Implicit Constraints, Incentives, and Systemic Risk Imposed by New Standards for Insurance Regulation

Within the last decade, the regulation of the European insurance sector has been subject to fundamental reforms aimed at the introduction of new risk-based solvency standards. The first new system in this regard came into effect in 2004 in the United Kingdom. Switzerland followed with its Swiss Solvency Test (SST) in 2006. Beyond these regulatory reforms of individual countries, Solvency II, the EU's flagship project to modernize and harmonize European insurance supervision, has entered its final development phase and is planned to come into force in 2013/2014. Although Solvency II is viewed to be one of the most innovative regulatory frameworks currently available, several important aspects with regard to the adopted risk modeling and risk measurement approaches have not been subject to scientific scrutiny yet. In addition, a thorough analysis of constraints and incentives for the behavior of insurance companies arising from the associated regulatory capital charges has not been conducted yet.

Consequently, within this large-scale research project, we intend to address six specific aspects of Solvency II that are of considerable importance for risk managers and policymakers alike. Due to harmonization efforts and the close integration of the Swiss and European economies, particularly through the capital and insurance markets, potential issues associated with Solvency II are also highly relevant for the Swiss Financial Markets Supervisory Authority (FINMA) as well as the Swiss insurance industry. Moreover, there are substantial consequences of insurance regulation for policyholders, since inadequate solvency capital requirements can either cause inefficient reductions in investment or lead to excessive risk taking, thus endangering the stability of the financial system as a whole. With the upcoming introduction of Solvency II, a systematic analysis and discussion of key limitations is a relatively urgent matter. Therefore, we believe that this proposal is very topical.

In the light of heavy lobbying efforts by industry sources, independent academic research constitutes a focal element in the ongoing discussion with regard to the adequacy of the new standards. Our goal is to combine the experience, competencies, and resources of research groups in St. Gallen (Switzerland) and Nürnberg (Germany). The suggested project design aims to maximize valuable spillover and synergy effects between the participants, particularly with regard to key preconditions as well as the employed methodologies and datasets. We are convinced that substantial economies of scope can be realized by channeling the research questions under consideration into one comprehensive grant. Together with an international network of affiliated academics, these aspects will allow to efficiently orchestrate the work on a new series of quality research papers that should have the potential for publication in the leading journals in the area of risk management and insurance.