One of the main lessons learned from the financial crisis in 2008 is the need to have a clear framework for crisis prevention and management in the financial sector to which the insurance sector belongs. The financial crisis also revealed the potential consequences of the lack of harmonisation of recovery and resolution frameworks as well cross-border coordination arrangements between countries.
To minimise the risk of crises occurring in the future, and to identify risks to the stability of the financial system and/or real economy (also known as systemic risk) in time, it is necessary to establish an agreed European supervisory approach that not only focuses on individual institutions, but also takes a macro-prudential view, by considering the financial system as a whole.
One of EIOPA’s key responsibilities is to ensure coordinated crisis prevention and management, as well as to preserve financial stability in crisis situations. EIOPA’s crisis prevention tasks can be split into three dimensions:
- The internal dimension, defining processes and procedures for EIOPA to be prepared for and act efficiently in crisis situations;
- The micro-prudential dimension, which focuses on risks affecting individual institutions, in particular, with respect to those that may pose a systemic risk; and
- The macro-prudential dimension, which seeks to identify sources of systemic risk and potential macro-prudential measures to address them.
An important element in carrying out EIOPA's tasks is the exchange of information between national authorities and participation in different fora. For this purpose, EIOPA has set up several Project Groups and participates in relevant fora both at the EU level (e.g. ESRB) and at the level of IAIS.
Crisis prevention and management
Crisis prevention is the less costly and most efficient way to deal with a crisis situation in advance and, therefore, takes place in normal times. It enables the identification of potential risks and vulnerabilities, sets out the main elements that need to be considered in times of stress and defines all necessary processes to face a crisis situation. While evaluating, supervisors follow a broadly based approach to considering the possibility of an emergency situation. For example, the failure of a small firm with few direct cross border links would typically not raise any issues. However, if that failure occurs at a time of more widespread financial fragility, it may precipitate problems. Crisis prevention includes, among others, the establishment of processes and escalation steps to be followed in a range of crisis situations, the monitoring of the risk of adverse developments, or the consideration of possible emergency situations. Carrying crisis exercises is also considered a good practice.
The role of EIOPA varies according to the severity of the situation. In case of adverse developments, the Authority has a facilitation and coordination role. Should the situation further deteriorate, EIOPA could issue a confidential recommendation to the Council of the EU on the existence of an emergency situation. Upon declaration by the Council, and if certain conditions are met, EIOPA can adopt individual decisions that would require national supervisors to take necessary actions in order to address the emergency situation. If further conditions are met, the Authority can adopt an individual decision directly addressed to a financial institution requiring the necessary action to be taken.
Recovery and resolution
When experts speak of measures which reduce the likelihood of an insurer failing, they usually refer to recovery planning and early intervention. If they talk about measures that reduce the costs and impact of an insurance failure - if this cannot be avoided - they use the term resolution. Following the failures and the unprecedented public support to financial institutions during the past financial crisis in 2008, the viability of national recovery and resolution frameworks has gained increasing attention. The focus has been extended to financial institutions other than banks, such as (re)insurance undertakings. Having a harmonised recovery and resolution framework in place is particularly relevant in fragile market environments where there is a risk of (collective or systemic) insurance failures.
EIOPA should contribute to and participate actively in the development and coordination of effective and consistent recovery and resolution plans, procedures in emergency situations and preventive measures to minimise the systemic impact of any failure.
The Authority should contribute to the assessment of the need for a European network of national insurance guarantee schemes which is adequately funded and sufficiently harmonised.
EIOPA should work on identifying best practices aimed at facilitating the resolution of failing cross-border groups and other financial institutions in order to avoid contagion.
The participation and contribution of EIOPA at the relevant Crisis Management Groups of the Global Systemically Important Insurers (G-SIIs) headquartered in the EU, is also of particular importance.
Systemic risk and macroprudential policy
The financial crisis showed the need to further consider the way in which systemic risk is created and/or amplified, as well as the need to have policies in place to address those risks. Experts evaluate, for instance, if the engagements in specific activities or the failure of an insurance undertaking have the potential to spread to other financial institutions or could cause damage to the real economy. If this potential exists, experts speak of systemic risk. So far, most of the discussions focused on the banking sector due to its prominent role in the recent financial crisis.
However, given the relevance of the topic, EIOPA initiated the publication of a series of papers on systemic risk and macro-prudential policy in insurance. The authority should ensure that it has specialised and ongoing capacity to respond effectively to the materialisation of systemic risks, in particular with respect to institutions that pose a systemic risk. To this end, EIOPA has initiated the publication of a series of papers on systemic risk and macro-prudential policy in insurance.