We are also alert to the possibility that financial markets may be mispricing risk. As the FSB concluded last week, “there are increased signs of complacency in financial markets, in part reflecting search for yield amidst exceptionally accommodative monetary policies. Volatility has become compressed and asset valuations stretched across a growing number of markets, increasing the risk of a sharp reversal.” In such circumstances, insurers’ proven ability to look through such short term volatility is invaluable. Nevertheless, an abrupt correction in term and risk premia could have a sharp impact on the valuation of securities that are marked to market and reduce the effectiveness and availability of proximate hedging strategies. More fundamentally, by squeezing margins, persistently low interest rates challenge business models. Insurers feel this pressure on both sides of the balance sheet: through muted investment returns; and as long-term obligations to policyholders – most common for life firms but increasingly relevant to general insurers that have Periodic Payment Orders on their books – become more expensive in today’s terms. An understandable response would be to move towards less traditional types of investments – such as infrastructure; into new or more complex types of business – like telematics pricing; or into new geographies like emerging markets. All these strategies bring new risks that must be well understood and prudently managed. Low rates are encouraging inflows of external capital into sectors like reinsurance. In effect, a “soft cycle” in financial markets is reinforcing a “soft cycle” in insurance – a particularly problematic combination.
More capital boosts market capacity, but can also test underwriting discipline. Putting the right ideas to work As supervisor, the Bank of England is monitoring closely how these new risks are being managed and how your business models are evolving. 2  BIS central bankers’ speeches  At the same time we’ll be implementing reforms. Reforms to promote a more resilient insurance sector without standing in the way of an effective insurance sector, and without imposing unnecessary impediments on your ability to evolve your business models in response to the challenges I described. To borrow the theme of this conference we will be “putting the right ideas to work”. Today I want to highlight three of them: •  Tailored, consistent and robust capital standards;  •  Holding the right people to account; and  •  Global standards for globally systemic insurers. With those right ideas, we are promoting a resilient, innovative insurance industry that supports the real economy. Right idea 1: tailored, consistent and robust capital standards The first right idea is to implement tailored and consistent capital standards to ensure the safety and soundness of insurers. Resilience against unexpected losses requires risk-based capital standards and robust valuation practices. The UK’s Individual Capital Adequacy Standards deliver this and were one reason why the UK’s insurance sector weathered the crisis so well. The Bank of England wants the principles behind ICAS to be applied as widely as possible; to establish as level a playing field as possible. That is why we support Solvency II.