26 September 2014 Insurance

Insurers’ models will be scrutinised, Carney warns

The Bank of England will hold insurers to close scrutiny in terms of the models they use to comply with regulations such as Solvency II, Mark Carney, the governor of the Bank of England, said in a speech this week.

Carney highlighted the dangers of using poorly designed models, saying such risks of getting it wrong had been made all too clear by the banking sector.

The Bank of England would not hesitate to withhold approval of inadequate or opaque models, he said, and would punish insurers that give a distorted view of risk to decrease the amount of capital they are expected to hold.

Models must be based on appropriate data and account for all quantifiable risks. Boards have the responsibility to ensure models remain appropriate and to show they are used in practice, he said.

Carney also indicated that systemic insurers – companies regarded as being fundamentally important to the smooth working of the financial system – will be held to higher standards.

AIG's well documented troubles during the financial crisis highlighted the need for higher standards, he said.

“While much progress has been made on the home front, the focus of the global reform agenda since the crisis has been on putting a third idea into practice: common global standards for systemically important insurers,” he said.

“The goal of this work is to increase systemic resilience; preventing spillovers from the failure of an insurer to the wider financial sector and the real economy.”

He did acknowledge that insurers are better able to withstand crises than other financial institutions.

He noted that the underwriting cycle is generally not correlated with the business cycle; the inherent resilience of business models that take a long-term view, and the fact that an insurer’s production cycle is inverted as it collects premiums today with a view to paying claims tomorrow.

“This model reduces liquidity risks and immunises insurers against risks of a run. Insolvency takes time to manifest, and wind-down when it happens has historically been more orderly,” he said.

But, despite this, he also backed this extended oversight.

“The financial crisis laid bare that the actions of some individual insurers – like AIG – can have broad spillovers; that some insurance markets – like the monolines – are systemic, and that the insurance sector plays a systemic role in diversifying the financial sector thereby reinforcing its resilience,” he said.

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