Abstract: This chapter considers capital adequacy and capital regulation of insurers and reinsurers. A basic theme is that capital standards should be less stringent for financial sectors characterized by greater market discipline and less systemic risk. Because market discipline is greater and systemic risk is lower for insurance than in banking, capital requirements should be less stringent for insurers than for banks. Similarly, because market discipline is generally greater in reinsurance (wholesale) markets than in direct insurance (retail) markets, capital requirements and related regulation plausibly need not be as stringent for reinsurers as for direct insurers. Current capital requirements and related solvency regulation for US and EU insurers and reinsurers are largely consistent with significant market discipline in the insurance and reinsurance sectors. Any federal regulation of US insurers/reinsurers, harmonized regulation of EU reinsurers, consolidated oversight of financial conglomerates, and increased centralization of regulatory authority to supervise insurance and other financial activities should be designed with full recognition of the limited systemic risk and strong market discipline in insurance/reinsurance and avoid undermining that discipline.

Keywords: capital regulation, capital requirements, market discipline, financial sectors, systemic risk,