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Procyclicality: Counter Cyclical Capital Buffers

This Working Party will look at different aspects of the capital regulation of Life Insurers and whether changes would reduce the tendency for Capital to be consumed or for Capital Requirements to increase in falling markets. This working party disbanded in June 2018.

Key Objectives:

  • Consider all the key areas where procyclical behaviour might be present in:
    • Insurance risk 
    • Counterparty risk especially that affecting reinsurance and derivative exposures
    • All areas of market risk
    • Liquidity risk especially in stressed environments
    • Consider how regulation and regulatory behaviour can exacerbate and make worse the reactions of life insurers.
  • Consider the behavioural reactions of low or disappointing results on life insurers causing them to take more risk in other areas and how this can lead to more procyclical behaviour after market or insurance volatility.  For example, low returns from equities having to be made up by writing riskier insurance benefits or low bond returns leading insurers to look at riskier investment classes.
  • To consider all within two World views:
    • “mean reverting markets” which assume that markets over-react and that they trend to a norm (maybe a new norm) eventually;
    • “efficient markets” which assume that market values are always a rational view of future financial returns allowing for uncertainty and risk
    • we are not going to comment on which World view is correct.
  • Should there be a countercyclical buffer within capital, or technical provisions or within the ORSA and risk appetite of the insurer?  Where is the best place for it if it is necessary?  Can the current SCR be seen as part of the buffer (i.e. have solvency levels below 100% of SCR)?  What market pressures might exist on life insurers with less than 100% coverage and will this cause procyclical outcomes in the market for insurance?
  • Establish how effective is the current counter-cyclical elements of Solvency II: equity symmetrical adjustment, long term guarantees package.
  • Consider long term and short term movements in markets and insurance experience.  Is the volatility a move to a new market “norm”.  How does anyone spot a “bubble” in asset prices?  Are there any statistics (or combinations of statistics) that can be relied on to give indicators that work over the long term
  • Can regulators “fine tune” regulations in times of stress?  Equally in times of “boom”?
  • Can life insurers take sensible actions that avoid them being open to procyclical spirals of the worst kind?  Examples might be avoiding providing insurance which requires liquid markets at all times in certain assets or in reinsurance all of which might disappear in times of stress, avoiding providing insurance that will gear up losses achieved in the asset portfolio and to consider extreme market scenarios and insurance events when determining strategy.

Key Outputs:

  • There were no key outputs form this working party.
Chair: Steve Dixon
Membership: 12
Established: 2016

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If you want more information about this research working party please contact the Communities Team.

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