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Regulators focus on risk transfer and capital arbitrage as convergence accelerates

International regulators are stepping up their oversight of the insurance industry for a multitude of reasons. The fear that life insurers are taking increasingly risky bets with long-term retail savings is high on the list. And so is the concern that the increasing convergence and risk transfer between the insurance and banking sectors may be creating unseen - and unforeseen - risks.

In recent weeks, regulatory bodies such as the UK's newly empowered Financial Services Authority (FSA) have been visiting banks and insurance companies to gather information on cross-market transfer risk between the two sectors.

Andrew Crockett, general manager of the Basle-based Bank for International Settlements, identified transfer risk as one of the potential vulnerabilities in the financial system in a recent article on future financial risks.

"The pace of development in financial markets during the past five years means that many new financial structures have yet to be tested in a downturn," wrote Crockett. "For example, a whole range of financial risk insurance and transfer products has developed to spread risk more widely. How robust will these prove if default rates rise? Will insurance companies hurt by the events of September 11 continue to buy credit risks from banks?"

The Bank of England devoted a large chunk of its most recent Financial Stability Review, published in mid-December, to an analysis by David Rule, of the Bank's G10 financial surveillance division, entitled Risk transfer between banks, insurance companies and capital markets.

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