IMF Economic Forum: Risky business? It's a new world when it comes to risk management in the insurance sector

• Pages: 234-236

Page 234

"One of the most important changes in recent years in the international financial system," observed the IMF's Hung Tran, "has been the blurring of the demarcation line between different sectors of the financial services industry." The use by banks of credit derivatives first caught everyone's attention, he said, but perhaps a more important development has been the "steady, relative reallocation of credit and other risks from the banking sector to various non- banking sectors, including the insurance industry."

Just how large has this transfer been? The U.S. insurance industry, for one, has for the past couple of years held more nonfarm corporate credit risk than the U.S. banking sector. The transfers of risk to the insurance sector, Tran said, naturally raises questions. And the transfer of credit risk to nonbanking sectors more broadly raises questions about whether risk has been reduced for the overall financial system, or merely shifted to less transparent sectors, with different systems of regulation and, in some cases, less developed credit risk management skills.

For the IMF, this transfer also raises questions about its effect on global financial stability. In the interest of learning more about the new factors shaping financial market activities and of deepening its understanding of risk taking and risk management, the IMF's April 2004 Global Financial Stability Report included an in-depth look at developments in the insurance industry, and a similar study of the pension industry will be published in September 2004. On the insurance industry, the IMF's key findings included the following:

- differences in market characteristics and in regulations were factors behind the sometimes significant differences in the composition of asset portfolios across countries and regions;

- credit instruments are appropriate for the life insurance industry, given the nature of many of its liabilities;

- where credit markets are more developed, insurers have developed greater credit management capabilities and allocate a larger share of their asset portfolios to credit instruments;

- insurance sectors in countries with more developed credit markets and with a larger share of credit instruments in their asset portfolios have tended to be more stable; and

- in light of their experience during the equity market downturn of 2000-02, many insurance companies-particularly in Europe-have increased capital, strengthened risk management, and allocated more of their assets to credit products-that is, corporate bonds and other credit instruments, including credit derivatives.

All in all, these developments have, according to Tran, reduced the risk of balance sheet pressures in the insurance industry. Given also the recently demonstrated strength of the banking sector, the transfer...