Download systemic risk

DOOMSDAY AND REINSURANCE
PART DEUX
ERNST N. CSISZAR
DEPARTMENT OF INSURANCE
STATE OF SOUTH CAROLINA
A RECAP OF PART ONE
• WHAT IS SYSTEMIC RISK?
– Confidence and interdependence
• WHY WORRY ABOUT SYSTEMIC
RISK?
– Source of potential financial crises
• WHO WORRIES ABOUT SYSTEMIC
RISK?
– The Financial Stability Forum and others
• WHY WORRY ABOUT SYSTEMIC RISK
IN THE RE INSURANCE SECTOR?
– The recent involvement of reinsurers with other
financial institutions
• WHAT CAN BE DONE ABOUT
SYSTEMIC RISK?
– Policy development and crisis prevention,
containment, and management
SYSTEMIC RISK - THE
CONTINUATION
• What factors drive the continuing concern
about insurance and reinsurance as sources
of systemic risk?
– “The house of cards” scenario
– “The perfect storm” scenario
The house of cards
Reinsurers and credit markets
• Credit transfer between insurers / reinsurers
and other economic sectors
– The effect of slumping global stock markets in
investment portfolios of reinsurers
– The downturn in corporate credit markets
• Defaulting bonds e.g., Worldcom, Enron etc.
• Exposures through commercial surety bonds
• The international payments settlement
process
– Loss of faith in financial system
– Fear of system-wide default
• The structure of credit-related products:
– Credit enhancements
– Credit derivatives e.g., credit default swaps
– Collateral debt obligations e.g., guarantors and
investors
• The impact of credit downgrades
• The issues
– Naïve capital
– Risk concentrations
– Financial contracts versus contracts of good faith
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Fiduciary aspects
Disclosure requirements
Proof of loss
Contested contracts
Reinsurance culture vs. financial institutions’ culture: contest
now and pay later vs. pay now and contest later
• The problem:
– No one knows
• Opaque transparency
• Inadequate disclosure
• Lack of oversight
The perfect storm
Reinsurers and the real economy
• Insurance as a “foundation” industry
– The “glue” of our economy
– Global capacity at a 1999 high based on $720 billion in
capital and surplus
• Global financial performance of the industry
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25% loss of capital and surplus in 2001 and 2002
Poor underwriting results
Poor investment results
Inverted risk / return relationship
• Causes:
– Self-inflicted wounds
• 1980 – 2002: $439 billion in underwriting losses
• Recent dismal investment results
– Catastrophes
• $100 billion in last three years
– Asbestos claims
• $160 billion
– Liability exposures
• Product liability and medical malpractice losses
– New risks
• Toxic mold and information technology risks
• Further terrorist activities
What can be done to improve
performance?
• Further reduce capital
• Reduce risk
• Improve net profits, particularly from
underwriting operations
– Public and regulatory resistance to higher rates
– Financial rating downgrades
THE PERFECT STORM!
• A REAL NEED FOR NEW CAPITAL
THE WORK OF THE IAIS AND
FSF
• Disclosure and transparency
– Task Force Re
– Development of a database for reinsurers