Solvency II modelling could cause systemic risk, industry warns

Industry experts warn uniform modelling under Solvency II could lead to risk contagion

Modelling regulations under Solvency II could lead to systemic risk for the insurance industry, according to speakers at the Federation of European Risk Management Assocations (Ferma) forum in Stockholm.

"Looking back at the 2007–2008 financial crisis, there was systemic risk created by the models," says Lex Baugh, chief executive at Chartis Europe. "If you look at the way we're building our models for Solvency II, there are basically three suppliers to the market and everybody is using a derivative of one of those models."

Baugh is concerned that insurance firms under Solvency II modelling could be subject to investment risk. If every insurer is using a similar model that allocates its capital in a similar way, capital from the entire industry could flow in the same direction at the same time. This could challenge confidence in the insurance sector's ability to prevent systemic risk, he argues.

"I think we did a pretty good job of minimising concern among stakeholders about the systemic risk in our industry through the last crisis," says Baugh. "We have to watch that Solvency II doesn't influence more of a herd mentality in the way we look at managing and allocating capital." The risk of 'model monoculture' has been discussed before in the context of systemic pricing risk across the financial industry.

David Batchelor, chief executive of insurer and risk adviser Marsh, agrees. "As an industry we need to make sure we are responding in the right way and that there isn't contagion in the same way perhaps as the banking crisis," he says.