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SESSION 04. Risk, governance and supervision in the long run

4. Risk, governance and supervision in the long run.

B. Gales (University of Groningen)
b.p.a.gales@rug.nl

ABSTRACT

Risk sharing is the essence of insurance, but insurance institutions itself are fragile and thus risky. Insuring can create problems, but also the investment activities which go with insuring. Looking at the past, insurers were convinced during mid-eighties that major problems would come to insurance via the assets side of the balance, if at all. Till today, academic literature qualifies the risks of insurance runs and fire sales of assets as unlikely. Such runs and sales signal, what is nowadays called systematic risk. This may be true, but is a non-life perspective. In life insurance, matching long-term liabilities with short-term assets can be a major aspect of systemic risk, exposing insurers to interest rate fluctuations. Investment strategies can and should solve the problem of a mismatch of maturities. In the end, much literature assesses the contribution of insurance to systemic risk as small. Smaller, at least, than the contribution of banking. The assumption is also based upon the assumption that market discipline is in the case of insurance is particularly strong. Market participants monitoring closely insurance companies explain why few bankruptcies occur. This then is an argument for limiting supervision by authorities, the more in combination with the “biting-back vision” that regulation itself induces less market discipline. Even authors like Eling and Pankoke, who are skeptical, conclude also that traditional insurance activities do not contribute to systemic risk.[1] Traditional is an important qualifier.

By now we have officially recovered from the financial crisis of 2008. Mergers and acquisitions and foremost the integration of banking and insuring made it not easy to distinguish the role of banking and insurance in the financial depression and even less easy to draw lessons for governance and supervision. The debate whether supervision of banking and insuring (and in social security) should be similar or specific continued and continues. It, however, is clear that also insurers were involved in what happened after the collapse of Lehman Brothers and fall of AIG. In the Netherlands, for example, major banks and insurers, both composite offices as specialized insurers, had to be bailed out. On a global scale it was true that the contribution of insurers to systematic risk was small, but nevertheless, the contribution of insurers to the fragility of the financial system peaked also around the financial crisis of 2008.[2] The problems of 2008 do remind of the shocks of the interwar period. In some countries, the early 1920s saw both insurance companies and banking companies experience major problems, elsewhere a financial crisis accompanies the onset of the Big Depression. The unrest of the interwar years stimulated the introduction of supervision or of modernized regulation. The role of the state in the financial sector had been a matter of debate for some time. The problems of the early twentieth century caused a shift in the regime of supervision in liberal environments.

The ambition of this session is to discuss governance and supervision of the financial sector in the long run and contrast recent experience and today’s differences of opinion with the historical record. Major crises are low probability events.[3] That does not imply that governance or supervision itself are low probability events or cannot cope with these. The test is rare. Despite the theoretical notion of active monitoring by stake holders, the industry is not fully transparent for outsiders and these have to thrust the business both daily and in special circumstances. Thrust might have become increasingly and difficult with the growth in scale and blurring of barriers between domains due to integrating businesses. For the session it might be especially interesting to look cases of mobilization of the insured or savers and consider the interaction with the design of internal and external supervision. Furthermore, both the culture of governance – the norms and values glueing consumers, intermediaries and firms – and the design of financial supervision by authorities are very pathdependent. For purposes of comparison, Masciandaro constructed two indices, producing surprising, perhaps telling outcomes. For example, the Netherlands is a remarkable outlier relative to Belgium or northern Europe overall and is classified close to southern Europe.[4]

All these aspects make it interesting (1) to compare regimes of supervision and governance over time and (2) to compare differences between countries in order (3) to understand designs and the changes of design. A focus upon stress might be extra valuable (4) to understand change under duress, thus design under special conditions. Stress can be seen as major upheavals, bankruptcies or insolvencies, but also institutional frictions involving intermediaries. It is also interesting (5) to have a financial sector perspective and to look, at least at the level of the session, not only at insurance companies – in itself covering already distinct fields – but also pension funds and banks.

[1] M. Eling, D.A. Pankoke, Systemic Risk in the Insurance sector. A Review and Directions for Future Research, in: Risk Management and Insurance Review 35, 1 (2016), 9-34.
[2] Ch. Bierth, F. Irresberger, G.N.F. Weiß, Systemic risk of insurers around the globe, in: Journal of Banking and Finance 55 (2015), 232-245.
[3] C. O’Brien, Insurance Regulation and the Global Financial Crisis. A Problem of Low Probability Events, in: Geneva Papers on Risk and Insurance 35 1, (2010), 35-52.
[4] D. Masciandaro, E Pluribus Unum? Authorities’Design in Financial Supervision. Trends and Determinants, in: Open Economies Review 17, 1 (2006), 78.

 


Paper 1

Bancassurance at the Heights: The LUYFE - BANESTO case.

José Luis García Ruiz (Universidad Complutense de Madrid)
jlgarciaruiz@ccee.ucm.es

By “bancassurance” we should understand the relationship between banks and insurance companies in order to help each other in their financial business. Bancassurance types are varied: distribution agreements, strategic alliances, joint ventures and integration into a financial group. In twentieth-century Spain, large banks had insurance subsidiaries, being remarkable the case of the Madrid institutions that dominated the financial system until the crisis of the 1970s and 1980s. In this paper, we would address the relationship between two institutions that were leaders in their sector for many years: LUYFE (insurer) and BANESTO (bank). Drawing on archival sources, the aim will be to rebuild the relationship, trying to establish whether it is possible to talk about a situation of dependence of the insurer with respect to the bank, because, as it is well known, the development of the insurance was much slower than that of banking, which would place insurers in a position of weakness against the bankers. A final question will be addressed: the attribution of responsibilities in the crises that in a very few years led to the disappearance of both LUYFE and BANESTO. What was the role of regulation and supervision in the rise and decline of this bancassurance experience at the heights.

 


Paper 2

Governance by Third Party Enforcement: Amsterdam’s Chamber of Insurance.

Sabine Go, Free University Amsterdam (Netherlands)
sabine.go@vu.nl

Managing the risks inherent to long-distance trade has always been of pivotal importance to merchants, ship-owners and entrepreneurs. The emergence of marine insurance meant that entrepreneurs could transfer the risk to a third party. Soon after marine insurances were introduced in early modern Amsterdam, the municipality realized that the financial instrument could advance long-distance trade and enforce the city’s standing as mercantile centre. However, it was also a market susceptible to fraud and deceit. At the request of merchants, fearing that fraudulent behaviour would harm the city’s reputation in general and their interests in particular, the authorities founded the Chamber of Insurance. From then on, the leading insurance market of the time was no longer self-regulated. An additional institutional layer was added and third party enforcement was to guarantee that all parties would honour their commitments.

The institutional structure introduced in Amsterdam would not only exist for almost two centuries, the Amsterdam-model was copied by several competing mercantile centres. The scope of its influence reached far beyond the city walls and its own time. How did the Chamber’s authority and adjudication influence the development of the market and the conduct of and interaction between various parties?

 


Paper 3

Regulatory capture to charm a crisis?

Ben Gales, University of Groningen (Netherlands)
b.p.a.gales@rug.nl

The regime of modern regulation of Dutch insurance was the consequence of thé big crisis in Dutch life-insurance, shaking the industry in the early 1920s. Latter, supervision gradually spread to the non-life branches of insurance. The basic question is whether the crisis had an impact upon the design of supervision and what that implied in the long run. Consensus that some kind of regulation was warranted did become consensus at the very moment ‘pre-modern’, administrative and rather partial supervision did break down by the last quarter of the nineteenth century. The ideas varied between freedom plus publicity, the British option, and supervision or paternalism, the Continental European, but also American option. But the debate and the political process remained inconclusive for decades. This paper will assess why and what changed the dead-lock. Did these factors have a major impact upon the design of supervision besides the special circumstances of the crisis. It will highlight in particular the role of public opinion and the press. For the crisis was not only one of firms in distress, but also one of a public opinion loosing trust and drawn to vociferous criticism.

 


Paper 4

Reinsurance and International Organisations

Niels Viggo Haueter (Swiss Re)
NielsViggo_Haueter@swissre.com

Reinsurers and large insurance companies increasingly seek collaborations with governments and international organisations. Various arms of the World Bank, especially, are now offering profit oriented reinsurance and alternative risk transfer solutions to support economic development in frontier and emerging markets. Urban and regional authorities team up with reinsurers to provide for more effective risk mitigation via insurance in their risk management regimes. The origins of such mutual attraction go back at least to UNCTAD’s approach in the 1960s to strengthen the development of reinsurance in developing countries. However, UNCTAD’s perceived radical support of import substitution created some tensions. Reinsurers became increasingly disenchanted as UNCTAD favoured the establishment of national reinsurance companies. Other UN organisations ridiculed UNCTAD as a debating forum while the real action was seen to be with the World Bank. Yet, UNCTAD’s contribution to help establish invisibles such as reinsurance as an important factor to link less developed economies with the global economy is generally underestimated. It took the World Bank considerably longer to detect the potential of reinsurance. The delay may be explained by some reluctance to abandon debt-creating loans in favour of insurance solutions. A further explanation may be found in unsuccessful attempts to resort to insurance and reinsurance methods to deal with disaster relief in early organisations such as the International Relief Union (IRU). Success was, eventually, aided by growing concern about environmental impacts. In the 1970s, UNESCO invited reinsurers to help assess earthquake risks and, with the UN Disaster Relief Organization (UNDRO), started outlining possibilities for coordinating disaster relief with the private insurance and reinsurance industry. Such attempts, however, remained largely theoretical. The breakthrough appears to have been caused by the combined impact of alternative methods for risk transfer such as insurance-linked securities and the development of micro-insurance solutions based on indices and parametrics. We evaluate these recent developments against theories of the political economy of insurance initiated by Susan Strange and look at the different roles that International Organisations and reinsurers play in overcoming some biopolitical and geopolitical constraints of earlier disaster relief.

 

 

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