Regulation Of Pro-cyclical Insurance Industry

Procyclicality is one of the important sources for the global financial crisis, arising fromrisk-based capital adequacy regime. Earmarked with the risk-based nature, China RiskOriented Solvency System (C-ROSS) is under way for Chinese insurance industry.Procyclicality is one of the key issues that the C-ROSS has to solve in the context of themacroprudential supervision. Procyclicality is a positive feedback mechanism exaggeratingvolatility of financial markets, including endogenous procyclicality reflecting internalfeedback of market and exogenous procyclicality caused by the supervisory regime. The―cycle‖in the―insurance procyclicality‖that is targeted by the macroprudential supervisionshould be designated to the―cycle of systemic risks‖. Supervision over insuranceprocyclicality should aim at mitigating potential systemic risks at booming times whiledampening the amplification of systemic risks by the insurance industry during the crisis. Thesystemic risks are risks arising from damages or suspension of financial services, which harmthe real economy with potential negative impacts. The systemic risks evolve with three stagesof common shocks, contagion effects and procyclicality. The insurance industry engages inthe chain of the systemic risks through businesses of systemic risk and quasi-systemic risk.Qualitative analysis and quantitative simulation show that the endogenous procyclicalityexists for the insurance industry and the exogenous procyclicality exists for the risk-basedsolvency regimes. Given the characteristics of insurance liability, short-terms liquidity shocksshould receive due concerns.Insurance needs customized monitoring system and supervisory tools for theprocyclicality. The procyclicality monitoring should aim at the exaggeration of systemic risksthat the damages to insurance, caused by the systemic risks, incur. The monitoring systemshould function to identify measure and alter the system risks and provide parameters forsupervisory intervention. The monitoring indicators should cover depth of systemic risks,density of procyclicality shocks and density of insurance feedback. Supervision ofprocyclicality should make differentiated goals for different objects, follow different principles in line with different shock persistence and be judged with two criteria of reversedirection and mitigating forces. Counter Cyclical Mitigator may apply to capital requirementto smooth the man-made harass of short-term volatility. Recognition rules for assets andliabilities should be de-risked. Solvency control levels should not be designed withprocyclicality. Extra capital charge should be allowed for those businesses of systemic riskwhile counter cyclical capital buffer may apply to export credit insurance in particular. Theshort-term liquidity risks produced by contingent payment obligations may be subject toLiquidity Pre-cycle Ratio. Entrance and exit of procyclicality measures should dominantlyfollow the rule-based principle and strictly limit use of supervisory discretion.Macroprudential bodies should cooperate to monitor the procyclicality while the insurancesupervisor should undoubtfully undertake the responsibility of supervisory intervention.