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How Insurers Differ from Banks: A Primer on Systemic Regulation

Christian Thimann

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The Financial Stability Board (FSB) and the G20 are currently developing a systemic regulatory framework for insurance that closely resembles that for the banking sector, and will require the nine greatest global insurers to keep capital reserves at levels greater than those required by prudential standards now currently in force. However, insurance companies play an economic rôle very different from that of banks.
Analysing in detail how banks and insurers operate, Thimann studies the principal things in common between the two sectors, and where they differ in their interactions with the financial system, concentrating on interdependence, maturity transformation (1), liquidity risk and the creation of money. While banks are connected via the interbank market, there is no such institutional link between insurance companies. In addition, insurers invest long-term in relation to their engagements with policy holders without making maturity transformations on their total balance sheet. Finally, insurers are not subject to the liquidity risk inherent in banking activity. The article pays particular attention to three essential characteristics of insurance companies with respect to systematic risk: the virtual absence of a leverage effect; the spread of risk thanks to the participation of insurers in potential losses through life insurance contracts; the fundamentally different rôle of capital in the insurance sector, where it is but an element of last resort in case of insolubility, while in the banking sector it is the first. The author concludes that in view of these differences, the regulation of capital such as it applies to banks cannot be extended to the insurance sector. While certain activities have recently raised specific concerns about systemic risk in the insurance sector, there are more appropriate measures to adopt than capital surcharges.
1. Financial and banking institution practice of borrowing in the short and very short-term, and lending for longer periods. It also covers putting short options from long-term assets on the secondary market..

Original title of the article: “How Insurers Differ from Banks: A Primer on Systemic Regulation”
Published in: PSE Working Papers n° 2014-32
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