S&P questions G-SII merits while acknowledging uncertainty in outcome of designation

Standard & Poor’s  is asking whether the global systemically important  insurers (G-SIIs) designation’s costs outweighs it benefits and appears in its analysis to be sliding toward the answer of yes, at least for some.

Of course, the effects of the designation have not played out at all, yet, so anyone who analyses any effects couches their prognosis in terms of uncertainty.

“The merits of the G-SII designation for global financial stability are not clear, in our view, and may not outweigh its costs for insurers and their regulators,” stated Standard & Poor’s (S&P) Financial Services LLC in a June 3rd report on its global credit portal.

S&P said it concluded after some analysis that “ultimately, the net impact of the designation may be negative for some G-SIIs and positive for others. The picture will become clearer as the new regime takes shape and the G-SIIs take management actions to respond.”

S&P analysts considered the positive and the negative and did find potential for both, but ultimately questioned whether insurers pose a systemic risk like some of  the large banks have been found to do.

This sentiment, and the question analysts posed, whether naming certain insurers as G-SIIs enhances financial stability and warrants the resulting costs to insurers and their regulators, colored the report’s analysis.

In fact, the analysis suggest that the creation of G-SIIs could possibly destabilize parts of the industry itself if there is too much  regulatory focus on these largest, most interconnected global insurers while the rest of the industry goes its own way, in a way, less scrutinized.  “We further believe that the creation of G-SIIs could divert regulatory resources toward these entities while more risk accumulates at the non-G-SIIs,” the analysts said.

The analysts do suggest there is a place for a systemic risk scrutiny domestically, though: “We believe that systemic risk was more evident in insurance at a national, rather than global, level during the financial crisis, when U.S. bond and mortgage insurance and trade credit insurance in some European markets posed systemic concerns.

It may be that the FSB [G-20 Financial Stability Board]  would never have pursued the G-SII regime were it not for AIG’s failure, S&P analysts stated. It was “a failure that resulted, in our view, from its shadow banking activities, which other insurers largely avoided,” S& P said.

Potential identification of systemically risky/important  global reinsurers by the International Association of Insurance Supervisors (IAIS)  in concert with the FSB, is expected in November.

“The FSB has postponed the announcement of reinsurer G-SIIs twice, which may be indicative of differing views on the potential candidates,” S&P stated.

The IAIS is expected to deliver the basic capital requirement (BCR) n November, but S&P  believes significant later modifications are likely as work continues on the other elements,  including the higher loss absorbency for G-SIIs (by 2015). IAIS said that ComFrame field testing is progressing well, with many meetings taking place over the next month to analyze data and prepare for the next BCR consultation in July.

S&P says that although basic capital requirement, higher loss absorbency, and advocated global insurance capital standard won’t be “hard” capital tests that require insurers to act on deficiencies until 2019, it expects the development of these myriad capital standards to influence regulatory supervision before then.

The ratings agency questioned also this need for capital loadings for G-SIIs.

“It’s understandable for banks, where recent empirical evidence has shown what a failure can cost taxpayers…While insurers, including some large insurers, have failed in the past, their resolutions have generally come at limited cost to taxpayers, in our view…. In light of the lack of data on the cost of these resolutions in general and for taxpayers, it’s unclear to us how the IAIS will calibrate the G-SIIs’ capital loadings,” they stated.

S&P has taken no rating actions on insurers thus far as a direct consequence of a G-SII designation so far.

However, insurers should not expect a ratings boon from S&P for their global designations, at least:

“We anticipate that governments would play a role in resolving failing G-SIIs (and D-SIIs), but don’t see the same incentive for governments to provide capital support to the insurance sector. Accordingly, we factor no government support into insurers’ ratings unless they are government-owned,” S&P stated.

“In our view, the G-SIIs generally aren’t too big to be allowed to fail because we believe it’s possible to resolve their liabilities post-failure without disrupting the financial system and without the injection of taxpayers’ money. Capital injections generally aren’t necessary when resolving insurers because, relative to banks, they have low financial leverage, lower liquidity risk, low interdependency, and extensive use of subsidiaries (rather than branches). The infrequency of insurer bailouts historically bears this out,” the S&P analysts team stated in the research report.

Policy measures under consideration for G-SIIs include heightened oversight, resolution plans, and capital loadings to absorb potential losses.

The U.S. G-SIIs are Prudential Financial, AIG and  MetLife.

Domestic systemically important insurers (SIFIs), as designated by the Financial Stability Oversight Council (FSOC)  are expected to match up with these, according to S&P, with a MetLife designation coming down the pike. MetLife has been in Stage 3 of the FSOC review process for months.

S&P states that  heightened oversight is already a reality: AIG’s lead supervisor, the Fed, has already allocated a dedicated staff of nine to the task–and “colleges” of most of the G-SIIs’ main supervisors are already in place, S&P points out.

Insurers must submit detailed resolution plans to their group supervisor by July, for example.

The primary analyst for this S&P research report, which looks at the nine G-SIIs globally, is in London, with a team in New York, Frankfurt and Singapore.

Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action).