An assessment of the potential industry impact if an insurer should fail is being undertaken by the Reserve Bank of New Zealand (RBNZ) as part of its prudential regulation.
The central bank says it needs to collect sound information in order to monitor the sector so as to mitigate the impacts that may stem from individual firm or system-wide stress.
The potential risks facing the New Zealand industry are examined in RBNZ’s report The insurance sector and economic stability
, published on Friday.
The report’s authors Annalise Vucetich, Roger Perry and Richard Dean, listed the following three main criteria for evaluating negative consequences on the economy:
- The failing firm’s size relative to its market or sub-market;
- Substitutability – or the extent to which other insurers can provide the same or similar service in the event of failure;
- The interconnectedness of a firm.
It also outlines how accumulation of risk in the sector and the behaviour of participants can determine the effect that internal and external shocks have on the economy.
With New Zealand exposed to both slow and fast-moving exogenous shocks – for example the new health risks that increased longevity has on life and health insurers plus the variety of natural catastrophes New Zealand faces by its location on the Pacific ‘ring of fire’ – the Insurance (Prudential Supervision) Act 2010 (IPSA) requires insurers to reserve for one in 1,000 year events, which is more stringent than international practice.
The kind of endogenous risks the New Zealand sector faces include being a price taker of international reinsurance rates, which exhibit cyclicality, the report says.
“For example, rates may be lower when New Zealand is experiencing a long period of benign claims. If a primary insurer can obtain reinsurance at low rates, this may incentivise them to uner-price risk and set their premium rates too low.
“If under-reserving results, the insurer may not have the capacity to pay out claims that exceed its reinsurance.”
The increase in property insurance that has occurred since the Canterbury earthquakes “suggests that the absolute level of risk was possibly being under-estimated by at least some insurers prior to the earthquakes,” the report says.
By placing constraints on insurers’ investment and asset allocation decisions, the introduction of the IPSA solvency standards should limit the potential for insurers’ activities to create endogenous risks. “For example, the standards explicitly require insurers to hold more capital against higher risk assets,” it says.
This is the reason for advancing the supervisory framework developed under IPSA, and RBNZ says it will continue to advance this.
“It is important to have sound information upon which to monitor the sector, and data collection will continue to evolve so that effective monitoring and analysis of developments in the sector can be achieved.”