Implicit Constraints, Incentives, and Systemic Risk Imposed by New Insurance Regulation

• Applicant: Professorin Dr. Nadine Gatzert
• Subject Area: Accounting and Finance
• Term: from 2010 to 2015
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 193321519

In our research project, one major aim is to provide input to important aspects associated with the current development of new risk-based insurance regulation. Depending on the specific requirements and imposed models by regulators, the introduction of new capital standards can have a considerable effect not only on individual policyholders, but also on the economy as a whole. One key risk driver in this regard is the asset base and the insurers¿ investment behavior, which can even lead to systemic effects if behavior is too much aligned and if huge stakes are shifted in a similar manner depending on the financial market development. It will thus be vital to study the implicit constraints for the insurers¿ asset allocation imposed by Solvency II¿s standard model on market risk as well as potential biases that arise from these constraints. We further specifically focus on the potential impact of the equity risk module and the spread (credit) risk module on procyclical behavior, which may amplify an ongoing crisis and thus pose a considerable systemic risk to the economy. Systemic effects in the economy can generally be reduced by promoting internal models that more adequately reflect an insurer¿s individual risk situation and should thus be implemented instead of or in addition to the standard model provided by the regulators. We thus also take a more comprehensive view and propose an internal model that includes the insurers¿ assets and liabilities as well as their interaction and dependencies. Focus is laid on relevant features and control variables, which can easily be adjusted and contribute to improving a non-life insurer¿s solvency level. In life insurance, the control variables at the company-level typically include the long-term guaranteed interest rate and a surplus participation rate to distribute asset surplus to the policyholders. Both parameters are generally limited or even defined by regulators, which in turn will affect the insurer¿s decisions with respect to the equity capital base and the asset allocation. Regulatory restrictions will thus also have a substantial influence on the value of a contract from the policyholders¿ perspective, which should be carefully examined. In this context, especially life insurers predominantly invest in corporate and government bonds. Thus, it is vital for companies and regulators to take credit risk associated with these bonds into account when evaluating contracts in a fair way or when measuring the associated risk. We thus study this crucial issue by considering traditional participating life insurance contracts, which represent an important product design in Europe.

• DFG Programme: Research Grants
• International Connection: Switzerland
• Participating Persons: Dr. Alexander Braun; Professor Dr. Martin Eling; Professor Dr. Hato Schmeiser