A financial institution’s asset size should not be the primary determinant of systemic risk, notes independent research released by The Property Casualty Insurers Association of America (PCI). PCI cautions that such a measurement can have major negative economic consequences, cost jobs and increase systemic risk if used in financial services reform legislation.

Release of the study, “Problems With Reliance On Firm Size For Systemic Risk Determination,” from NERA Economic Consulting, comes as the Senate considers sweeping financial services regulatory reform measures. In December 2009, the U.S. House of Representatives passed its version of financial services regulatory reform, H.R. 4173. Both bills use size alone for financial institutions as a threshold for determining who pays for proposed systemic risk assessments.

“This important new report shows that using size alone will likely lead to additional, damaging unintended consequences,” said David Sampson, president and CEO of PCI. “We believe steps need to be taken to ensure that taxpayers are protected and to prevent another economic crisis from reoccurring. But any such changes should be designed with a clear understanding of what caused our nation’s financial crisis—and what did not.”

NERA’s study reached a number of conclusions that should give lawmakers pause before they create a systemic risk calculation based solely on a firm’s size. Among those findings:

•    U.S. job losses and other economic inefficiencies
•    Consumer price increases for basic financial services
•    Heightened systemic risk as a result of increased moral hazard

“The moral hazard associated with the establishment of a systemic risk dissolution fund based solely on firm size could actually lead to increased risk within the economy,” said Christopher Laursen, senior consultant for NERA. “We need to instead focus on the standards governing a firm’s leverage, liquidity and transparency.”

“We hope that Congress can use these findings as a tool as deliberations over systemic risk and resolution regulation continue,” said Sampson. “This is a critical time for our nation’s financial markets and insurers remain committed to seeking appropriate solutions for identifying systemic risk and protecting consumers.”

The NERA study’s findings support the conclusions of others who found that property/casualty insurers did not contribute to the current fiscal crisis. The Obama Administration’s 2009 whitepaper on the financial crisis concluded that “the current crisis did not stem from widespread problems in the insurance industry,” and a 2009 study by the investment firm MSCI Barra measured the degree to which some 34 different industries were leveraged. The insurance industry ranked 27th, while financial services firms ranked 7th. And on February 12, Federal Reserve Gov. Daniel Tarullo told a Senate panel that a new evaluation system is needed that instead focuses on a financial institution’s leverage and interconnectedness with other banks as a better way to measure systemic risk.

“We reiterate that home, auto and business insurers did not cause the financial crisis and are not systemically risky,” said Sampson. “They are not highly leveraged or interconnected with other financial firms as a source of credit or liquidity. This is an example of a healthy, non-systemically risky industry that could suffer if miscast in a duplicative federal regulatory system that uses firm size as a qualifying factor.”

PCI engaged NERA in December 2009 to produce third-party analysis to examine systemic risk regulation. PCI commissioned a series of studies to establish scientific methods to assess and define systemic risk. The NERA report was commissioned by PCI, but NERA’s experts are wholly responsible for its content and conclusions.

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