What about increasing unemployment benefits for the young?
Claudio Michelacci, Hernán Ruffo 18 November 2014
Like any insurance mechanism, unemployment benefits involve a trade-off between risk sharing and moral hazard. Whereas previous studies have concluded that unemployment insurance is close to optimal in the US, this column argues that replacement rates should vary over the life cycle. Young people typically have little means to smooth consumption during a spell of unemployment, while the moral hazard problems are minor – regardless of replacement rates, the young want jobs to improve their lifetime career prospects and to build up human capital.
It is well known that workers suffer when they lose their job and experience an unemployment spell – surveys indicate a sharp decrease in happiness, and average consumption falls by around 20% upon job displacement. And much research has studied how to efficiently insure workers against the risk of unemployment. Like any other insurance mechanism, unemployment insurance involves a trade-off between the gains from providing liquidity and insurance to unemployed workers and the cost of the implicit problem of moral hazard.
unemployment, insurance, happiness, Unemployment insurance, unemployment benefits, moral hazard, replacement rates, human capital, life cycle
Adverse selection and moral hazard in the Japanese public credit guarantee schemes for SMEs
Kuniyoshi Saito, Daisuke Tsuruta 14 November 2014
In Japan, loans with 100% guarantees account for more than half of all loans covered by public credit guarantee schemes, but banks claim that they do not offer loans without sufficient screening and monitoring even if the loans are guaranteed. This column presents evidence of adverse selection and moral hazard in Japanese credit guarantee schemes. The problem is less severe for loans with 80% guarantees.
Credit rationing caused by capital market imperfections is widely seen as an important phenomenon in the loan market, especially for small and medium enterprises (SMEs). Among various ways of alleviating the problem, credit guarantee schemes are one of the most important policy tools in many countries. An economic rationale for such public intervention is that it can enhance efficiency by providing additional funds for SMEs that are in fact healthy but unable to secure enough loans because of the informational gap between lenders and borrowers.
credit rationing, SMEs, credit, public guarantees, Japan, capital markets, asymmetric information, moral hazard, adverse selection, loan guarantees, insurance
How insurers differ from banks: Implications for systemic regulation
Christian Thimann 17 October 2014
Having completed the regulatory framework for systemically important banks, the Financial Stability Board is turning to insurance companies. The emerging framework for insurers closely resembles that for banks, culminating in the design and calibration of capital surcharges. This column argues that the contrasting business models and balance sheet structures of insurers and banks – and the different roles of capital, leverage, and risk absorption in the two sectors – mean that the banking model of capital cannot be applied to insurance. Tools other than capital surcharges may be more appropriate to address possible concerns of systemic risk.
Regulation of the insurance industry is entering a new era. The global regulatory community under the auspices of the Financial Stability Board (FSB) is contemplating regulatory standards for insurance groups that it deems to be of systemic importance. Nine insurance groups received this FSB classification in 2013, and the design of systemic regulation for these groups is now in progress.
insurance, reinsurance, banking, financial intermediation, regulation, systemic risk, maturity transformation, BASEL III, investment, capital, capital requirements, bail-in, loss absorption
Regulating the global insurance industry: Motivations and challenges
Christian Thimann 10 October 2014
Regulation of the global insurance industry, an emerging challenge in international finance, has two central objectives: strengthening the oversight of insurance companies designated ‘systemically important’; and designing a global capital standard for internationally active insurers. This column argues that it is a Herculean task because the business model of insurance is less globalised than other areas in finance; because global regulators have less experience of insurance than banking where global standards have been pursued for a quarter of a century; and because, as yet, there is limited research-based understanding of the insurance business and its interactions with the financial system and the real economy. But in the aftermath of the global financial crisis and the AIG disaster, regulators are under strong pressure to make progress.
The Financial Stability Board (FSB) has completed its framework for the regulation of systemically important banks (FSB 2013a), and is now turning to the insurance industry. Its approach is inspired by the banking framework, under which 29 banking groups have been classified as systemically important. These banks are subject to a three-pronged framework consisting of enhanced supervision, the preparation of risk- and crisis-management plans, and the application of capital surcharges.
Financial markets Global crisis
systemic risk, insurance, global crisis, AIG, regulation, capital requirements, Bailouts, bail-in, financial intermediation, accounting standards, mark-to-market, risk management
A fiscal shock absorber for the Eurozone? Lessons from the economics of insurance
Daniel Gros 19 March 2014
Since the onset of the sovereign debt crisis, the argument for a system of fiscal transfers to offset idiosyncratic shocks in the Eurozone has gained adherents. This column argues that what the Eurozone really needs is not a system which offsets all shocks by some small fraction, but a system which protects against shocks which are rare, but potentially catastrophic. A system of fiscal insurance with a fixed deductible would therefore be preferable to a fiscal shock absorber that offsets a certain percentage of all fiscal shocks.
Even before the euro crisis started, it had been widely argued that the Eurozone needed a mechanism to help countries overcome idiosyncratic shocks. The experience of the crisis itself seemed to make this case overwhelming, and throughout the EU institutions it is now taken for granted that the Eurozone needs a system of fiscal shock absorbers. For example, The Report of the President of the European Council calls for:
EU institutions Macroeconomic policy Welfare state and social Europe
eurozone, euro, insurance, fiscal policy, Eurozone crisis, fiscal union, fiscal shocks, fiscal shock absorbers
Googling systemically important insurers
David Veredas, Matteo Luciani, Mardi Dungey 22 April 2013
An unintended consequence of tighter banking regulation is that businesses are looking beyond banks for their loans. This column argues that this arbitrage opportunity may create systemic risks, including amongst major insurance companies. Using a new methodology, evidence tentatively suggests that insurers are indeed becoming systemic.
An arbitrage opportunity is being created for insurers and, if not overseen, it may entail systemic risks.
Countercyclical regulation in Solvency II: Merits and flaws
Jon Danielsson, Roger Laeven, Enrico Perotti, Mario Wüthrich, Rym Ayadi, Antoon Pelsser 23 June 2012
October 2011 saw the latest draft of Solvency II, the European Union’s code for regulation of the insurance industry. This column argues that the latest proposals need to be drafted again, urgently.
The October 2011 Solvency II draft introduces the possibility of a countercyclical premium. Upon declaration by the regulator – the European Insurance and Occupational Pensions Authority – that distressed market conditions exist, an additional wedge is to be added to the risk-free term structure to value all insurance liabilities subject to fair market valuation.1
EU policies International finance
insurance, financial regulation, Solvency II, countercyclical premium
Addressing the incompleteness of long-term care insurance
Joan Costa-i-Font 09 June 2012
As if the current debt problems for industrialised economies were not enough, many face the added challenge of ageing populations. This column argues that the biggest threat from an ageing population is the lack of cover for long-term care.
With rapid population ageing, expenditure on long-term care – that is, care and assistance for old-age dependent elderly – has risen faster than health expenditure. Perhaps surprisingly, this increase is far more due to population ageing than to changes in people’s health (Colombo and Mercier 2012, Breyer et al. 2011).
insurance, Ageing population, long-term care
What determines the optimal mix of public and private insurance?
Giuseppe Bertola, Winfried Koeniger 29 April 2011
Why do public and private insurance coexist in all countries? This column analyses the determinants of the optimal insurance mix. It reveals how public insurance schemes are constrained if available information on private insurance transactions is incomplete. It discusses how the optimal insurance mix strikes a balance between the overall costs and benefits of insurance as well as the preservation of work incentives.
In all economies, both public policies and private contracts provide insurance. Government-sponsored social insurance programmes cover many health, employment and disability risks. Households can also insure partially against these and other risks in private markets by buying explicit state-contingent insurance or by accumulating wealth.
Insurance is costly and reduces incentives
These insurance schemes cannot and should not cover risk perfectly, for two reasons.
Financial markets Labour markets
Valuing insurers' liabilities during crises: What EU policymakers should NOT do
Con Keating, Jon Danielsson 18 March 2011
In crises, insurance companies' asset values may fall significantly without a corresponding drop in their liabilities. European insurers have argued that their liabilities should be discounted by a higher rate during crises, lest regulations force them to raise more capital at exactly the wrong time. This column argues that that would be the wrong approach to the problem.
At the height of the last crisis, the market value of the assets of insurance companies fell sharply while the present value of their liabilities remained essentially unchanged. Under recently proposed insurance regulations, similar events might result in insurance firms ending up in breach of regulations, thus requiring them to increase capital quickly to avoid official interventions.
insurance, liquidity premium, solvency