Managing Insurers Liquidity Risk - Introducing a Practical Tool

The shortage of liquidity has been historically something driving corporates in the financial industry into recovery actions or even into liquidation. Especially the financial crisis on 2008 was an example of several such cases in the Financial industry. On the other hand, the insurance sector has usually survived quite well from such events and at least by some evidence, was even actually able to provide liquidity for the markets and policyholders during the financial crisis. Similar evidence can be found from the current global pandemic, where there has been a lot of evidence e.g. from Europe on how the insurance sector have been able to provide liquidity in terms of being flexible towards their individual and corporate customers and for loan payments. Also forced selling of assets in large scale has been avoided.

In the recent years, there has been a growing interest amongst insurers to invest more into illiquid assets as the low yield environment has been encouraging to hunt for the yield. In the same time, both EIOPA and IAIS have been active in bringing out ideas from the macro prudential regulation perspective whether liquidity risk should be something insurers to better monitor and report and whether even additional capital requirements would be needed. Currently, EU is reviewing the Solvency II directive, where also new tools to managing liquidity risk is been introduced by the European commission. On the other hand, the 2021 EU stress tests for the insurance sector didn’t bring out major concerns for liquidity risks for the industry.

This study aims to introducing a practical four step approach on assessing the level of liquidity risk for an insurance company or group. The model is based to studying the balance sheet and also off-balance sheet items quite holistically and then setting market, and lapse shocks over the different balance sheet items to capture the liquidity profile and any risk there might be. By this approach, the different aspects of liquidity like the various needs, timing and shortages can be captured. The approach is practicable and simplistic but still seems to fit well for the purpose providing also the needed transparency.

This model has been discussed with both EIOPA and ESRB on 2019 and is also quite in line with the industry best practice in in Europe and with many of the ideas that was introduced by EIOPA on 2020 when setting the stress parameters for the 2021 Insurance stress test.

Find the Q&A here: Q&A on 'Managing Emerging Risks'