Insurance Activities and Systemic Risk

Abstract

European sovereign debt crisis, the concept of systemic risk has become increasingly relevant. After the collapse of Lehman Brothers in particular, the debate on systemic risk has been primarily focused on banks. However, recent empirical evidence suggests that institutions not traditionally associated with systemic risk, such as insurance companies, also play a prominent role in posing systemic risk. Thus in the present paper we investigate the relative systemic risk contribution of insurance companies vis-à-vis other industries and the determinants of systemic risk within the insurance industry. In the first part of the analysis, we conduct an aggregated industry analysis based on 3 measures of systemic risk, namely CoVaR, DMES and the linear Granger causality test, on 3 groups, namely insurers, banks and non-financials. In the second part of the analysis, we investigate the relation between the systemic risk contribution and different balance sheet positions and proxies.Our evidence suggests that in the aftermath of the recent crises financial institutions tend to cause more systemic risk than non-financial institutions; among financial institutions, banks pose more systemic risk than insurers, especially after the Lehman bankruptcy. Insurers do cause systemic risk, especially when they engage in non-insurance activities, e.g. banking activities. Furthermore, we find that systemic risk in the insurance industry is mainly driven by the liability side, i.e. the capital structure rather than the asset side. However, on the asset side we find that the level of diversification is also a strong determinant of systemic risk, although further investigation is needed. In addition, traditional variables associated with systemic risk in financial institutions, such as size is of importance, whereas price-to-book and leverage seem to play a counterintuitive role. This is however in line with previous findings, which confirm for instance that leverage in insurance is fundamentally different compared to leverage in banking. Results are robust to a set of different specifications, different panels and different econometric methods. Finally, the choice of the time span should shelter the analysis from biases stemming from sample (time-dependency) selection.In this paper, we provide new evidence on the role of insurers in posing systemic risk, in particular on the role of insurance activities compared to non-insurance activities. Also, we are among the first to provide empirical evidence on the role of diversification in posing systemic risk, which should be further analyzed in future research. Moreover, we are the first to use a European set of companies and to use variables of stock rather than flow: the latter is particularly relevant to show how the stock of the outstanding business drives systemic risk contribution in the insurance industry.Concluding, our research has the potential to provide a significant contribution to shedding additional light on the debate on systemic risk in the insurance industry as well as insig...

The rising interconnectedness of the insurance sector

“…On the other hand, the largest insurers are more likely to have closer links with other financial and nonfinancial firms than smaller insurance companies. Moreover, some of the largest insurers have massively engaged in NTNI activities, thus increasing their exposure to external shocks (Berdin & Sottocornola, 2015). For example, Harrington (2009) shows that the near default of AIG during the financial crisis resulted from the issuance of credit default swaps.…”

Systemic Risk in the Insurance Sector: A Review and Directions for Future Research

“…3.4.1) . Furthermore, we differentiate business activities according to their degree of innovation, thus classifying them as either traditional or nontraditional insurance business, as is common in the literature (see, e.g., Baluch et al., ; Kessler, ; Cummins and Weiss, and Berdin and Sottocornola, , instead use the terms core and noncore activities). This classification is not always clear‐cut but, in general, we consider an activity to be traditional when its accompanying risks are mostly (1) idiosyncratic, (2) not correlated with one another, and (3) not influenced by economic business cycles (see IAIS, ) .…”

“…Their results support the view that banks contribute the most to systemic risk. See also Berdin and Sottocornola ().…”

Systemic risk and real economic activity: A South African insurance stress index of systemic risk

“…constitute a potential source of systemic risk. Similarly, Berdin and Sottocornola (2015) apply the linear Granger causality test, ΔCoVaR, and MES to assess systemic risk in the banking sector, insurance sector, and non-financial sectors in Europe. Their results show that, although the insurance sector plays a less important role in causing systemic risk compared to the banking sector, it shows a persistent systemic relevance over time.…”