Protectionist practices restrict re/insurance market development

Protectionist restrictions on allowing foreign insurance and reinsurance players into local markets are hindering market development, creating barriers to economic growth and risking the build-up of concentrations of risk, according to Insurance Europe.

As certain jurisdictions place protectionist controls on which insurance or reinsurance firms can easily do business there, Insurance Europe explains that this can have a negative effect on policyholders, with costs potentially increasing.

It can also hurt domestic insurers, as access to reinsurance capital from a broad range of counterparties and geographies is essential to bring costs down for risk transfer, as well as to broadly disperse the risk.

Ultimately, protectionist policies can hurt the development of the local insurance and reinsurance market, Insurance Europe says in a briefing published today.

Cristina Mihai, head of international affairs and investments at Insurance Europe, explained; “While jurisdictions may believe that protectionism will enable their domestic market players to grow, in reality it could endanger their entire economies. This is because, when a significant loss event occurs, that loss will have to be borne exclusively by the domestic market, rather than spread out over the international (re)insurance market.”

Concentration risk is a significant issue here. The idea of risk markets is that they efficiently enable risk transfer and that risk can be broadly dispersed, to companies specialising in bearing that risk or those that specialise in diversifying it away within their portfolios.

Mihai continued; “Limiting domestic insurers’ access to foreign reinsurance could constrain their ability to manage their risk exposures and capital requirements. This could increase costs for both insurers and their customers. Such a move could also result in the accumulation of risks by insurers faced with less interesting opportunities to cede risks, therefore potentially compromising their underwriting performance.”

Restricting access to markets, through protectionist regulations, can mean that concentration risk increases and is held within the very country where a major loss event occurs, which would magnify the impact on the local economy potentially significantly.

Diversity of risk capital is one of the key factors that makes the re/insurance market work so well as a tool for transferring and dispersing risk away from the original source. It’s something that can get forgotten though, particularly as pressure ramps up and change is forced on global re/insurers.

Insurance Europe’s report focuses on regulatory protectionism, which is an issue that has reared its head repeatedly over the years and is currently being discussed with respect to the U.S. and also German markets.

But protectionism can also rear its head in other forms, such as in the defensive efforts of some of the major global re/insurance players in the wake of softening pricing and competition from the capital markets.

If the goal is to achieve efficient risk transfer, with risks broadly dispersed across global markets and using a wide range of risk capital providers, which is without question the optimal way for the global risk markets to function, then some of the defensive measures taken by global players could be seen as a type of protectionism.

There are many cases recently of large reinsurance layers which had been transferred to the capital markets in catastrophe bond or collateralised form, being renewed by traditional re/insurers who in some cases take the entire layer at very low pricing.

Is that a healthy dispersal of risk? For the client the attraction is perhaps lower costs, but what they are also doing is concentrating their risk transfer often on increasingly few counterparties, while retreating from the open marketplace, which could potentially come back to bite at renewals to come.

The trend towards smaller reinsurance panels has also been a response to market conditions, in many cases. But thankfully there is evidence that panels may broaden again, as some large ceding companies recognise contracting their panel too far comes with its own risks.

This is just an example of how market pressures, such as we’ve seen in reinsurance, can result in defensive responses that mimic the issues highlighted as the results of regulatory protectionism.

Risk transfer is vital for the health of re/insurance markets, economies and ultimately society as a whole. Protectionist regulation and defensive practices could risk turning a functioning global re/insurance market into one which is not just multi-tier but which begins to see the benefits to the consumer shrinking.

“(Re)insurers can play a crucial role in facilitating that growth by offering financial protection and dispersing insured risks across a global network,” Insurance Europe explains.

Reducing the broad dispersal of risk “Could lead to a concentration of risk within the respective insurance markets, which could in fact have a severe impact their wider economies in case of major events,” the briefing explains.

But with “optimum insurance coverage of major loss events is only possible through a wide geographic diversification of the risks,” protectionist and we’d add defensive practices risk reducing the benefits that this broad dispersal of risk brings to society as a whole.

Insurance Europe warns that; “Even as the world becomes more interconnected in practice, several jurisdictions are worryingly adopting protectionist measures to limit the involvement of foreign (re)insurers in their domestic markets.”

At the same time the soft market defense that we’ve seen, in terms of heavily discounted lines of business and the underwriting of large layers which used to be more broadly syndicated, could actually increase the risks.

Global peak risks need to be well-diversified out into the re/insurance market, in order for risk transfer to be as efficient as possible. The risk capital behind this also needs to be efficient and hence diversity there is also key.

It will be interesting to see how technology affects protectionism, as typically open and liquid market promote broader diversification and dispersal of risk, something that a number of insurtech start-ups have been focusing on

Protectionism in all its forms can be damaging for the function of free and open markets. Regulatory practices need to recognise the benefit of welcoming a broad range of reinsurance capital providers, both geographically broad as well as by capital source, in order to maximise market efficiency.

“Such actions could have serious unintended consequences for those economies, leaving them not only isolated but — more dangerously — exposing them to a much greater concentration of risks,” Insurance Europe says.

That risks undermining the very value-proposition of re/insurance.