Working Paper Series no. 857: The Rising Interconnectedness of the Insurance Sector

The interconnectedness of the insurance sector represents the linkages with other parts of the financial system and the real economy, which can serve as a channel for shock propagation and amplification. Regulatory authorities consider that the interconnectedness of the insurance sector contributed to the spread of the 2007–2009 global financial crisis. As a result, in the aftermath of the crisis, the authorities decided to strengthen the regulation of the insurance sector by introducing new macroprudential measures primarily based on the interconnectedness of insurers.

Recognizing the critical need to better monitor the interconnectedness of the insurance sector, regulators have undertaken considerable work to collect detailed accounting data on bilateral linkages (G20 Data Gap Initiative). However, to date, these proprietary datasets are mostly available over the short term, at relatively low frequency, and cover a limited scope of institutions and potential linkages. In this context, this paper introduces a new measure of interconnectedness for insurance companies based on public stock market data, which cover an extended timeframe and reflect information more rapidly than accounting data. Unlike other market-based indicators that focus on the linkages of insurers within the financial sector, the proposed measure can capture the linkages of insurers with both financial and non-financial companies. We argue that measuring the interconnectedness of the insurance sector with the real economy is essential to assess the likelihood of future insurance crises.

The main goal of this paper is to investigate whether the level of interconnectedness of the insurance sector has increased over the past decades. A better understanding of the evolution of interconnectedness can help determine whether the probability of a crisis in the insurance sector has risen over time. Even though insurers played a central role during the global financial crisis, their status as systemically important financial institutions remains questioned, considering that, historically, insurance crises have been rare and have had limited consequences (Baluch et al., 2011). To our knowledge, this article is the first to test for a long-term rise in the level of connectedness of the insurance sector.

Our empirical analysis is conducted from 1973 to 2018, for 16 developed countries, at both the sectoral and institution levels. We show that the level of connectedness of the entire insurance sector with financial and non-financial companies has significantly increased over the last decades (see Figure 1). On the other hand, the linkages of non-financial firms (with the financial sector and the real economy) have not experienced the same phenomenon. Besides, while the interconnectedness of the insurance sector remains lower on average than that of the banking sector, the largest insurance companies appear as interconnected as the largest banks.

These results shed light on the rise in the interconnectedness of the insurance sector, which supports the ongoing development of macroprudential regulation. Specifically, our results suggest that there is a case for the current shift toward regulation that targets the entire sector rather than a small number of large insurers. In addition to this new framework, our findings call for continued annual identification of global systemically important insurers, as the level of interconnectedness of some major insurers stands out well above the rest of the sector.