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Globalization and the Insurance Industry

Globalization101 > News Analyses > Globalization and the Insurance Industry Published on: October 23rd, 2008 Share This

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Commodity-series
Culture Due to tremendous losses connected to the current global financial crisis, insurance
Development
Culure giants, such as AIG and Fortis, are being rescued by their governments and are being Environment
Development nationalized in the process. These insurance companies face losses because they too Health
Education had invested their funds in mortgage securities and credit default swaps and were Investment
highly leveraged. If these companies had failed, the fallout would have been felt Technology
Energy
worldwide, with defaults on all types of insurances and loans that were Trade
Environment underwritten. Already AIG’s credit problems are still reverberating, as it has already
Health spent most of the bailout funds. Newsletter Signup
Human-rights
Imf-world-bank The purpose of insurance is to spread risk over time. The risk of an event where
International-law 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
Investment probability of its occurrence. Insurance companies (or other institutions that offer
Media insurance products, such as banks and governments) charge a premium based on the
Migration risks and the potential loss associated with that risk.
Technology
Trade Insurance companies also defer risk through reinsurance, in which a reinsurance
company insures the risk of insurance companies, thus allowing the insurance
What-others-think
companies to offer higher levels of protection to the policyholder, since they do not
Women have to worry about covering the full losses.

Connect With Us 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 the federal government offers the National Flood
Insurance Program (NFIP) to insure property for flood damage and the Federal Crop
Insurance Corporation (FCIC) to protect crops against 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 increases; 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

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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 percent 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; two-thirds 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 time 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 one 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

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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.  

1 Lezgovko, Aleksandra. “The Lithuanian Insurance Market Under Globalization.”

http://www.leidykla.vu.lt/inetleid/ekonom/63/str3.html
2 Rankin, Jennifer. “Should you go global?” Loma. October 2003.
http://www.loma.org/res-10-03-global.asp
3 Poposki, Klime. “Globalization of the Insurance Industry and Emerging Markets.”
http://isi.cbs.nl/iamamember/CD2/pdf/925.PDF
4 Rankin, Jennifer. “Should you go global?” Loma. October 2003.
http://www.loma.org/res-10-03-global.asp
5 Badeau, Dumitru, and Laura Elly Novac. “Romanian Insurance Market Facing
Globalization Process.” Theoretical and Applied Economics. Issue 9 (526) 2008.
http://www.ectap.ro/articole/334.pdf
6 Ibid.
7 “Report to the Committee on Homeland Security and Governmental Affairs, U.S.
Senate March 2007.” http://www.gao.gov/new.items/d07285.pdf
8 “Terrorism and Risk Insurance.” September 2008. Insurance Information Institute.
http://www.iii.org/media/hottopics/insurance/terrorism/

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