All forms of insurance are financial instruments. Not all forms of insurance are as regulated. Premiums are another word for savings/downpayments for some potential future payout. Insurance is an appropriate word for credit default swaps - as it is insuring against the default on a given loan.
In this case, I have my doubts as to how significant the role CDS's played in the crisis in the first place given that after they were all netted out, the actual size of the market was nowhere near the initial scare numbers put out in the press. Here's a decent overview of how the market works: http://www.wilmott.com/blogs/satyajitdas/index.cfm/2009/4/12...
In the aftermath I figure we'll probably find that the much larger issue was in the debt markets and fears of the underlying asset values related to subprime cascaded down to other loans.
You're arguing over semantics. Insurance is about making bets. Life insurance? You bet you're going to die, your insurer bets you won't die that soon.
From the link you provided: "Many swaps can be thought of as being like an insurance contract, should one be so inclined." Just because you call it insurance, doesn't mean that insurance commissioners should regulate it as such. Just as insurance commissioners shouldn't regulate financial options even though they can also be used conservatively as insurance against given financial risk as much as wild financial bets.
As wikipedia says, with insurance there has to be a debt obligation. With CDS there is none. i.e I can't buy life insurance on you, but I could (potentially) buy a CDS that covers me if you declare bankruptcy.
Maybe CDS 'should' be regulated as insurance but thats for another day. :)
CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the events specified in the contract occurs.
However, there are a number of differences between CDS and insurance, for example:
- The buyer of a CDS does not need to own the underlying security or other form of credit exposure; in fact the buyer does not even have to suffer a loss from the default event.[1][2][3][4] In contrast, to purchase insurance, the insured is generally expected to have an insurable interest such as owning a debt obligation;
-the seller need not be a regulated entity;
-the seller is not required to maintain any reserves to pay off buyers, although major CDS dealers are subject to bank capital requirements;
-insurers manage risk primarily by setting loss reserves based on the Law of large numbers, while dealers in CDS manage risk primarily by means of offsetting CDS (hedging) with other dealers and transactions in underlying bond markets;
-in the United States CDS contracts are generally subject to mark to market accounting, introducing income statement and balance sheet volatility that would not be present in an insurance contract;
Hedge Accounting may not be available under US Generally Accepted Accounting Principles (GAAP) unless the requirements of FAS 133 are met. In practice this rarely happens.
Definitions in a regulatory context and simple definitions can be different as this shows. Look up insurance in any dictionary and you'll get some variation of this definition:
"A promise of compensation for specific potential future losses in exchange for a periodic payment."
Look up viaticals for instance. However, whether or not you call it insurance, is irrelevant given the underlying components still exist - the risk and the financial instrument that can either be used to offset that risk or essentially gamble. This applies as much to regulated insurance markets as it does to derivatives.
In this case, I have my doubts as to how significant the role CDS's played in the crisis in the first place given that after they were all netted out, the actual size of the market was nowhere near the initial scare numbers put out in the press. Here's a decent overview of how the market works: http://www.wilmott.com/blogs/satyajitdas/index.cfm/2009/4/12...
More here: http://seekingalpha.com/article/138047-how-cds-spreads-affec...
In the aftermath I figure we'll probably find that the much larger issue was in the debt markets and fears of the underlying asset values related to subprime cascaded down to other loans.