Back Matter

Back Matter

International Monetary Fund. Monetary and Capital Markets Department
Published Date:
October 2004
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      Ahearne, Alan, WilliamGriever, and FrankWarnock, forthcoming, “Information Costs and Home Bias: An Analysis of U.S. Holdings of Foreign Equities,”Journal of International Economics.

      Bank for International Settlements, 2003, “Trends in Risk Integration and Aggregation,”The Joint Forum, Basel Committee on Bank Supervision (Basel, August).

      British Bankers’ Association (BBA), 2002, Credit Derivatives Report2001/2002 (London).

      Briys, Eric, and Françoisde Varenne, 1995, “On the Risk of Life Insurance Liabilities: Debunking Some Common Pitfalls,”Wharton Financial Institutions Center Working Paper No. 96–29 (Philadelphia: The Wharton School, University of Pennsylvania).

      Committee on the Global Financial System (CGFS), 2003, “Credit Risk Transfer,” Bank for International Settlements (Basel, January).

      Das, Udaibir S., NigelDavies, and RichardPodpiera, 2003, “Insurance and Issues in Financial Soundness,”IMF Working Paper No. 03/138 (Washington: International Monetary Fund).

      Financial Services Authority, 2002, “Cross-Sector Risk Transfers,”Discussion Paper (London: May).

      FitchRatings, 2003, “Global Credit Derivatives: A Qualified Success,” Fitch Ratings Special Report (September).

      FitchRatings, 2004, “Securitization and Banks: A Reiteration of Fitch’s View of Securitization’s Effect on Bank Ratings in the New Context of Regulatory Capital and Accounting Reform” (February).

      Fukao, Mitsuhiro, 2002, “Barriers to Financial Restructuring: Japanese Banking and Life-insurance Industries” (unpublished; Tokyo: Keio University, February).

      Hall, Keith, and ErinStuart, 2003, “Credit Risk Transfer Markets: An Australian Perspective,”Reserve Bank of Australia Bulletin (Sydney: Reserve Bank of Australia, May).

      Hartmann, Philip, AngelaMaddaloni, and SimoneManganelli, 2003, “The Euro Area Financial System: Structure, Integration and Policy Initiatives,”ECB Working Paper No. 230 (Frankfurt: European Central Bank).

      Häusler, Gerd, 2004, “The Insurance Industry, Systemic Financial Stability, and Fair Value Accounting,”The Geneva Papers on Risk and Insurance, Vol. 29, No. 1 (January), pp. 6370.

      Ibbotson Associates, 2003, Stocks, Bonds, Bills, and Inflation2003Yearbook (Chicago).

      International Association of Insurance Supervisors, 1999, Supervisory Standard on Asset Management by Insurance Companies (Basel, December).

      International Association of Insurance Supervisors, 2003, Credit Risk Transfer Between Insurance, Banking and Other Financial Sectors (Basel, March).

      IMF, 2002a, “How Effectively Is the Market for Credit Risk Transfer Vehicles Functioning?,”Global Financial Stability Report; World Economic and Financial Surveys (Washington: International Monetary Fund, March), pp. 3647.

      IMF, 2002b, “The Financial Market Activities of Insurance and Reinsurance Companies,”Global Financial Stability Report, World Economic and Financial Surveys (Washington: International Monetary Fund, June), pp. 3047.

      IMF, 2003, Global Financial Stability Report, World Economic and Financial Surveys (Washington: International Monetary Fund, March), pp. 2224.

      Joint Forum, forthcoming, Credit Risk Transfers, Joint Forum Working Group on Risk Assessment and Capital (Basel: Bank for International Settlements).

      Kiff, John, 2003, “Recent Developments in Markets for Credit-Risk Transfer,” Financial System Review, Bank of Canada (Ottawa, June).

      Kiff, John, Francois-LouisMichaud, and JanetMitchell, 2003, “An Analytical Review of Credit Risk Transfer Instruments,” Financial Stability Review, Banque de France (June).

      Le Pan, Nick, 2003, “Adding Value to the Life Insurance Industry,” notes for a speech to the Life Insurance Institute of Canada Annual Conference (Toronto, June3).

      Moody’s Investors Service, 2003, “Moody’s Views on Current Conditions in the U.S. Life Insurance Industry” (New York, December).

      Rajan, Raghuram, and LuigiZingales, 2003, “Banks and Markets: The Changing Character of European Finance,” NBER Working Paper No. 9595 (Cambridge, Mass.: National Bureau of Economic Research).

      Rule, David, 2001a, “The Credit Derivatives Market: Its Development and Possible Implications for Financial Stability,”Financial Stability Review (London: Bank of England, June), pp. 11740.

      Rule, David, 2001b, “Risk Transfer Between Banks, Insurance Companies and Capital Markets: An Overview,” Financial Stability Review (London: Bank of England, December), pp. 13759.

      Standard and Poor’s, 2003a, “Structured Finance: ViewPoint on Credit Derivatives” (New York).

      Standard and Poor’s, 2003b, “Demystifying Banks’ Use of Credit Derivatives,” RatingsDirect (New York, December).

      Statistical Yearbook of German Insurance, 2003 (Berlin: German Insurance Association).

      Swiss Re, 2000, “Asset-Liability Management for Insurers,” Sigma, No. 6/2000.

      Swiss Re, 2003, “Insurance Company Ratings,” Sigma, No. 4/2003.

      Zucker, Jason, and JonathanJoseph, 2003, “The Life Preserver,” Fox-Pitt, Kelton Insurance Industry Update (November).

    Global Financial Stability Report

    Market Developments and Issues

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    International Association of Insurance Supervisors (2003), Financial Services Authority (2002), and Rule (2001b) examine the credit risk transfer between banks and nonbank financial sectors, including the insurance sector.

    Häusler (2004) discusses how the blurring of boundaries between insurance and other financial institutions implies heightened importance of insurers for financial stability. Das, Davies, and Podpiera (2003) also explore the potential for the insurance sector to affect the vulnerability of the financial system, focusing on the banking-type activities that life insurance companies have increasingly taken on, as well as risks stemming from the possible failure of a large reinsurer.

    Somewhat separate issues regarding reinsurance disclosure and risk (primarily concerning insurance liabilities) are being discussed in various fora, including an IAIS Task Force that reported to the Financial Stability Forum in March 2004. These issues are not dealt with directly in this chapter. See Swiss Re (2003b) for an overview.

    See Committee on the Global Financial System (2003) and the Joint Forum (forthcoming) for a broad review of credit risk transfer techniques. See also Kiff (2003); Kiff, Michaud, and Mitchell (2003); IMF (2002a); and Hall and Stuart (2003) for more on credit risk transfer.

    Rajan and Zingales (2003) discuss the difference between the more market-based system in the United States and the relationship-based system in continental Europe, which remains despite Europe becoming more market-oriented and the increase in corporate bond issuance following the introduction of the euro. Hartmann, Maddaloni, and Manganelli (2003) discuss the difference between a market-based U.S. system and a bank-based Japanese system, with Europe placed somewhere between.

    For a more general discussion of home bias, see Ahearne, Griever, and Warnock (forthcoming).

    Insurance company balance sheets are divided into general and separate accounts. Separate accounts are established by insurers to legally segregate funds—for example, related to pension or variable life insurance products—where the investment risk is borne by the client, not the insurer. General accounts contain all other assets and liabilities of the insurer.

    Zucker and Joseph (2003). These figures are consistent with the 24 percent equity allocation of the life insurance sector reflected in U.S. flow of funds data, which comprise both general and separate accounts. Complete data on separate accounts are not available for insurance companies in other regions. Discussions with market participants suggest that equity holdings in the general account could also be somewhat lower than for the combined accounts in the euro area, the United Kingdom, and Japan, but remain well above U.S. general account levels. For example, among some of the largest life insurance companies in Japan, the differences between the equity share in the general and combined accounts is approximately one percentage point.

    An example of this expansion would be the growth of the asset-backed securities, mortgage-backed securities, and covered bond markets in Europe. In Germany, the “True Sale Initiative” (TSI) is aimed at developing securitizations as an additional funding source for small and medium-sized German business loans. TSI is supported by a consortium of 13 banks (Landesbanks, cooperative, savings, and commercial banks, including Citigroup) led by RfW, the German industrial development bank. A press release giving some details on TSI is available at See Chapter II for a broader discussion of the growth of securitization markets in Europe.

    Standard and Poor’s (2003b) provides a review of the factors underlying banks’ use of credit derivatives. See also FitchRatings (2004) for a similar study.

    See Box 3.1 for a discussion of CDOs and credit quality.

    The Joint Forum is a group of technical experts working under the umbrella of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors.

    IMF (2002b) compared regulatory frameworks for the insurance industry across countries and discussed the additional oversight roles played by others, such as rating agencies and investors. The following section focuses on how regulation affects insurance company investment activities and risk management. The Appendix describes these regulations in greater detail.

    Some U.S. states have limits relating to the credit quality of securities. For instance, New York state limits below-investment grade instruments to 20 percent of total fixed-income investments.

    The Japanese system allows deferred tax assets to be included in full in solvency margin calculations, while the U.S. system allows them to be included only up to a maximum of 10 percent of capital and surplus.

    Information from the EU Commission about the Solvency II project can be found at Annex 3 of Bank for International Settlements (2003) also provides a useful summary.

    An overly prescriptive regulatory framework tends to retard these skills. This was previously seen in the U.S. savings and loan industry where, before deregulation, managers pursued a “3-6-3” risk management approach: “borrow at 3 percent, lend at 6 percent, and be on the golf course at 3 p.m.” After deregulation, many thrift managers were ill-equipped to manage different or changing risk positions.

    EU directives require that holdings of securities by a single issuer should not be greater than 5 percent of the gross technical provisions (i.e., the net present value of future liabilities before reinsurance recoveries).

    German regulations, for instance, set limits for the amounts of equities and derivatives in the portfolio. The limit for equities (measured in book value terms) was 25 percent of total assets covering technical provisions until 1992; 30 percent from 1992 to 2002; and has now been raised to 35 percent. The limits for derivatives are as follows: for interest rate and currency swaps designed to increase yield, 7.5 percent of total assets; for derivatives to meet short-term cash flow needs, 7.5 percent of total assets for contracts of up to a year in length and 5 percent for contracts beyond one year; and for structured products such as asset-backed securities (ABSs) and CDOs, 7.5 percent and 5 percent of assets covering technical provisions, for investment-grade and other instruments, respectively.

    The guaranteed minimum rate of return is effectively set by the technical interest rate for calculation of provisions against future liabilities.

    Briys and de Varenne (1995) demonstrate that guaranteed rates of return and bonus features can shorten duration considerably at relatively low interest rates, and that asset allocations may be biased toward equity investments.

    Swiss Re (2000) discusses asset-liability management, including its growth in importance during the 1970s, as high and rising inflation led to an increase in the volatility of interest rates.

    Unit-linked products held in separate accounts pass the risk to policyholders, so the investments chosen to back these products have no direct balance-sheet risks for the insurer, and in many cases the investments or risk profile are selected by the policyholder.

    The Canadian Superintendent of Financial Institutions states that this matching approach is reinforced by the Canadian Asset Liability Method actuarial and accounting standard (Le Pan, 2003).

    Similar comparisons of returns and volatility in Europe and Japan over long periods are not available, as the corporate bond markets in these regions have historically been smaller and much less liquid.

    Rule (2001b) makes a similar point that the need to pay guaranteed minimum nominal returns that were in excess of current nominal returns on government bonds was leading some insurers to take more risk.

    For example, in Germany, the share of equities rose to 30 percent of investment assets at the peak of the stock market in 2000, from 21 percent in 1997, as the regulatory ceiling was raised (as described earlier). Most of this increase was at the expense of their fixed-income (primarily government bond) holdings, which fell to 49 percent from 58 percent during this period. The regulatory ceiling on equities was also relaxed in Switzerland.

    The German authorities also established in late 2002 an “insurance” scheme for policyholders, called Protektor, which could assume the portfolios of any failed life insurance company, and act to preserve market confidence. Life insurance companies were to contribute equity stakes in proportion to their liabilities, and further funds, if required, up to one percent of their investments. Protektor has assets of €5 billion, and it has taken over the portfolio of failed insurer Mannheimer Leben and is administering the portfolio as it runs off.

    CGFS (2003) also makes these points, and indicates that it agrees with similar recommendations by the IAIS Working Group. It should, of course, be kept in mind that the degree of credit experience varies between companies and between countries, including credit products other than bonds. In the Netherlands, for instance, life insurers hold one-third of their assets in commercial and mortgage loans.

    Standard and Poor’s (2003a) provides an overview of the synthetic credit markets by region and reviews how synthetic, structured credit products are created. See also Rule (2001a) and Appendix 2 of FitchRatings (2004) for more on synthetic credit products.

    The European CDO market has grown very rapidly, particularly in Germany. See Rule (2001b).

    The level of the required mortality reserves is calculated by using a conservative mortality table provided by the regulator. If life insurers wished to use more realistic mortality assumptions to set more competitive premiums, they were required to place additional reserves for the difference at a sharply higher rate.

    Japanese regulations place a limit of 30 percent on the amount of equity in the portfolio, but this is measured at book value.

    In 2001, the Japanese FSA improved the robustness of its regulations by revising the risk-based regime to be based more closely on market values for assets.

    IAS 39 distinguishes between assets “held for trading” or “available for sale,” which are marked to market, and those intended to be passive investments to maturity (and thus held at book or amortized value).

    The EU Parliament passed a resolution in 2002 requiring listed companies to use IAS for published accounts from 2005 onwards.

    See Swiss Re (2003) for a detailed discussion of the methodology of the major rating agencies, as well as the relationship between ratings and the insurance firm’s cost of funds and ability to attract business.

    This appendix was prepared by the IMF’s Monetary and Financial Systems Department.

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