ASSESSMENT OF FINANCIAL STABILITY OF INSURANCE COMPANIES

Abstract

By the nature of their business, insurance companies are exposed to risks.  An insurance company’s distress or failure can arise through inadequate provisions for claims or insufficient capital to withstand unexpected losses either from insured events or volatility in the assets they hold. The likelihood of distress or failure may be heightened through certain activities insurance companies can engage in. This article sets out two main ways in which insurance companies could have adverse effects on financial stability and focuses on the key channels for transmission of risks to financial stability rather than conjunctural risk assessment. The first transmission channel relates to the risk that private and commercial policyholders face disruption in the critical financial services provided by insurance companies if one or several insurers fail. This might occur if resolution arrangements and guarantee protection schemes did not provide sufficient protection for policyholders against interruption to critical financial services, or if in the absence of alternative providers, the failure of an insurance company disrupted the provision of critical services to prospective policyholders. This risk is more likely to arise when a small number of insurance companies dominate supply in a sector. The second source of systemic risk stemming from the insurance sector involves activities that propagate or amplify shocks to financial counterparties or markets. There are several channels through which this could occur. Insurance companies could affect the resilience of their financial counterparties if, on a significant scale, they stopped funding them, stopped lending them securities, or were unable to meet claims following the occurrence of insured events.

Evidence suggests that insurers can also behave in a procyclical way, exacerbating the credit cycle (for instance by extending guarantees) or the volatility of financial markets. In practice, it is the second source of systemic risk that is considered more important for the insurance sector.