Why Insurers are Faring Better than Banks

I was impressed by Bob Hartwig’s (President Insurance Information Institute) presentation to the Association of General Contractors Surety Bonding & Construction Risk Management Conference in Naples, FL today, so here’s my take-away:

There are important differences between insurers and banks. During this global economic crisis insurers around the world are operating normally, unlike banks.

Why? For two reasons: 1) Insurers have a superior risk management model; and, 2) insures have low leverage (i.e., they don’t rely on borrowed money to underwrite or play claims).

The reason insurers are faring better than their financial brethren on the bank side according to Dr. Hartwig is that insurers have a superior risk management model:

•Emphasis on Underwriting
Matching of risk to price (via experience and modeling)
Limiting of potential loss exposure
Some banks sought to maximize volume and fees and disregarded risk

•Strong Relationship Between Underwriting and Risk Bearing
Insurers always maintain a stake in the business they underwrite, keeping “skin in the game” at all times
Banks and investment banks package up and securitize, severing the link between risk underwriting and risk bearing, with (predictably) disastrous consequences—straightforward moral hazard problem from Econ 101

•Low Leverage
Insurers do not rely on borrowed money to underwrite insurance or pay claims. There is no credit or liquidity crisis in the insurance industry

•Conservative Investment Philosophy
High quality portfolio that is relatively less volatile and more liquid

•Comprehensive Regulation of Insurance Operations
The business of insurance remained comprehensively regulated whereas a separate banking system had evolved largely outside the auspices and understanding of regulators (e.g., hedge funds, private equity, complex securitized instruments, credit derivatives—CDS’s)

•Greater Transparency
Insurance companies are an open book to regulators and the public

Click here to read more about this.

Insurers to Take TARP $$ - Why? Why not!

>Lake Forest, Illinois, February 9, 2009 – The Dow Jones Newswires report that insurance companies that applied for capital injections from the U.S. government's $700 billion bailout fund could get approval as early as today (Monday), according to the Reuters news agency, citing two unnamed sources (why is it always put this way?) familiar with the matter.Some insurance companies recently got approval to buy banks, which would allow them to participate in the government program, the report said.

The program is part of the government's overall Troubled Assets Relief Program, or TARP. Insurance companies could hear from the Treasury as soon as Monday about whether they are eligible for the injections, it said. Unless a company was really on the verge of ruin, why would a management team want the government looking over its shoulder? This flood of money in any other country would portend the nationalization of a portion of the insurance industry.

However, in the U.S., there are different standards at work. It goes something like this: Let’s take the money – why not, we can influence Washington to forgive the debt at a later time. Actually, it must be that they don’t feel the government can or will look at anything – their plates are full and the assembled group of elected officials don’t know anything about the business anyway.

It’s more or less, free money.