Research On Pro-cyclicality And Mitigation Measures Of Insurance Industry

The global financial crisis of 2007-2009 has pushed the global economy to the brink of recession once again. This financial crisis has exposed the demerits of the traditional financial regulation in the way of concepts, methods and tools and has raised the profound study of academicians and regulatory authorities. Especially the issues that the inherent procyclicality of Financial institutions and financial system, and the external rules such as risk measurement model, capital regulations, accounting standards which enhanced the procyclicality, caused unbalance of the financial system, exacerbated the economic cycle have been concerned.As the essential sectors of financial market, the insurance industry is also procyclical, which caused the attention of the insurance regulators and they generally considered that the procyclical problems would have the systematic influence to the insurance field. In the 7th CCISSR Forum, the Chairman Wu of CIRC suggested that the insurance authorities should master the relationship between supervision and the economic cycle, study the method of macro-prudential regulation, explore the solutions of procyclical issues in aspects of the internal risk assessment, the reserve calculation, the fair value measurement, solvency standards, capital buffers and the salary system and other to the insurance industry, and gradually establish the insurance’s macro-prudential regulation system.However, taking a wide view of the existing studies on procyclicality, mainly concentrated in the theoretical studies and empirical analysis of the existence and the cause factors of bank’s procyclicality, proposes ways to mitigate the procyclicality from the standpoint of banking practice and the research of counter-cyclical prudential regulation, the studies of procyclicality based on are rare, even if are lack of depth. Based on this background, this paper follows the economics principles of procyclicality, discusses the widespread procyclicality existing in the insurance operations and regulations and its factors, proposes ways to mitigate the procyclicality from the standpoint of insurance practice as well as measures to prevent the procyclicality from the viewpoint of insurance supervisors.The paper is contributed by introduction and four chapters, the basic thought and framework as follows:The first chapter is an overview of the insurance industry’s procyclicality. This chapter first introduces the relevant theories of economic cycle and procyclicality. And then to distinguish the major differences between the insurance industry and banks, raise the need for an individual study on insurance. At last, we define the connotation of the insurance industry’s procyclicality.The second chapter discuss on the insurance procyclicality from the forming factors and the transmission mechanisms. The insurance’s operating processes of underwriting and investment is procyclical, and the root is the salary incentive mechanism based on short-term interests. Besides, solvency regulation, risk model, fair value accounting rules for the insurance industry will promote the procyclical features. then, we research the transmission mechanism of insurance procyclicality.The third chapter analyzes the influences of insurance procyclicality from the aspects of insurance industry, financial system and economic system. In addition, this chapter also analyzes the insurance procyclicality in China which is not significant, and explains the conclusion by the actual situation in China.On account of the factors mentioned above that cause insurance procyclicality, this paper discusses current plausible measures of mitigation respectively in the forth chapter. For insurance operation, take the count-cyclicality operation strategy, consider the forward-looking provisioning methods and introduce of non-liquidity risk premium to mitigate the provisioning procyclicality and improve the salary management system. For solvency regulation, the paper describes the relevant measures of SolvencyⅡregulatory in mitigating procyclicality, proposes the counter-cyclical adjustment programs of dynamic capital adequacy ratio and analyzes the feasibility of improving the current regulation on capital adequacy ratio from the viewpoint of adding leverage ratio supervision. For risk measurement and accounting standard, the paper discusses the directions for the procyclical problems. Finally, we discuss the potential difficulties we will meet and what should we pay attention to when establish the mitigation mechanisms in practice.The paper is according to a general logical order to address. Not only focus on theoretical research methods, but apply the comparative analysis methods, drawing on the research findings of bank in pro cyclicality, and take into account the characteristics of the insurance industry, redefining the connotation of insurance industry’s procyclicality, according to its characteristics to the research. The paper studies by combining macroscopic with microcosmic research method, taking into account individual behavioral characteristics of the insurance businesses, and analyzing the influence of the individuals’concerted action on macro-economic cyclical fluctuations. In the proposal of the mitigation mechanisms, we also take full account of the micro-prudential and macro-prudential supervision measures.The contribution of this paper is to systematically analyze the causes or exacerbate procyclical factors of the insurance industry, discusses the transmission mechanism of its procyclicality and how to establish the mitigation mechanisms. In addition, the paper also describes and analyzes procyclicality of the insurance industry in China, making up for the insufficiencies in the existed academic research in this field.