Similarities Between Banks and Insurers

This is the second part of a four part series exploring the impact of COVID-19 on the Financial Sector. Read Part I here.

The role as financial intermediaries

Just like banks, insurers are financial intermediaries as far as their life insurance business lines are concerned. Their liabilities represent financial claims for policyholders, and their assets are predominantly financial assets. Insurers collect savings, intermediate between savers and investors, channel funds, and fulfil a function of capital allocation in the economy. They are indeed important sources of funding for the real economy, also as a wide range of assets are eligible for them.

The role as investors

Just like banks, insurance companies are large investors in financial markets. They receive insurance premia against a promise to cover adverse events and carry savings forward. The premia are invested in a diversified portfolio of assets, encompassing government and private sector bonds, equities, loans, infrastructure finance, and other assets.

Links Between and Banks

Insurers might typically be much less inter-linked with each other than banks are, but the industry might exhibit greater commonality or linkage when viewed as a whole. For example, most life insurers are implicitly or explicitly long in the equity market. A severe enough decline in equity markets can therefore lead to widespread distress potentially leading to forced sales of equities further exacerbating the stress for everyone, i.e. with the stress being transmitted by a mechanism outside the industry itself. Some non-life insurance markets may share similar types of external linkages.

There may also be linkages in terms of capital suppliers, since large insurers and banks are both constituents of wider capital markets (and may be material investors in each other’s equity or debt) and this creates further potential stress transmission mechanisms, e.g. via both industries building up exposures to sovereign debt, see e.g. Impavido et al (2011).

Of course, the banking industry is not itself immune from such transmission mechanisms. Many parts of it are implicitly or explicitly have long residential and commercial real estate exposures. Banking crises (and, in intervening times, failures of individual banks) are often linked to weak real estate markets (the recent credit crisis being no exception, given its linkage to the US sub-prime market).

Insurers’ Financial Assets

The importance of insurers for financial stability is also increasing as the size of the euro area insurance sector has grown rapidly over the last few decades. For example, euro area insurers’ financial assets increased by some 90% from early 1999 to 2008, or from 35% to 50% of euro area GDP. This growth was mainly driven by economic development, which raised the demand for non-life insurance, and ongoing public reforms in pension systems, which encouraged an ageing population to allocate more savings to life insurers (and pension funds). 

Growth has continued at pace in the decade or so since then. In the first quarter of 2018 total assets of euro area insurance corporations amounted to €7,949 billion, €53 billion higher than in the fourth quarter of 2017. Total insurance technical reserves of euro area insurance corporations amounted to €6,009 billion, €32 billion higher than in the fourth quarter of 2017. Holdings of debt securities increased to €3,312 billion, from €3,308 billion. Net purchases of debt securities amounted to €5 billion in the first quarter, which was offset by price and other changes amounting to €2 billion.

Traditionally, insurers are seen as stabilisers of financial markets that act countercyclically by buying assets whose price falls. Recent studies challenge this view by providing empirical evidence of procyclicality. Insurance companies are large institutional investors. They provide the bulk of long-term funding to the economy. The sector has been growing in recent years and has become more interconnected with banks and other financial intermediaries. Therefore, insurers’ response to changes in asset prices could have a significant direct impact on the availability of funding sources to the economy.

Moreover, in crisis periods, large asset sales could amplify price falls and negatively affect other investors holding the same assets, potentially threatening the stability of the financial system. In boom periods, on the other hand, if insurers buy assets whose value is rising, they may contribute to the development of asset price bubbles.

Owing to the long duration of their liabilities, insurers are expected to hold assets until maturity and buy assets whose value declines. Such investment behaviour is particularly relevant from a financial stability perspective since insurers are strongly interconnected with other financial intermediaries and play a key role in the long-term financing of the economy. For instance, more than 40% of euro area investment in bonds with maturity over 10 years is provided by the insurance sector. A recent paper, Insurers’ investment strategies: pro- or countercyclical?, challenges this traditional view by unearthing the reasons why insurance investment behaviour can turn procyclical in distress periods.


Banks may securitize debt for several reasons including risk management, balance sheet issues, greater leverage of capital and to profit from origination fees. Debt is securitized by pooling certain types of debt instruments and creating a new financial instrument from the pooled debt. The types of debt instruments used may include residential mortgages, commercial mortgages, car loans or credit card obligations. The banks receive fees for selling the new debt security. Insurers are also turning to securitisation again more than ten years after the financial crisis.

In the wake of the 2008 crisis, insurance companies reduced Asset Back Securities (ABS) exposure in their portfolios, concerned by lack of confidence in the underlying assets that underpinned the securitisations. Their withdrawal accelerated with the announcement of revised Solvency II legislation, effective January 2016, which classified securitisations into Type 1 and Type 2 and imposed punitive capital requirements on insurers investing in most of the asset class in response to its perceived risk.

Three years on, however, in January 2019 the securitisation market received a boost from the introduction of the Simple, Transparent and Standardised (STS) securitisation framework, designed to strengthen investor confidence in senior, high-quality European ABS. It is hoped that this will enable insurers who have waited on the sidelines for some time to re-engage with the asset class.

Investor Due Diligence

STS also introduces a single set of regulatory requirements for investors' due diligence, as well as a direct requirement for risk retention and data transparency obligations on originators, sponsors or original lenders for new transactions. Institutional investors wishing to invest in securitisations will have to verify certain features and carry out specific due diligence activities. This includes thorough due diligence on the robustness of each individual transaction.

For insurers, securitised debt has the potential to offer compelling benefits including diversification from and a "complexity premium" over public bonds; secured, floating-rate returns; and liquidity, particularly at the senior end of the capital structure. They are secured by the cashflows of identified pools of assets in a variety of sectors, the largest asset class being residential mortgages.

In a note on securitisation issued before COVID-19, fund manager M&G explained that ABS remain attractive to insurance investors and not just because yield spreads have increased. UK consumer risk offered value as Brexit downsides appeared to be overpriced in their view. Resilience of deals was strong, while underlying collateral defaults remained low but it remains to be seen how that assessment stands up to the post virus environment, which was assessed by the European Insurance and Occupational Pensions Authority (EIOPA) when it published an updated Risk Dashboard based on the fourth quarter 2019 Solvency II data.

Despite the fact that some indicators used in this Risk Dashboard do not capture the latest market development in the context of Covid-19 outbreak, it does address the current high uncertainty in the insurance market. The results show that the risk exposures of the European Union insurance sector increased as the outbreak of Covid-19 strongly affected the lives of all European citizens with disruptions in all financial sectors and economic activities.

Post Date: 01/07/2020

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