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

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