Download Introduction to international risk and insurance

Introduction to international risk
and insurance
Tapen Sinha, ITAM
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Why international?
Definition of international risk
Management of international risk
Multinational enterprises
Insurance classification
Country classification
Economic development and insurance
Importance of internationality
• Coca-Cola is the most recognized brand
name in the world
• AIG operates in 173 countries (started in
China! Operates in Bulgaria!)
• growth in international trade has been
double that of the growth in world GDP
• foreign direct investment has grown twice
the rate of international trade
Why does foreign ownership
matter at all?
• only domestic: less competition/monopoly
• pricing is less competitive
• global: more competition hence pricing is of
strategic importance
• future: internet sales of insurance products
• Does it matter where you are located?
• international competition forces domestic
companies to price products better
Major factors
• insurance companies are local (they have
local distribution channels)
• insurance companies are global (they may
have foreign owners): reinsurance
• government (sets tax rates, approve policy
forms also perhaps rates)
• local investment climate (most investment
require domestic laws)
• other local institutions (banks)
What is international risk and
insurance?
Two characteristics of international risk and
international insurance
– unintended outcome
– insurance transactions that transcend national
boundaries
Examples
– Tokio MFI sells a policy to AG (Germany)
– typhoon causing property damage in several
countries
Defining and managing risk
• insurance: to cause loss/chance of loss
• economics: relative variation of actual from
expected outcome
• risk management:
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identifying and evaluating possible outcomes
exploring techniques for dealing with them
implementing a plan
dynamically evaluating plans
MNE MNC TNC
• multinational enterprise/multinational
corporation/transnational corporation same
• 38,000 MNE
• 250,000 affiliates
• 90% based in market based developed
countries
• 50% affiliates in developing countries
Types of insurance
• social versus private
– government provides some types of insurance
retirement benefits (IMSSS in Mexico)
– unemployment benefits (UI in US/UK)
– government sometimes provides straight
insurance as well (France)
Types of insurance
• life
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death benefits (usually called life insurance)
living a certain period (endowment/annuity)
disability (disability insurance)
injury or incurring diseases (health insurance)
• property casualty/general (UK)
– property (damage to home/business etc.)
– liability (negligence: product/professional)
– worker’s compensation payments
Types of insurance
• Commercial versus personal lines
– personal lines are purchased by individuals
such as homeowners insurance, automobile
insurance, etc. (in Europe, they are called mass
risks)
– non-life insurance purchase by businesses such
as product liability, business interruption,
automobile fleets, etc. (also called large risks in
Europe)
Types of insurance
• Direct versus reinsurance
Insurance sold to the public and non-insurance
commercial organizations are called direct
insurance and they are called direct writing
insurers (premiums are called direct written
premiums)
Insurance bought by direct writing insurers are
classed as reinsurance and is sold by reinsurers
Reinsurers purchase reinsurance-retrocede
Country Classification
Two major categories of classifications
• United Nations (UN)
• International Monetary Fund (IMF)
These approaches are not consistent with one
another
• Alternative
– by membership of intergovernmental
organizations
– by stage of economic development
Intergovernmental organizations
• European Union (EU-was called EC)
Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Ireland, Italy, Luxembourg,
The Netherlands, Portugal, Spain, Sweden, UK
• European Free Trade Association (EFTA)
Iceland, Liechtenstein, Norway, Switzerland
• NAFTA
• OECD: 26 members
Intergovernmental organizations
• Members of OECD
Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Ireland, Italy, Luxembourg,
The Netherlands, Portugal, Spain, Sweden, UK,
Iceland, Norway, Switzerland
Canada, Mexico, US
Australia, Czech Republic, Korea, Japan, New
Zealand, Turkey
Latest: Mexico, Czech Rep., Korea
Intergovernmental organizations
• G7: US, Japan, Germany, France, Italy, UK
and Canada
• G10
• ASEAN: Brunei, Indonesia, Malaysia, The
Philippines, Singapore, Thailand, Vietnam
• MERCOSUR: Argentina, Brazil, Paraguay,
Uruguay
• Arab League/CARICOM
Stage of Economic Development
• Developed market-economy countries (also
called north/advanced/firstworld/industrialized countries)
• Economies in transition (Eastern Europe)
• Developing countries (include least
developed to Newly Industrialized
Economies (NIEs)) also called
LDC/south/third world/developing
countries
Worldwide insurance market
• Largest markets are US (31%), Japan
(30%), EU (23%) and others
• Another measure: insurance density
– average per capita premium within a country
– two measures: absolute (dollar) value or
measured relative to GDP (which is better?)
– high penetration is correlated with high saving
countries
International Environment
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Economic/financial environment
Political/legal environment
Regulatory/tax environment
Demographic and social environment
Physical and technological environment
Financial development and
economic growth
Importance of capital accumulation in
economic growth
– capital accumulation needs domestic saving
and/or foreign investment
– efficient use of capital is possible by financial
development-it also reduces the risk for foreign
investor
– Levine shows positive association between
various measures of financial developments and
economic growth for many countries
Why does insurance help in
economic development?
• promoting financial stability
– uninsured losses cause business failure
– uninsured persons become a burden on the
social system (government or family)
– uninsured business/person suffering loss has a
negative impact on government tax revenue
thereby reducing benefits to others
– provides “sleep insurance” reducing uncertainty
Why does insurance help in
economic development?
• insurance (especially life) can substitute
government sponsored programs
– OECD recognizes this and provides tax relief
for insurance premium (ITAM study)
– Swiss Re study showed that there is a negative
relationship between social expenditure and life
insurance premium in OECD countries
Why does insurance help in
economic development?
• Facilitates trade and commerce
– modern trade depends on insurance
– by law: flying commercial airplanes is illegal
without proper insurance
– banks and other creditors insist that collateral
be insured or else they will not loan money or
that insurer purchase life insurance
– without liability cover products will not be
sold, freight will not be carried etc.
Why does insurance help in
economic development?
• mobilizes saving
– fact: countries that save (invest) more tend to
grow faster in the long run (but causality is not
clear)
– insurance (especially life) offers channeling of
savings
– financial intermediaries help de-couple saving
from investment (i.e., saving and investment
need not take place in the same sector)
Why does insurance help in
economic development?
• Insurers enhance efficiency of financial
system in three ways
– reduced transactions costs: insurance premia
from many insureds can be invested where
necessary
– liquidity creation: insurer “borrows” short term
and “lends” long term
– economy of scale: small policies can fund large
projects
Why does insurance help in
economic development?
• Is insurance company any better than any
other financial intermediary?
– compare them with banks: banks are more
likely to invest short term in a developing
market than in the long term (why?)
– insurance companies (and pension funds) are in
the business of investment in the longer run
Why does insurance help in
economic development?
• enables risk to be managed more efficiently
• how?
• risk pricing: insurer prices risk at two levels
– insurers quantify the consequences of their risk
causing and risk reducing activities-hence
create better pricing
– insurers only insure creditworthy insured,
hence sends a signal to business owners,
potential investors, customers, creditors,
employees and other stakeholders
Why does insurance help in
economic development?
• risk transformation
– insurance permits transformation of risk
exposure to suit their own needs better
– property, liability, income loss risk exposures
can be transferred to insurer thus reducing the
variability of cash flows (in that process, it can
bring in adverse selection and moral hazard
problems that may cause insurance company to
lose money)
Why does insurance help in
economic development?
• risk pooling and reduction
– law of large numbers permit insurance
– both insurer and insured gain from it
• More efficient capital allocation
– individual savers/investors cannot gather all the
information about riskiness
– insurers monitor the firms for their own interest
– signals potential investors about riskiness
A digression
• Fact: In many (developing) countries,
foreign firms are allowed to operate in some
sectors but not in others and especially in
insurance sectors, they are prohibited
(example: recent liberalization in India but
not in insurance)Why?
• Many objections are raised for the
following reasons (most of them make very
little economic sense)
Common objections policy makers raise in
against foreign insurance companies
– First, foreign insurers might dominate the
domestic market and thereby precipitate
adverse microeconomic (less consumer choice
and value) or macroeconomic (failure to
contribute adequately to economic
development) effects.
Common objections policy makers raise in
against foreign insurance companies
– If a market offers great potential and if
domestic insurers are inadequate and
unsophisticated, market liberalization could
lead to foreign domination.
– In such a case, however, no rational basis exists
to support a parallel belief that the nation's
consumers and businesses will suffer harm or
that the national economy will be harmed.
Common objections policy makers raise in
against foreign insurance companies
– On the contrary, that the market offered great
potential, was unsophisticated, and had an
inadequate capacity suggests that the status quo
was stifling microeconomic and
macroeconomic improvements.
– Only if the foreign company is allowed to run a
monopoly, there is a problem
– Such monopolies can be granted by
government in exchange for monetary favor
Common objections policy makers raise in
against foreign insurance companies
– Second, foreign insurers might market
insurance selectively, thereby leading to
adverse microeconomic or macroeconomic
effects.
– This selectivity may be because of concern that
foreign insurers will market insurance only to
the most profitable segments, only to
multinational corporations or only to the
commercial sector ignoring the retail market.
Common objections policy makers raise in
against foreign insurance companies
– Governmental efforts to discourage selective
marketing can be harmful.
– Specialization and market segmentation lead to
efficiency improvements.
– It is true that segmentation could cause some
market segments to be under served.
Common objections policy makers raise in
against foreign insurance companies
– If it does and if these under served segments are
judged critical, government policymakers
would be wise first to examine whether
repressive regulation (such as price
suppression) was at fault.
– If not, insurers can be enticed into neglected
segments through less distorting subsidies or
other positive means.
– example: airline license is usually bundled
Common objections policy makers raise in
against foreign insurance companies
– Third, foreign insurers might fail to make
lasting contributions to the local economy
– This is the common objection to any foreign
involvement in industry or services
– The fact remains that whenever given a choice
most foreign companies have decided to stay in
the country
– Fourth, domestic market is already well-served
by locally owned insurers or through
reinsurance.
Common objections policy makers raise in
against foreign insurance companies
– Fifth, national industry should remain locally
owned for strategic reasons, such as national
security concerns or because of the desire for
economic diversification
– Who typically raises such objections?
– Special interest groups
– Diversification just for the fun of it is no good!
– Examples: Singapore imports ALL food
whereas Saudi Arabia exports wheat!
Common objections policy makers raise in
against foreign insurance companies
– foreign insurers may provoke a greater foreign
exchange outflow
– But, loss of foreign exchange may not be
substantial enough to justify the opportunity
cost involved in running and upgrading national
insurance corporations
– Why is foreign exchange such a valuable
commodity in the first place?
Common objections policy makers raise in
against foreign insurance companies
– Seventh, full market liberalization should await
insurance and possible macroeconomic
regulatory reforms so as to minimize the
chances of micro- or macroeconomic
disruptions
– Wait for how long?
– Reasonable insurance laws and regulation are
essential
– This is true for both domestic and foreign
insurers