many activities that are typical of
life insurers. Although the IAIS framework did not emphasize size and global reach, the G-SIIs emerging from the
assessments are nine of the largest global providers of life insurance. The evidence suggests to us a political dimension
to the designation process.
Domestic SII (D-SII) regimes are operating or under development in some jurisdictions as well. The U.S. system is the
most advanced and currently designates two insurers as nonbank systemically important financial institutions under
Federal Reserve Board supervision. The Fed's assessment process differs from the FSB's and views life insurance
business as inherently more systemic. However, the end result is the same: The Fed considers two of the U.S.-based
G-SIIs as D-SIIs; the remaining one (MetLife) is in the final stages of the process, and the regulator's recent annual
report indicates that it will likely receive the designation soon.
Our view of the systemic risk large insurance groups pose extends to large reinsurers, although we expect the FSB to
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Insurers May Not Pose A Systemic Risk, So Do The G-SII Designation's Costs Outweigh Its Benefits?
name some reinsurers G-SIIs in November. The FSB has postponed the announcement of reinsurer G-SIIs twice,
which may be indicative of differing views on the potential candidates.
Our views of the relative systemic importance of banks and insurers are reflected in our ratings. We currently include
one or two notches of systemic government support in our ratings on many large banks, including those the FSB has
designated as global systemically important banks (G-SIBs), because we believe government support is likely in a time
of stress. As a result of the emerging bank resolution regimes, we may remove some of that support from ratings in the
U.S. and the EU (see "The Rating Impact Of Resolution Regimes For European Banks," published April 29, 2014). We
anticipate that governments would play a role in resolving failing G-SIIs (and D-SIIs), but don't see the same incentive
for governments to provide capital support to the insurance sector. Accordingly, we factor no government support into
insurers' ratings unless they are government-owned.
The G-SII Designation's Consequences Are Unfolding
The policy measures under consideration for G-SIIs include heightened oversight, resolution plans, and capital
loadings to absorb potential losses. The heightened oversight is already a reality. Lead supervisors for each G-SII have
been identified--AIG's lead supervisor, the Fed, has already allocated a dedicated staff of nine to the task--and
"colleges" of most of the G-SIIs' main supervisors are already in place. Insurers must submit detailed resolution plans
to their group supervisor by July. Such plans may be useful to prepare a G-SII for certain stress scenarios it could face.
Moreover, on behalf of the FSB, the IAIS will be developing an approach to capital loadings, also known as higher loss
absorbency (HLA), in 2015.
The need for capital loadings for G-SIIs is questionable, in our view. It's understandable for banks, where recent
empirical evidence has shown what a failure can cost taxpayers. This actual cost has informed the systemic capital
loadings regulators have applied to banks. While insurers, including some large insurers, have failed in the past, their
resolutions have generally come at limited cost to taxpayers, in our view. We explained why in "Possible Ratings
Implications For Global Systemically Important Insurers," published July 19, 2013 (under the heading "Standard &
Poor's differentiates between G-SIBs and G-SIIs in its analysis"). We also explained that while certain insurers
benefited from government support during the financial crisis, we would not characterize these as "rescues" (under the
heading "Evidence from the financial crisis underpins our analytical differentiation between banks and insurers"). In
light of the lack of data on the cost of these resolutions in general and for taxpayers, it's unclear to us how the IAIS will
calibrate the G-SIIs' capital loadings.
The Global Capital Standard May Be Beneficial In The End, But The Lead Time
Is Short
The FSB has advocated the development of a global insurance capital standard (ICS) similar to that for banks under
Basel III. Its first application would be as a baseline for the capital loadings the G-SII regime requires. We view this as
a beneficial development for the industry because there are dozens of different national or regional regulatory capital
adequacy regimes in place around the world today, so the ICS framework could provide greater consistency.
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Insurers May Not Pose A Systemic Risk, So Do The G-SII Designation's Costs Outweigh Its Benefits?
Widespread adoption of the ICS by countries or regions for all insurers over time would underscore its validity and
could help even out the global competitive playing field. Furthermore, assuming that the ICS model is well designed
and its outcomes are transparent, it would be valuable to investors and analysts. We would consider opportunities to
refine our own capital adequacy analysis if an ICS were in place.
However, the planned timing is aggressive, notably for the basic capital requirement (which is somewhat comparable
to the leverage ratio applied to banks), which we expect the FSB to announce in November of this year (see "Proposed
Capital Standard Further Complicates Insurers' Regulatory Agendas," published Oct. 24, 2013). While labeled "basic,"
the methodology under consideration is not simple, in our view. The IAIS is working to meet this mandate at a time
when most countries are updating their own insurance solvency regimes in significant ways (for example, the rollout of
Solvency II in Europe and the Solvency Modernization Initiative in the U.S.). For the purpose of comparison, Solvency
II has taken 15 years to develop so far, and Standard & Poor's spends approximately one year to plan, design, and
consult on its periodic updates of its capital adequacy model.
The IAIS has been set a demanding task. Although we expect it to deliver the basic capital requirement as planned in
November, we also believe significant later modifications are likely as work continues on the other elements of the ICS,
including the higher loss absorbency for G-SIIs (by 2015) and the comprehensive ICS design (by 2016). The basic
capital requirement, higher loss absorbency, and ICS won't be "hard" capital tests that require insurers to act on
deficiencies until 2019, but we expect them to influence regulatory supervision before then.
Many fundamental questions about ICS remain open, including:
Will it be a target or minimum level?
Will it render basic capital requirements redundant?
What happens if an insurers' capital is deficient?
What authority will a group supervisor have over national supervisors?
What laws and regulations are needed to enforce the ICS?
How will the ICS and basic capital requirements interact with existing and planned regional or national capital
standards?
The ICS regime will not be confined to G-SIIs. It will also apply to insurers the IAIS designates as Internationally
Active Insurance Groups (IAIGs), which we expect to number approximately 50. The approach to IAIGs (known as
ComFrame) is currently undergoing field testing and will add a new layer of supervision for large insurers with
significant international operations.
So Far, G-SII Designations Have Had No Direct Rating Impact
We've taken no rating actions on insurers thus far as a direct consequence of a G-SII designation. However, there are
potential credit upsides and downsides in the longer term (see table 2 for an overview), which we first anticipated in
"Rating Implications For G-SIFI-Designated Insurers," published June 28, 2011.
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Insurers May Not Pose A Systemic Risk, So Do The G-SII Designation's Costs Outweigh Its Benefits?
Table 2
Potential Credit Upsides And Downsides Of Being Designated A Global Systemically Important Insurer
Positive Negative
More capital Higher cost of capital
Higher quality of capital Potential shift in the competitive playing field with non-G-SIIs
More regulatory oversight Regulatory cost
Perceptions of government support Disposal of credit positive, but systemically risky activities
G-SII--Global Systemically Important Insurer.
G-SIIs may be required to hold more capital or enhance their quality of capital, both of which would be positive for the
ratings, all other things being equal. However, a resulting higher cost of capital would partly offset this benefit and
would be a credit negative if financing costs rise, which could in turn tilt the competitive playing field toward non-G-SII
players. G-SIIs will also face heightened regulatory oversight, which may be negative in terms of cost and management
time. However, this oversight might cause G-SIIs to avoid potentially risky activities, which could protect their ratings.
A G-SII might also be motivated to restructure, for example, by divesting itself of activities that the FSB perceives as
more systemically risky, but we might not regard as risky from a ratings perspective. A number of these activities,
notably third-party asset management, contribute positively to some of the G-SIIs' current ratings.
Finally, the G-SII designation might create an expectation, however misguided, of government support in the eyes of
customers and investors. This would be positive for G-SIIs' ratings, if it provided them with a competitive edge over
non-G-SIIs. However, we've seen little evidence of this perception--which would not, in our view, reflect reality--so far,
nor efforts by G-SIIs to nurture it. As we've stated, we don't incorporate expectations of government support into our
ratings on insurers, unless they are government-related entities. The creation of the G-SII designation has not altered
our view.
Ultimately, the net impact of the designation may be negative for some G-SIIs and positive for others. The picture will
become clearer as the new regime takes shape and the G-SIIs take management actions to respond.
Related Criteria And Research
Proposed Capital Standard Further Complicates Insurers' Regulatory Agendas, Oct. 24, 2013
Possible Ratings Implications For Global Systemically Important Insurers, July 19, 2013
Rating Implications For G-SIFI-Designated Insurers, June 28, 2011
What May Cause Insurance Companies To Fail--And How This Influences Our Criteria, June 13, 2013
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Additional Contact:
Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com
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