The Insurer of England
Don’t be fooled by the post-financial crisis outbreak of relative humility. Underneath the banks still feel they are the senior financial service, looking down on the rest of us.
And is it any wonder? They have had a massive head start on us country cousins in insurance.
This is because they first co-opted the power of the State to back them up 352 years ago.
The Swedes were way ahead of their time. They founded the first central bank way back in 1668. The Brits came pretty quickly behind, starting a lender of last resort in 1694.
So what about us? How about a Sveriges Forsakring or a BundesVersicherung?
The Insurer of England and the Federal Insurance Reserve both have nice rings to them, don’t you think?
The first obvious thought is that we aren’t banks, we are insurers.
Banks can have runs on their deposits. When too many folks lose confidence in a bank’s solvency they ask for their money back. The bank doesn’t hold that much cash and has to start calling in its own loans to pay off depositors.
This is of course bad for the economy and decreases confidence further.
It can become an economic doom loop, with domino-effect bank runs and huge recessions.
And that’s why you have a central bank. The big bank is there to make emergency loans to tide the commercial banks over without forcing them to pull in good loans and pull the plug on commerce.
P&C Insurers can’t have runs in this way. Yes, people can lose confidence in an insurer’s financial strength and make a note not to renew next year, but the premium is not a deposit, it is a fee for a service.
Sorry, no refunds.
The worst that can happen is an insurer goes into sudden, disorderly run-off. And the worst-case scenario is one where catastrophic investment losses, under-reserving or fraud lead to that disorderly run-off becoming insolvent and policyholders left with reduced or no cover.
But any decent regulatory regime will minimise these risks. Even when these failures do happen, as we have seen periodically, new cover will be available from other insurers only too willing to step in.
Yes, insureds may have to stump up for a second premium to cover the unexpired portion of their now almost worthless cover, but that is about the size of it – unpalatable, an extra cost and vexing in the extreme, but by no means a financial disaster.
For this reason insurers are almost impossible to classify as systemically important or vulnerable in the way that banks are.
Even the sudden loss of a big reinsurer like Swiss Re or Munich Re would be manageable and not necessarily catastrophic. New capital would be raised to replace their lines in short order.
So the fact is that insurers don’t have institutionalised support from the State because they don’t need it.
We have sailed serenely through 352 years without the need for State institutions to help keep us solvent.
But that is rather limiting, isn’t it?
As insurers we have to be wary of genuinely systemic risks. Once we find them we have to either aggregate and severely limit them, or exclude them altogether. Systemic risk is our Achilles heel.
It is the one thing that ruins the maths of probability and mutual exclusivity of discrete groups of insureds. Yes, improbable accumulations like the great fire of London can bite, but at least London can’t set fire to New York, Paris or Beijing.
Systemic risks set the whole world ablaze simultaneously and mess up the economics of diversification. This is the maths that we need to keep insurance both solvent and cheap at the point of sale and make us a useful and relevant industry.
Globalisation and technology has made risk more systemic. Terrorism, cyber attacks and now pandemics can all strike simultaneously across the globe in joined up ways that make diversification impossible. The more systemic the risk, the less useful we insurers can be.
As this has happened we have started to see the outlines of the central insurer emerge, but these have been ad-hoc and mostly single peril.
I’m thinking Pool Re, TRIA, NFIP, Flood Re and the like.
Each is set up to solve a specific insurance problem as it arises. Or better put, it is set up to solve a political problem that has arisen because commercial insurance doesn’t work any more.
Each of these constructs is selected against and none gets any meaningful diversification benefits.
As we wrangle about Pandemic Re and debate whether we might need a Cyber Re, surely we should be thinking bigger?
I have been impressed by the thinking behind Totus Re, a singular UK-based conceptual response to the Covid pandemic and the insurance industry’s failure to help society and governments cope with its effects and financial consequences in any meaningful way.
Let’s bring all the perils together into something big, coherent, with real diversification. Happily cyber, pandemics and terrorism are largely exclusive of each other.
Such an institution whould therefore have the chance of being capital-efficient, building up major reserves and developing novel pre- and post-event financing to be called upon in a time of national need.
Perhaps the Insurer of England is an idea whose time has finally come?