Insurance and Resolution in Light of the Systemic Risk DebateA contribution to the financial stability discussion in insurance

February 2012

The Geneva Association (The International Association

for the Study of Insurance Economics)

The Geneva Association is the leading international insurance think tank for strategically important insurance and risk management issues.The Geneva Association identifies fundamental trends and strategic issues where insurance plays a substantial role or which influence the insurance sector. Through the development of research programmes, regular publications and the organisation of international meetings, The Geneva Association serves as a catalyst for progress in the understanding of risk and insurance matters and acts as an information creator and disseminator. It is the leading voice of the largest insurance groups worldwide in the dialogue with international institutions. In parallel, it advancesin economic and cultural termsthe development and application of risk management and the understanding of uncertainty in the modern economy.The Geneva Association membership comprises a statutory maximum of 90 Chief Executive Officers (CEOs) from the worlds top insurance and reinsurance companies. It organises international expert networks and manages discussion platforms for senior insurance executives and specialists as well as policymakers, regulators and multilateral organisations. The Geneva Associations annual General Assembly is the most prestigious gathering of leading insurance CEOs worldwide. Established in 1973, The Geneva Association, officially the International Association for the Study of Insurance Economics, is based in Geneva, Switzerland and is a non-profit organisation funded by its members.

Chairman: Dr Nikolaus von Bomhard, Chairman of the Board of Management, Munich Re, Munich.

Vice Chairmen: Mr John Strangfeld, Chairman and CEO, Prudential Financial, Inc., Newark; Mr Kunio Ishihara, Chairman of the Board, Tokio Marine & Nichido Fire Insurance Co., Tokyo; Mr Michael Diekmann, Chairman of the Management Board, Allianz SE, Munich.

Members of the Board: Dr Carlo Acutis, Vice President, Vittoria Assicurazioni S.p.A., Turin; Dr Sergio Balbinot, Managing Director, Assicurazioni Generali S.p.A., Trieste; Mr Henri de Castries, Chairman of the Management Board and CEO, AXA Group, Paris; Mr Patrick de Larragoiti Lucas, President, Sul America Seguros, Rio de Janeiro; Prof. Denis Kessler, Chairman and CEO, SCOR, Paris; Dr Stefan Lippe,* CEO, Swiss Re Group, Zurich; Mr Jos Manuel Martnez, Chairman, MAPFRE SA, Madrid; Mr Mike McGavick, CEO, XL Group plc, Hamilton; Mr Andrew Moss, CEO, Aviva plc, London; Mr Martin Senn, CEO, Zurich Financial Services, Zurich; Mr Donald A. Stewart,* CEO, Sun Life Financial Inc., Toronto; Mr Tidjane Thiam, Group Chief Executive, Prudential plc, London; Dr Richard Ward, CEO, Lloyds, London; Dr Yan Wu, Chairman and President, The Peoples Insurance Company (Group) of China Ltd., Beijing.

Secretary General and Managing Director: Mr Patrick M. Liedtke, Geneva.

Vice Secretaries General: Prof. Jan Monkiewicz (Head of PROGRES and LiaisonEastern Europe), Warsaw; Mr Walter Stahel (Head of Risk Management), Geneva.

Heads of Programmes and Research Directors: Dr Etti Baranoff (Research Director for Insurance and Finance), Richmond; Dr Christophe Courbage (Research Director and Head of Health & Ageing and Insurance Economics), Geneva; Mr Daniel Haefeli (Head of Insurance and Finance), Geneva; Mr Donald Inscoe (Head of Institutional Relations), Basel; Mr Anthony Kennaway (Head of Communications), Geneva; Prof. Krzysztof Ostaszewski (Research Director for Life and Pensions), Normal, Illinois.

Special Officers: Mr Katsuo Matsushita (Liaison - Japan & East Asia), Yokohama; Mr Gordon Stewart, (Liaison - North America), New York; Dr Hans Peter Wrmli (Chairman of Chief Risk Officers Network), Zurich.

Chairman of the Scientific Advisory Council: Prof. Harold Skipper, Georgia State University, Atlanta.

Former Presidents of The Geneva Association: Mr Raymond Barre, Paris (1973-1976); Mr Fabio Padoa, Trieste (1976-1983); Mr Julius Neave, London (1983-1986); Prof. Dr Dr e.h. Reimer Schmidt, Aachen (1986-1990); Sir Brian Corby, London (1990-1993); Drs. Jan H. Holsboer, Amsterdam (1993-1999); Mr Walter Kielholz, Zurich (1999-2003); Mr Henri de Castries, Paris (2003-2008); Mr Martin J. Sullivan, New York (2008); Mr Jacques Aigrain, Zurich (2008-2009).

Insurance and Resolution in Light of the Systemic Risk DebateA contribution to the financial stability discussion in insurance

Edited by Daniel Haefeli, Head of Insurance and Finance, The Geneva Associationand Patrick M. Liedtke, Secretary General and Managing Director, The Geneva Association

The Geneva Association53 Route de Malagnou,

CH-1208 Geneva,Switzerland

E-mail: secretariat@genevaassociation.orgTel: +41-22-707 66 00Fax: +41-22-736 75 36

www.genevaassociation.org

February 2012

Insurance and Resolution in Light of the Systemic Risk Debate The Geneva Association ISBN 978-2-9700339-6-7Published by The Geneva Association (The International Association for the Study of Insurance Economics), Geneva

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Contents

Foreword 1 Key results of the analysis 2

1. Preface 5

2. Insurersandinsuranceactivitiesandtheirrelationtofinancialstability 9 2.1. Insurance and insurance activities 9 2.2. Institutions and systemic riskiness 11 3. The impact of insurance failure 15 3.1. Introduction 15 3.2. Options for recovery and resolution of an insurance company 17 3.3. Consequences of insurance failures 18 3.3.1. Historic experience and systems of protection 18 3.3.2. Systemic resilience of the insurance balance sheet 22

3.4. Failureofinsurersthatareinterconnectedwithotherfinancialinstitutions 23 3.4.1. Insurers as participants in capital markets 23

3.4.2. Insurers as market participants 25 3.4.3. Failure of reinsurance companies 30 3.4.4 Failure of insurance-led entities with potentially systemically-risky activities (pSRAs) 37 3.4.5. Bank comparison: understanding the cost of failure 43

4.Policyholderprotectionintheinsuranceindustry 454.1. Introduction 45

4.2. Insurance Guarantee Schemes in Europe 46 4.3. Insurance Guarantee Schemes in the U.S. 47

5. Outlook 49

Appendix.Insuranceguaranteeschemes:futherdetailsoftheU.S.system 53 A.1. The U.S. system for policyholders protection in case of failed insurers 53 A.2. The funding of the guaranty funds in the U.S. 54 A.3. Mechanism of the guaranty funds 54 A.4. The actual need for assessments 55 A.5. Guarantysystemfinancingandcapacityconsiderations 55

References 57

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Insurance and Resolution in Light of the Systemic Risk Debate

Exhibits

Exhibit 1: Approach used to analyse and assess non-core insurance activities against the criteria for determining systemic risk 11Exhibit 2: Comparison of large global banks and insurers 13Exhibit 3: Range of actions as insurer moves towards non-viability 18Exhibit 4: Statistics on insurance company run-offs across jurisdictions 20Exhibit 5: Typical priority of claims on companys assets on liquidation 21Exhibit 6: Different balance sheet dynamics of insurers and banks 22Exhibit 7: Total investments of major institutional investors 24Exhibit 8: Debt and equity issuances by insurers, 2005-2011 24Exhibit 9: Group structure of hypothetical insurer 25Exhibit 10: Impact of events on insurer balance sheet 26Exhibit 11: Impact of potential action on insurer balance sheet 27Exhibit 12: Sequence of actions 28Exhibit 13: Reinsurance historically represents a marginal cause of failure in the U.S. P&C insurance sector 30Exhibit 14: Impact of reinsurers failure on primary insurers equity 31Exhibit 15: Comparison of connectedness between insurers and reinsurers 31Exhibit16:Totaleconomiclossesofeventsaresignificantlylargerthan reinsurance losses 32Exhibit 17: What would it take to bring down a major reinsurer? 32Exhibit 18: Group structure of hypothetical reinsurer 33Exhibit 19: Impact of events on reinsurer balance sheet 34Exhibit 20: Sequence of actions 36Exhibit 21: Group structure of hypothetical insurer 39Exhibit 22: Sequence of actions 41Exhibit 23: Resolution options for a bank (illustrative case example) 43Exhibit 24: Public interventions in the EU banking sector 44

Tables

Table 1: NAICs supervisory ladder of intervention 16Table 2: Supervisory ladder of intervention under Solvency II 16Table3: Selectedhigh-profileinsurancefailures(1990-2010) 19Table 4: Possible options available to management focused on reducing the impact on the insurer 27Table 5: Possible options available to the supervisors 28Table 6: Impact on external stakeholders 29Table 7: Possible options available to management looking to recover the reinsurer 34Table 8: Possible options available to the supervisors 35Table 9: Impact on external stakeholders 36Table 10: Possible options available to pSRA Co and Insurance Co to reduce the impact of pSRA Co 40Table 11: Possible options available to the supervisors 41Table 12: Impact on external stakeholders 42

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Acknowledgements

Thisreportisanextensionofthemajorresearchprojectonthefinancialcrisisandfinancialstabilitythat The Geneva