This report discusses the causes and the negative effects of the insurance market crises. Using some case studies, it suggests a number of solutions to help eliminate or at least reduce the damage caused to global economic crunch and insurance market crisis.
The aim of this research is to examine the causes and effects of market insurance crises. This work takes a comprehensive analysis of past crises while exploring how these disasters affect the entire insurance industry, and target market such as increasing liabilities underwritten by insurers. The paper proceeds to explore how the crisis affected insurers’ performance in several markets while accessing the scope of universal insurance risk.
The problem with the insurance industry emerged from global economic crises. Because of the interconnection between the insurance industries with other sectors such as banking, impacts of global crunch resulted in the insurance market crisis. The outcome is a continuous reduction in profits, retrenchment, restructuring and insolvency in extreme cases.
Although universal risk is less prevalent in the insurance industry in comparison to major industries such as banking, it is not insignificant and has recorded a significant increase in the recent past. The increase is mainly an aftermath of rising connections with banks and their current emphasis on contemporary insurance undertakings that include organized finance. Therefore, this work makes a conclusion by addressing the organizational changes that could alleviate the current problems while highlighting issues that could escalate the problem.
In the recent years, several insurance crises have been witnessed. In this past, there has been a distinctive difference between the banking, insurance and other financial markets in several nations. In that case, the occurrences on one of these industries had an insignificant impact on the other. However, several changes have been experienced in the economic world as this dissimilarity transformed to a significant relationship between these industries due to close correlation in their business activities. This close relationship between industries is the main cause of financial crises in the insurance sector, which begins in the banking sector. Kočović (2011) calls this trend the spill of the financial crisis.
The insurance market crises have been significant to the extent of being compared to the credit crunch with others being linked to the banking sector. Several occurrences in the insurance sector have been labeled as crises. In order to provide an understanding to this issue, Baluch (2011) provides a comprehensive meaning of crises. This market researcher views a crisis as a period when a business undergoes poor market performance and subsequent losses. The outcome of these failures is a downfall in insurance service provision and a major decrease in economic activities.
As Schich (2010) establishes, the financial crisis spreads to the insurance markets. Therefore, after combining with insurance crises, the outcome has escalated economic problems not only in the insurance industry but across the related industries.
Causes of the insurance market crisis
The first insurance crisis was witnessed between 1984 and 1986. This crunch, labeled as liability insurance crises, led to a declaration of loss by major insurers. This loss resulted in a trend of bankruptcy. As more companies closed their operations, the number of target clients continued to reduce. As a result, the total investments in the insurance industry reduced as the existing insurers competed for remaining companies because they had to maintain profits. The main causes of liability insurance crisis remain unknown. However, analysts and previous studies show varying and viable arguments. Several studies maintain that the collapse of major companies that acted as clients to the insurance industry was the key contributor to the crisis.
For life insurance, payment of claim may remain inflexible when the insurance industry is experiencing a market crisis. However, there is a high likelihood of reduction in demand for a mortgage and saving plans, forcing insurance companies to reduce their costs. The downfall of Swiss Re is a confirmation that life insurance has been significantly impacted by global economic downturn.
Another case illustrating cause of the insurance market crises is the Lloyds Insurance market crisis. This crisis dates back to the early 1990s. A similar crisis led to near collapse of AIG insurance company (OECD, 2011). The main cause of Lloyds Insurance market crisis was injudicious underwriting, internal administrative issues, and the emergence of several misfortunes within short time duration. However, absolute failure and bankruptcy was not the outcome in Lloyd insurance. However a loss of $ 7.9 billion was significant to result in insolvency among several underwriting companies while making the company nearly declare bankruptcy.
The shortage of terrorism cover is another significant factor associated with insurance market crisis. This issue emerged in the early 1970s, following the emergence of terrorism as a major insurance risk. Terrorism threats continue to prevail in modern society. After the terrorist attack on world trade center, several insurance companies started to review their definition of comprehensive insurance cover. Studies show that this issue has been previously underestimated until the industry witnessed the aftermath of 9/11 terrorist attack. After the 9/11, the insurance industry was going through another crisis as the industry increased premium costs for comprehensive cover. The table below summarizes the premium growth in selected countries between 2006 and 2008.
Effects of insurance market crisis
In case of liability insurance crises, analysts provide varying explanation on effects. The main effect of the crises was diminishing profits. During such unbearable moments, most businesses resists from giving correct financial figures at their end of the financial year. In the long run, several investors withdraw capital from falling companies. This impact was sapient in Lloyds Insurance Company. During liability insurance crisis, Lloyds recorded a significant reduction in share prices. Another significant effect is closure of business activities that depend on these insurance companies. For example, the aftermath of liability insurance crises was shutting down of various children playgrounds when it emerged that obtaining insurance proved costly. This is because insurance companies increased premiums for covering institutions with children playground. As a result, they opt for an alternative solution such as defensive medicine. However, the law of demand and supply explains that an increase in demand leads to an increase in price. A similar case emerged after liability insurance crisis, when institutions with playground withdrew from insurance cover in favor for defensive medicine. An increase in demand for defensive medicine triggered a rise in price.
Several damages to the general economy are reported by Baluch (2011). As the researcher establishes, these damages have a high likelihood of triggering emergence of global economic recession. Contrary to most perceptions, a rapid increase in insurance cost is unlikely to trigger a significant destruction to the real economy. However, several studies refute this claim. For instance, Ciumaș (2012) insists that the insurance costs are high for several businesses. However, this claim is rejected by market analysts that maintain that insurance cost is insignificant to several businesses. Despite of the increase in insurance cost, companies will continue securing insurance for their business. The fact that the world has never experienced a global insurance crunch clearly shows that there are some major differences between the insurance industry and other industries such as banking, which have a high likelihood of collapsing and spreading major risks to other businesses (Congleton, 2011).
In a global economic recession, the number of non-life insurance claims mainly records an increasing trend. Almost certainly, there is a rise in claims on fraudulent and exaggerated risks as a result of economic recession. During this period, the claim for trivial risks – that go unclaimed in good economic times – increases. The demand for non-life insurance is comparatively inflexible based on the fact that insurance cover has limited substitutes (such as defensive medicine while only addresses health issues). Moreover, the demand for insurance remains inelastic because some covers such as motor vehicle insurance are compulsory. Nevertheless, a financial crisis and subsequent economic downturn will have a reducing impact to demand. As a result, insurers will have to reduce costs through measures such as retrenchment as a way of ensuring that they continue making profits (Schwartz, 2011). As a confirmation for this trend, Swiss recorded an average reduction of 0.7 percent of the people securing the non-life cover (Baluch, 2011). The trend was caused by demand decrease and reducing rates. In developed economies, a reduction of 2 percent was counterbalanced by growth of new markets.
Another effect of insurance market crisis targets the liability and asset side. Insurers are among the largest institutions targeting investment in capital market. Therefore, unfavorable development affecting asset value is inevitable. From the liability perspective, insurance companies are likely to be unfavorably affected through insurance in the credit market by officials and managers, through insurance default and errors and omissions. Moreover, in the event of a global financial crunch, insurance companies will suffer a reduction in demand for insurance products because consumers use their limited income on more significant uses such as basic needs.
Under the prevailing insurance market crises, several companies are opting to retrench. However, this solution may be inappropriate in the long run. In order to address the challenges facing this industry, an alternative move should involve recruitment of skilled personnel, training and career development. This approach has proved to be favorable to companies targeting to increase financial earnings. In the competitive labor market, successful organizations should establish strategic approach to human resource management that will effectively foresee and respond to the evolving business requirements and workforce anticipations.
Mergers and acquisition (M&A) is another move of stabilizing companies succumbing to the effect of insurance market crisis. For instance, Lloyds Insurance emerged successful because it has a strong capital foundation. However, smaller companies are unable to survive during such unfavorable economic periods. Because of limitation encountered when funding business, mergers and acquisitions could assist insurance organizations in establishing complementary profit streams while reinforcing their operations against giant competitors. Although large companies like Lloyds Insurance may not close down their operation because of a market crisis, they are forced to invent more creative business approaches to remain profitable. For instance, Lloyds Insurance had to restructure and reinvent its operations with an aim of reclaiming competitive control in the large insurance industry.
The continuous failure of the insurance industry is a clear call for appropriate actions that will reduce the tide. As this work establishes, the impact of the insurance market crises spreads to other economic sectors. The most affected sectors are those depending on services provided by the industry. The fact that no close supplementary services are available to serve clients in case of unfavorable costs in the insurance industry makes the problem more complicated. These failures require the insurance industry to establish appropriate measure that will address contentious issues affected insured and insured. Following the global crises of 2007, operations in insurance industry have destabilized. From the analysis provided in this paper, it is apparent that financial crisis negatively affects the insurance industry. The impact is a trend of reducing performance of banking institutions in spite of boldness due to high liquidity possessed by major companies such as Swiss Re. In order for the insurance industry to desist from the financial crises facing several industries, it should explore for an alternative approach of funding deficits without having to make retrenchment decisions.
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