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The environment in which insurance companies operate has changed significantly over the last several years. In five sections, this issue offers readers a very comprehensive review of the shifts taking place within the insurance industry.
The first section introduces the situation of the market in France, the United States, and Europe, and the world-wide strategies of insurance companies. The question of the level of capital required by companies is taken up next, particularly as concerns the new regulatory requirements. The third and fourth sections are devoted to the specific challenges of the life insurance and casualty insurance branches. Finally, the fifth section deals with the consequences of the arrival of new risks, and of technological and societal shifts.
The review also includes a column on financial history devoted to analogies between setting reference interest rates in medieval Italy and today in the international monetary market. The issue concludes with two additional articles. The first deals with the danger of the trilemma for the international monetary system, and the second with the needed adaptation of financial analysis tools for universities with their new-found autonomy.
publication : October 2017 312 pages
Insurance in France collects more than €200 billion of premiums each year and has a portfolio of investments of nearly €2 300 billion, equivalent to 103% of the GDP. These statistics reflect the peculiarity of this industry, which has a particularly high economic and social weight, as it accompanies all French, households and companies, at all stages of life or development. Indeed, insurance protects the French and their property (car, dwelling, etc) against all natures of risk. It also protects assets and activity of companies, more and more of a cyberattack’s consequences. It finances the economy massively, in part because of the life insurance success. Companies (59%) are the largest recipient in insurers’ investment portfolio, ahead of the States (33%). Bonds (71%) are the largest assets in insurers’ investment portfolio, ahead of the shares (17%). Lastly, French insurance is slowly internationalizing, with slightly higher revenues abroad, as well as sales by foreign insurers in France, a sign of a mature French insurance market.
The election of Donald Trump will likely considerably modify the economic environment for insurance companies. This article aims to describe the changes that have been proposed by the president and the Republican Congress in various areas – health insurance, regulation, individual and corporate taxation, international trade and customs duties, financial counseling services for retirement, and so on – and to deduce the probable consequences for the American insurance industry. However, the scope of the reforms and the extent of their actual implementation will depend on the relationships of forces that exist within the Republican and Democratic parties themselves.
Large insurance companies are facing a multitude of challenges requiring a deep transformation of their organizations, targets and operating models. While major European insurers pioneered the internationalization process through numerous cross-border acquisitions worldwide since the early 1980s, the changing financial and economic environment raises questions about the rationale of their international footprint and ambitions. Internationalization strategies over the past 30 years have been led by the geographic expansion rather than by a convergence of products sold, mechanically reducing potential economies of scale. Financial regulation and market conditions, as well as technological breakthroughs, are now leading insurance companies to refocus their geographical footprint on stable markets offering predictable economic and political conditions. As insurance companies face visible pressure to maintain consistent strategies and sustained profitability, one can foresee that the focus will be put on optimizing their international footprint rather than the continuation of a profuse expansion.
In the aftermath of the recent financial crises, capital has regularly increased and the European Insurance sector seems to be adequately capitalized. The implementation of the Solvency II represents a new step, with the introduction of a new capital standard, more in line with economic principles and more risk sensitive.
Prudential balance sheets based on a more economic valuation relies on fair values but makes the supervision more delicate. Insurers’ prudential own funds are now the result of complex calculations and are based on numerous assumptions that should be carefully assessed and closely monitored, by the undertakings and by the supervisor.
Lastly, a particular focus is warranted regarding the insurers’ capital management policies.
They are particularly important in the current financial environment, with low interest rates and the risk of higher volatility and insurers should consider dividend policies as well as alternative capital financing methods. On this issue, new regulatory tools are available to undertakings, such as the ORSA (Own Risk and Solvency Assessment), to ensure an appropriate capital management policy and strengthen the dialogue with their Boards or their supervisors.
Some insurance markets are affected by the well-known phenomenon of “underwriting cycles,” made up of a tight phase during which premiums and profits increase while capacities decline, followed by a slacker period, characterized by lower prices and replenished capacities. It is difficult to explain these cycles within the classic framework of perfect financial markets. They imply a certain degree of predictability for premiums, a correlation between insurance company ROE and claims, which appears to contradict the principle of the no-arbitrage condition.
We demonstrate that these properties can be perfectly well explained in a competitive equilibrium model with financial frictions. Our model extends the classic approach of ruin theory to a macroeconomic model where insurance premiums are endogenous and result from the balance between policy supply and demand. Companies determine their underwriting policies and stock issuance and buyback policies in a way calculated to maximize their stock share price. Insurance premiums are a deterministic function of the total market capitalization of all insurance companies.
Our results explain why insurance premiums are predictable, as well as the correlation between ROE and claims. In fact, rather than genuine cycles, premiums and capacities oscillate between two extreme values with trends changing direction once one of these two values is attained. Our model illustrates the power of the new generation of macroeconomic models with financial frictions, introduced by Brunnermeier and Sannikov (2014), which can be successfully applied to the analysis of other important questions for insurance and reinsurance markets.
Life insurance, the main component of French insurance, owes it success to its ability to respond both to the needs to manage wealth long-term as well as to protect French households against life’s ups and downs. It offers them total liquidity, predictable returns, and tax breaks. However, today this success is threatened by the unprecedented drop in interest rates since the financial crisis. This decline weighs on the returns of new insurance policies and undermines the economic model of insurance companies. Nevertheless, only insurance techniques appear to be capable of responding to the long-term challenges resulting from the population’s need for protection, in particular the challenges related to aging. The life insurance business must necessarily reinvent itself in order to adapt to this economic environment. This means a reduction in the costs and marketing fees borne by these companies, changes in the regulatory and fiscal framework, and finally, the emergence of a service model.
In this paper, we study the question of insurability of longevity risk thanks to an Enterprise Risk Management approach. We start by identifying the different components of longevity risk. Then, we present the different ways to model, measure and detection changes in this risk. Finally, we study the possible risk controls and their associated residual risks.
The French discussion on pension funds has been confined to their capacity to reduce the consequences of demographic decline, overshadowing their other economic advantages over the defined benefit system. After having presented pension funds and their great diversity regarding benefits, joining, and exiting, the article explains their role in France and in the other advanced economies, as well as the underlying socio-economic stakes. It then expounds and critically analyzes the main arguments that have long been used in France to oppose their development. However, there seems to have been a shift with the creation, by the recent Sapin law, of the legal and prudential vehicle that is necessary for their development. It remains to give this vehicle a fiscal and social status that would allow it to play a genuinely complementary role to the defined benefit system, while helping to finance French businesses.
Insurance marketing has historically been agressive, leveraging mass communication for the almost unique purpose of brand building. The brand image was designed to inspire trust in the company and its products, and also to develop the traditional distribution networks (agents and proprietary sales forces). Today, this model is challenged by the growing role of digital distribution channels. Insurance digitalisation is making product differentiation, and brand image construction, more difficult. Besides, it opens up great perspectives regarding consumer targeting, rendering mass communication obsolete.
Overall, it creates a major opportunity for players who understand the codes of the digital world, both in the fields of distribution and post-sale user experience. Likewise, it constitutes a threat for the others.
Digitization of the economy is a factor of progress but also brings a lot of new risks, cybercrime and other forms of cyber-attacks, which come to erode its benefits. While the arsenal of IT security tools and services is developing to counter the attacks, businesses are struggling to quantify the impacts. In a geopolitical and economic context favorable to attackers, States are becoming aware of the risks and develop more comprehensive regulations.
The cyber-insurance market is under construction and its products in the adjustment phase. While it enjoys sustained growth, it meets the ignorance of an emerging and evolving risk and the potential for cyber-catastrophes that both impede the reinsurance offer. Sound risk management by the insured, proper regulatory environment and development of expertise among insurers and reinsurers are the conditions for this market to reach maturity.
Beyond its mere coverage, the cyber peril is indicative of the coming transformations in the risk landscape of the insurance and reinsurance market.
Insurance companies are faced with an increasingly insured liability risk and with claims that were not envisaged when policies were written. In order to illustrate this state of fact, the article relies on how the nature of damages has evolved, as determined by the Court of
Cassation. Insurance companies are thus faced with substantial uncertainty, with both the lack of knowledge of the risk involved at the time the policy is written and the potential, retroactive modification of this risk by the judge. The article then analyzes the technique of globalizing claims, which is used by insurance companies in order to limit the amount of their obligations. In the end, as the list of risks effectively insured continually increases, insurance companies are implementing techniques and legal means to make it possible to effectively cover these risks while preserving their own solvency.
We are currently witnessing the emergence of personalized medicine, defined as the use of genetic information to better tailor individual diagnostic, prevention and treatment decisions. These medical and technological advances make it necessary to think through their consequences on health insurance markets. One major decision consists in deciding whether the information generated by genetic tests should be shared with health insurers.
This article first discusses the economic consequences of such a sharing of genetic information: risk discrimination if the information is not shared, and adverse selection if it is. We then discuss four different types of regulation of genetic information which are used around the world. We then present the main results of a recent study we have undertaken, which compares (using both a theoretical and an experimental viewpoint) two such regulations. We conclude with a few suggestions for further research.
Catastrophe bonds are securities with payoffs linked to natural tail events. Using a new proprietary database, we investigate the determinants of the pricing of CAT bonds.We find that CAT bonds are low beta securities: they have low exposure to stock-market market risk and (although to a lesser extent) to corporate bonds risk. Their risk-premium is significantly positive and is not explained by exposure to systematic risk. We show that issuer’s reputation matters for pricing: issuance of inexperienced issuers are priced at a discount.
Under the combined effects of a decline in rates and the political desire to help finance the economy within a regulatory environment that is restrictive for banks, since 2012 the law has authorized insurance companies, under certain conditions, to allocate up to 5% of their clients’ savings to the private loan market and in this way to help finance small and mid-size companies. After describing the features of the financing mechanism with non-bank loans, the goal of this article is to use economic theory to propose a debate on the advantages and disadvantages of such a mechanism.
The famous impossible trilemma is well known: only two out of these three objectives can be achieved: fixed exchange rates, absence of capital controls and the possibility of having an independent monetary policy. Central banks have themselves rendered the choice of the impossible trilemma unsustainable because of the resulting instability of exchange rates.
But a return to fixed exchange rates is also impossible, as they would also be destabilised by large-scale speculative capital flows. What alternative should be taken into consideration ?
French universities have undergone a transition towards financial and operational autonomy since the passage of the RCE law in 2007. Since then, some of them experienced a financially constrained environment and, more specifically, had to dip in their reserves to balance their budget. This context raises the question of how financial analysis could be developed in order to help universities manage the uncertain adjustment between their resources and expenses. This article has a triple purpose. First, in the light of the new public management literature, we propose a public financial management model for the university, which we compare with both the financial management models of a firm and of a local government. This leads to analyze the specificities of existing financial analysis tools for universities. Second, we analyze the reasons why French universities experienced difficulties since the RCE. Lastly, after we define the concept of sustainability, we highlight the necessity of a pluri-annual vision of financial analysis for French universities, and we propose a prospective approach.