Due to tremendous losses connected to the current global financial crisis, insurance giants, such as AIG and Fortis, are being rescued by their governments and are being nationalized in the process. These insurance companies face losses because they too had invested their funds in mortgage securities and credit default swaps and were highly leveraged. If these companies failed, the fallout would have been felt worldwide, with defaults on all types of insurances and loans that were underwritten. Already AIG’s credit problems are still reverberating, as it has already spent most of the bailout funds.

The purpose of insurance is to spread risk over time. The risk of an event where insurance money is paid out (i.e. a car accident, burglary, fire, terrorist incident, job loss, bank failure, weather-related event, etc...) is assessed based on the probability of its occurrence. Insurance companies (or other institutions that offer insurance products, such as banks and governments) charge a premium based on the risks and the potential loss associated with that risk.

Insurance companies also defer risk through reinsurance, in which a reinsurance company insures the risk of insurance companies, thus allowing the insurance companies to offer higher levels of protection to the policyholder, since they do not have to worry about covering the full losses.

Sometimes events are deemed too risky for private insurance and the loss associated with that event is either paid out-of-pocket or by government intervention (by helping defer costs after the event has taken place or by offering an alternative insurance option). For example, in the U.S. many private insurance companies do not offer flood insurance, hence federal government offers National Flood Insurance Program (NFIP) to insure property for flood damage and the Federal Crop Insurance Corporation (FCIC) to protect crops for flood and drought damage.

The insurance sector is deeply tied to trends in globalization. The outcomes of trade agreements, environmental problems, global health pandemics, volatility in financial market, terrorists attacks and security problems, and basically any worldwide trend, will impact individuals, companies, and governments, all of whom own insurance policies. 

General Trends for the Global Insurance Industry

Since the 1990’s, the following trend have been broadly experienced by the global insurance industry:

1. Concentration and centralization processes: formation of strategic alliances between insurance and reinsurance companies; fusion of banks, insurance companies, and credit companies to form transnational financial groups; mergers between small and medium insurance companies to form large international insurance companies.
2. Modification to traditional forms and types of insurance services and new insurance products: organizing insurance coverage through securitization; insurer participation in pension insurance and reduced participation of governments in providing payment of old-age and disability pensions; new insurances against political, military, security, and informational risks.
3. Change of market environments: Internet sales of insurance and reinsurance products; insurances losses due to urbanization, climate change, and private property cost increase; liberalization of state and supra-state regulations of financial and insurance markets.¹

Insurance and the Developing World

Many of the world’s citizens and small-businesses do not own insurance because the premiums are too expensive. In many developing countries, the only insurance available is government insurance products, which do not tend to be heavily marketed and diversified. The benefits of opening up the insurance markets to competition is better customer service, new insurance products, and technology and know-how transfer from the private sector to the public sector and to local companies.

Asia, Latin American, and Eastern Europe are considered growth markets for insurance companies, because many countries in these regions are liberalizing their insurance sectors, by opening it up to competition from private companies. The growing middle class in these areas is demanding more sophisticated insurance products and is willing to pay for them.²  Most of these regions are starting to privatize social security systems, pension plans, health insurance, and workers compensation insurance, thus there are many opportunities for private insurance companies.³

One of the challenges facing insurance companies who are trying to enter these markets is that many of these developing countries do not require their companies to follow generally accepted accounting principles (GAAP), making it difficult for insurance companies follow financial reporting rules, such as Sarbanes Oxley.⁴  In general, regulators from different countries should share information and best practices to make it easier for companies to comply with their regulations.

Case Study: Romania

Romania has gone through cycles, having private insurances companies for its early history, privatizing in 1956, and opening itself up to competition in 1989. The insurance market grew from 47 companies in 1997 making 167.7 million Euros in premiums to 73 companies in 2000 making 337.79 million Euros to 2.15 billion Euros industry in 2007. The main offerings include car insurance and property insurance.⁵  

In 2007, Romania constituted the fast growing insurance market for Europe. Their accession to the EU brought more sophisticated insurance products and companies, more stability, and better transparency within the industry. As part of the EU, Romania benefits from Europe’s insurance liberalization allowing any European provider to provide services in Romania.⁶ 

Challenges Facing the Insurance Industry

The insurance industry faces many challenges. The impacts of climate change and terrorism on the insurance industry are outlined below.

Climate Change
According to the U.S. Government Accountability Office, rising temperatures will increase the number and severity of floods, hurricanes, droughts, and other catastrophic weather events. Government and private insurances will have to pay bigger claims that could deplete the insurers and reinsurers capital. In response private insurance companies will charge higher premiums and restrict coverage. Thus, more services will have to be covered by governments; revenues will have to shift from other priorities to pay for these services.

Weather-related losses account for 80% of the losses paid by insurance companies between 1980 and 2005: $320 billion dollars. Climate change increases the probability of a 500-year event becoming a 100-year event, thus major weather-catastrophes would be taking place much more frequently. Further compounding the problem is the increased coastal development, increasing the numbers of those affected by hurricanes and other severe weather events.⁷  

Terrorism
Similar to the issue of climate change, resolving claims associated with terrorist attacks involves joint public and private insurer involvement. The insurance industry had to pay $31.6 billion dollars from the aftermath of 9/11; 2/3 of these costs were paid by reinsurers.

Soon thereafter, the U.S. passed the Terrorism Risk Insurance Act (TRIA), allowing the insurance industry and the U.S. government to share losses in the case of a major terrorist attack; this act has been extended until 2014. While most property owners have reasonable premiums, some property owners in high-value property urban areas are finding the premiums prohibitive. Terrorism insurance has grown dramatically from 27 percent in 2003 to 59 percent in 2006. 

Managing the risks associated with terrorism is difficult. Since terrorism is not random, only those most at risk buy the insurance and are most likely to file a claim. Other types of risks, such as auto insurance, are more random and most of the recipients will not have to file a claim at the same or even at all. The timing of the claim makes it difficult for insurances to spread the risk over time.

Other countries have also initiated terrorism insurance programs, including among others: Australia, whose bill created a reinsurance pool to cover 3rd party losses and nullified commercial policies once a terrorist attack has been declared; Belgium, which created a 1 billion euro pool; and, France, whose bill provides a reinsurance pool, guarantees government payment of claims exceeding a specified amount, and sets premiums based on insured amount rather than riskiness of location.⁸

Looking Ahead

As the world is becoming increasingly interconnected and events in one country deeply impacts events in another, the need for a wide range of insurance policies is apparent. The question dividing many countries is who will provide this insurance.
The success of insurance liberalization can been seen in many countries throughout the world, such as Romania, as outlined above; The success stories followed periods of nationalization, when the insurance industry was stagnant and few products of interests were offered.

Since liberalization has helped many, why is it so controversial? When insurance is privatized, it is often not guaranteed. Many view the role of the government to provide health insurance, wage insurance, and other insurance products, so that no members of the population are left without these safety nets. They believe that risks, such as the current collapse of AIG, would outweigh the benefits, as many people’s pensions, social security (if it were completely privatized) could disappear in a market downturn. The resulting bankruptcies would further devastate the economy and continue its downward spiral.

There are just so many insurance plans, banks, and other institutions that the government can insure without incurring major losses itself. While the nationalization of many corporations and industries are not meant to be long-term, the tax payer will still be stuck with much of the bill and it is not clear that they will reap any of the benefits. Similar to the banking industry, the insurance industry will most likely be more heavily regulated worldwide in the coming years.

To read more about the debates on government health insurance plans, please read Health Care Coverage in a Globalized World.