Study finds insurance is not a systemic risk

By: ISU Communications and Marketing Staff, ISU Communications and Marketing Staff
May 20, 2010

Research completed by a Networks Financial Institute fellow has concluded that systemic risk is not a feature of the insurance industry because the failure of American International Group in 2008 did not adversely affect major insurers.

Martin F. Grace, a professor of legal studies and risk management and insurance at Georgia State University who serves as a senior research fellow for Networks Financial Institute at Indiana State University, presented his findings earlier this month in Washington, D.C. to a group of industry leaders, regulators and lawmakers.

Grace offered his new methodologies for assessing systemic risk in the insurance industry - which includes system breakdown, causality of loss and uncertainty in evaluating the relative strengths of insurance companies - in an effort to inform decision makers and to contribute to the discussion about increased federal oversight of the insurance business.

Terrie Troxel, acting director of Networks Financial Institute in the Donald W. Scott College of Business at Indiana State, said Grace's findings have significant ramifications for the financial services industry.

"The structure, operations, and size of AIG are unique," Troxel said. "Traditional insurance products AIG and other insurers offer do not threaten contagious financial failures."

While some policy analysts have suggested that the presence of systemic risk among insurers necessitates changing the governmental level at which all insurers are regulated, Grace's policy brief, available at www.NetworksFinancialInstitute.org, suggests otherwise.

By examining the month-long turmoil that began in September 2008, Grace concluded that the insurance industry did not avoid systemic risk as a result of state-based insurance regulation.

Rather "that success is more likely attributable to the fact that insurers differ from banks. A demand for financial innovation by banks which help them to fix their asset-liability maturity mismatch though securitization did not exist in insurance."

Further, Grace's research concludes "the governmental level at which insurance is regulated is immaterial as long as similar moral hazard risk is present in both regulatory systems. However, there is a risk that this would change if an Optional Federal Charter law is enacted."

In Washington, D.C. on May 13, Grace shared his research with a panel of respondents that included James Segel, Baird Webel and Eric Thompson.

Segel serves as special counsel to Congressman Barney Frank, chairman of the House Committee of Financial Services. Webel is a specialist in financial economics at the Congressional Research Service and provides background information about the insurance industry to the House Financial Services Committee and the Senate Banking Committee. Thompson is a senior professional staff member of the House Committee on Financial Services and is the chief insurance advisor for committee Republicans.

Discussion included how the insurance industry might be assessed to fund the dismantling of insolvencies; the infeasibility of more bailouts in the current political climate; and the reactive rather than proactive nature of the current state-based insurance regulatory system.

Networks Financial Institute in the Scott College of Business at Indiana State University was founded in 2003 with a grant from the Lilly Endowment, Inc. Networks Financial Institute strives to facilitate broad, collaborative thinking, dialogue and progress in the evolving financial services marketplace, concentrating on the areas of education, outreach and research. Headquartered in Terre Haute with offices in Indianapolis and Washington, D.C., and international outreach, the organization's goal is to serve as a catalyst for positive change in the financial services industry.

More information about Networks is available at www.NetworksFinancialInstitute.org. A copy of Grace's policy paper is available at http://www.networksfinancialinstitute.org/Lists/Publication%20Library/Attachments/160/2010-PB-02_Grace.pdf. More information about the Scott College of Business can be found at www.indstate.edu/business.

Contact: Terrie Troxel, acting director of Networks Financial Institute and executive director of the Gongaware Center for Insurance and Financial Services, Scott College of Business, Indiana State University at 812-237-2028 or terrie.troxel@indstate.edu.