The Prudential Regulation Authority’s chief executive has argued that there is a case for enabling the ‘special resolution’ powers that exist primarily to regulate banks, to be used in respect of insurers.
Speaking at the Bermuda Monetary Authority Seminar, Andrew Bailey, the deputy governor for prudential regulation, explained that special resolution regimes are powerful tools in that they enable the resolution authority to change property rights outside the framework of normal insolvency law.
“They should therefore be used only when absolutely necessary,” he stated, adding that there is still a case for enabling them, but such interventions must be justified by the risks insurers run.
Mr Bailey argued that micro-prudential regulation should be complemented, but not substituted, by the use of macroprudential tools where appropriate.
“The risk of procyclical asset liquidation by insurers in response to sharp asset price corrections could be one such case where macro-prudential tools are warranted, but I use that as an illustration rather than a statement of need today.”
Giving a selection of 10 insurance firm failures, Mr Bailey mentioned Equitable Life, which collapsed due to under-pricing, inadequate reserving and misunderstanding legal risks.
He added that methods like insurance guarantee scheme helped compensate covered policyholders, noting that one third of insurers authorised by the PRA are in some form of run-off.
“History tells us therefore that insurers are not immune to failure. Some of the common causes of insurance failure are: rapid but unprofitable growth; under-pricing and under-reserving; concentrated exposure to catastrophes or major loss events; excessive appetite for investment risk; and management and governance risks.”
Mr Bailey mentioned the case for robust firm-level supervision of insurers that was recently re-made by Paul Wright in a publication for the Centre for the Study of Financial Innovation.
He backed the report’s calls for use of regulatory tools – especially capital requirements but also liquidity risk assessment for those products like variable annuities. “The message is that there is no substitute for effective on the ground supervision at the firm level.”
peter.walker@ft.com
