managing financial risks in (re)insurance in the postpandemic world
by Thomas Weber & Jörg Günther increased financial uncertainty After almost 25 years of relative macroeconomic stability and growth – a period called the Great Moderation (1980s to 2007)1, the shock of the Global Financial Crisis in 2007/2008 has now been succeeded by another global crisis, the coronavirus pandemic. This pandemic has caused a global economic shock not seen before in the past 75 years, triggering a rollercoaster ride in the financial markets. At the same time, debt levels are at record highs. Additionally, central banks are increasing their balance sheets, thus raising major concerns. How does this translate into the risk management perspective of (re)insurance companies? Financial risk management for (re)insurance balance sheets typically uses a liability-based replication portfolio to define a risk-free position2. The balance sheets of (re)insurance companies consist of claims to be paid in the future and of assets backing those claims. Claims are partially sensitive to inflation (a sensitivity not always precisely known), and some of these have longer maturities than the longestmaturity liquid traded assets available, creating what is commonly known as mismatch risk. This poses new challenges in the current situation.
financial risk management considerations From a long-term-perspective, there could be significant risk in what we call risk-free (bonds). Fixed income with almost zero (USD) or negative (EUR) nominal interest rates has little upside and significant downside from both rising interest rates and/or rising inflation scenarios. What is being discussed in capital markets as an investment problem could destabilize the foundations of financial risk management, also taking into account that there is a leverage of fixed-income asset length in relation to risk-absorbing capital.
1 / Episodes of financial crisis like the bond market crisis of 1994, the Asian financial crisis of 1997, and the bursting of the dot-com bubble in the early 2000’s still occurred. 2 / Once the replication portfolio is translated into the world of real assets such as government bonds, risk (as credit/default risk) is unavoidable, even when considering the lowest-risk asset available.
018
Intelligent Risk - July 2021
