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Insurance Industry: Regulations and Improvements
Insurance Industry & Companies Overview
Insurance is a means of predicting future risks and protecting against future financial losses, and it is of great significance in the modern society. Benefitting the society and the economy, insurance protects consumer and business transactions, and it provides recovery from catastrophes (Marquit). It is estimated that the total net premiums written in the United States was 1.2 trillion dollars in 2015 (“Industry Overview”), which could be invested in various areas, such as bonds and stocks, to generate profits and make contributions to the economy (Marquit). The overall insurance industry has experienced constant changes and developments of various formats; this paper would mainly examine the government’s regulations of the insurance industry after the financial crisis of 2007-2009 as well as the improvements that insurance companies have achieved.
As financial intermediations, insurance companies receive funds from customers and then make investment. Figure 1 below shows that insurance companies comprise around 14.6% market share of financial intermediary assets in 2000 (“What Is the Economic Function of a Bank?” ), indicating the great importance of insurance companies in the market as they play an essential role in the financial market with their crucial functions. What’s more, insurance companies also share the five functions of financial intermediaries, which are “pooling savings, safekeeping and accounting, providing liquidity, diversifying risk, and collecting and processing information services” (Cecchetti & Schoenholtz 274). According to Cecchetti and Schoenholtz, these functions help insurance companies to lower transaction costs, operate smoothly, and then provide specialized services to customers (274).
Figure 1 (Source: Federal Reserve Bank of San Francisco)
To get a more comprehensive view of the insurance industry, it is helpful to understand insurance companies’ balance sheets and the related weighty entries. In this paper, I would take the balance sheet of American National Insurance Company in 2017 as a typical example to illustrate, which is extracted from The Wall Street Journal website and is shown in Figure 2 below.
Figure 2: American National Insurance Co. Balance Sheet 2017 (Source: The Wall Street Journal)
In terms of the assets of American National Insurance Company, we can see from the chart that around 83% of assets is investment assets, of which fixed income securities investment, mostly bonds, take a large proportion of 62%. The rest of investment assets is comprised of mortgage, policy & other loans, equity securities investment, real estate assets, etc. The insurance company also has other assets like premium balance receivables. It is worthy of attention that cash is only around 1.4% of total assets. For the liabilities, the largest part is insurance policy liabilities including insurance reserves, unearned premiums, and policy claims, and it is around 33% of total liabilities. And total equity is mostly common equity for the insurance company. Therefore, investment is the major part of the insurance company’s total assets and would exert huge influences to the company, which holds pretty limited amount of cash; in the meanwhile, insurance policy liabilities play an essential role in the company’s total liabilities.
Losses of the Insurance Industry in the Financial Crisis
The financial crisis in 2008 exerted detrimental influences on the insurance industry as the insurance companies’ businesses were confined to a very limited range, therefore leading to the situation where the value of assets was lowered significantly while the value of liabilities grew extensively in the financial market (Marović, Njegomir & Maksimović).
Figure 3 in the next page shows that according to Bloomberg, as of January 2010, there was a total of 254.3 billion dollars in write-downs and credit losses in insurance in the world while the United States had a loss of 188.9 billion dollars, which comprises of 74% of total loss worldwide (OECD). It shows the important role that the U.S. insurance industry plays in the world, but also implicates the huge losses that the insurance companies in the U.S. suffered during the financial crisis.
Figure 3 (Source: Bloomberg)
Besides the total loss that the U.S. insurance industry suffered, it is also noteworthy that a few insurance companies’ losses took a relatively large portion in the total loss. From Figure 4 in the next page, we can see that American International Group (AIG), in particular, had 98.2 billion dollars of write-down and loss, which exceeded the loss amount of any other insurance company greatly. Including AIG, four insurance companies represent around 54% of total loss in the world, and the other three companies are ING Groep N.V., Ambac Financial Group Inc, and Aegon NV, whose losses are all greater than 10 billion dollars (OECD). It is perceivable that those companies are the major and vital ones in the industry and could have enormous effects on the financial system and financial market during a recession or expansion.
Figure 4 (Source: Bloomberg)
Regulations of the Insurance Industry
The influences of financial crises are massive and destroyable that the government would intervene and regulate to make sure the financial intermediaries are working normally and the financial market is smooth (Cecchetti & Schoenholtz 361). After the financial crisis of 2007-2009, the U.S. government, under Obama’s administration, passed Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (Dodd-Frank Act), which is a legislation of U.S. financial reform (Ross and Schwartzman). In terms of the insurance industry, Dodd-Frank Act created Federal Insurance Office to monitor the U.S. insurance industry at the federal level ((“Post-Crisis Financial System Reform”), and the Act also reformed state-based insurances to some extent, reinsurance and surplus lines insurance in particular (Ross and Schwartzman).
Created after the establishment of Dodd-Frank Act, a systemically important financial institution (SIFI) refers to the financial institution that is “too big to fail”. SIFIs may exert detrimental influences to the economy and may lead to a financial crisis, and thus they are more rigorously regulated (Bacani). Determined by Financial Stability Oversight Council (FSOC), the insurance companies labeled as SIFIs in 2013 and 2014 were AIG, General Electric Capital Corp. Inc., the financial arm of General Electric Co. (GE); Prudential Financial Inc. (PRU) and MetLife Inc. (MET); later, the designations of MetLife, GE, and AIG were rescinded successively in 2016 and 2017 (“Systemically Important Financial Institution – SIFI.”).
Besides the direct effects that the financial reform has exerted to the insurance industry through federal and state regulations, Dodd-Frank Act also has indirect influences in the industry through changing insurance companies’ business activities such as investment.
As a part of Dodd-Frank Act, Volcker rule prohibits banks from conducting certain business activities including hedge funds, private equity funds, etc. with customers’ deposits (Amadeo). As fewer transactions are made in the financial market, the limitation of banks’ investments would lower market liquidity, which would affect insurance companies indirectly but significantly. As it is shown in the balance sheet, the largest investment of insures is most likely bonds. They tend to purchase newly issued corporate bonds with long periods of maturities, so the insurance companies have to liquidate other investments or assets to ensure smooth and efficient operations or transactions. But if the market does not have enough liquidity, then it would generate volatility, which may exert some negative impacts to the market (“Post-Crisis Financial System Reform”). What’s more, the financial reform also regulates the derivatives market. The regulation of certain derivatives such as swaps may increase the cost of risk management for insurers (“Post-Crisis Financial System Reform”).
Improvements of Insurance Companies
Besides the government would step in to regulate and monitor the insurance industry to prevent tremendous loss, insurers would also take actions to improve their performance and to solve some problems such as asymmetric information. The insurance companies have developed many improvements, and this paper would focus on two, which are the use of Big Data and Internet of Things.
Big data is the technological foundation for the insurance industry for collection and analysis of sophisticated information. Its strong “computing power” enables insurers to improve efficiency and detect fraudulent claims. The insurance industry has suffered from sophisticated data management over years (Bharal and Halfon). Customers always have a high demand of a convenient and fast claim processing process, and insurance companies have been working on eliminating fraudulent claims for a long time. Known as a “high-volume, high-velocity and high-variety” data set (“Big Data”), big data manages to solve these two problems, contributing to the process of information processing and decision making.
With enormous technological development, big data nowadays plays an essential role in the insurance industry, facilitating processing of various and tremendous information (Bharal and Halfon). With big data, insurers are able to gather data of different types and then identify and analyze claims. For example, customers can report their claims by providing images or videos through website or mobile applications (Bharal and Halfon). The data management system then can assess the claims and generate brief reports to insurers. So some frauds can be detected automatically by the system, and insurers are likely to further evaluate claims with more accuracy and efficiency.
The system also helps to reduce costs by lowering labor fees and preventing some possible mistakes of insurers through the use of big data. According to May, a senior actuary from California Public Employee’s Retirement System, the “computing power” is one of the present trends of the insurance industry. Big data has its unique and strong “computing power” in the transaction and process of data. This power can never be replaced by human beings, and what insurers can do is to take advantage of it by creating general models to predict possibilities of future incidents of the insured. As a consequence, the unnecessary costs can be eliminated, which can in turn to further develop the “computing power” to avoid mistakes.
The Internet of Things (loT) are defined as the physical objects that can collect information through connection with the Internet (“The Internet of Things: The Future of Consumer Adoption”). Through embedded sensors, many in-home smart appliances and wearable technology are able to transmit information. Appliances, such as lights and refrigerators, Wearable devices, including Apple Watch and Fitbit, can be connected to loT (Meola). A survey has shown that consumer adoption of loT devices is increasing over time, which is illustrated in Figure 5 (“The Internet of Things: The Future of Consumer Adoption”).
There are various benefits of loT. First, it was estimated that the global connected home market was going to generate $235 billion revenues by 2016 (Armond and Mulhall). The loT is a valuable opportunity for insurers to create new insurance models and products to meet customers’ needs and increase customers’ satisfaction (Armond and Mulhall). New insurance policies for customers also boost better relationships between customers and insurance companies. Furthermore, innovations of new insurance products are also means of earning profits for insurance companies.
Besides, the technology involved in loT is another huge benefit for insurers. Real-time data of loT enables great improvement efficiency of claim processing (Armond and Mulhall), and there is little likelihood for the technologically advanced devices to transmit wrong data and information. Otherwise, it might take a long time for other types of immediates to transform data to insurers with an unsatisfying level of accuracy. Insurance companies can also be benifited by determing more proper premiums for customers and thus make profits.
More specifically, the wearable techonology facilitates health insurance companies to keep track of real-time health conditions and daily life of consumers, who wear cetain technological bracelets to transmit information. In this way, insurers can better analyze the possible risks of the insured and then make protection against possible illnesses and injuries. The home appliances perform as a form of protection of the insured’s properties, contributing to the homeowners insurance. Smart in-home appliances can transmit real-data to both customers and insurance companies as well. It provides more accurate information to the insurers, who can develop more precise models for customers with more efficiency. As a result, the Internet of Things not only benefits consumers with its useful functions, but also provides the insurance industry with many opportunities, creating a win-win situation.
- Amadeo, Kimberly. “6 Ways the Volcker Rule Protects You (and Why Banks Hate It).” The Balance Small Business, The Balance, 31 May 2018, www.thebalance.com/volcker-rule-summary-3305905.
- Armond, Cindy De, and Mulhall, John. “What opportunities do smart homes provide for insurers?” Property Casualty 360. N.p., 18 May 2015.
- Bacani, Louie. “These Insurers May Trigger a Financial Crisis If They Fail.” Insurance Business, 28 Nov. 2016, www.insurancebusinessmag.com/us/news/breaking-news/these-insurers-may-trigger-a-financial-crisis-if-they-fail-41071.aspx.
- Bharal, Puneet, and Halfon, Amir. “Making Sense of Big Data in Insurance.” ACORD and MarkLogic. 2013.
- “Big Data.” Gartner IT Glossary. N.p., 19 Dec. 2016.
- Boris Marović, Vladimir Njegomir & Rado Maksimović (2010) The Implications of the Financial Crisis to the Insurance Industry – Global and Regional Perspective, Economic Research-Ekonomska Istraživanja, 23:2, 127-141, DOI: 10.1080/1331677X.2010.11517417
- Cecchetti, Stephen G., and, Kermit L. Schoenholtz. Money, Banking, and Financial Markets. McGraw-Hill Education, 2017.
- “Industry Overview.” Insurance Information Institute. N.p., n.d.
- Marquit, Miranda. “Five Ways Insurance Benefits Our Economy.” All Business. Dun & Bradstreet, 22 Feb. 2011.
- Meola, Andrew. “Internet of Things devices, applications & examples.” Business Insider. Business Insider, 19 Dec. 2016.
- “Post-Crisis Financial System Reform: Impact on the U.S. Insurance Industry in the Evolving Regulatory Landscape.” National Association of Insurance Commissioners, National Association of Insurance Commissioners (NAIC), www.naic.org/capital_markets_archive/170120.htm.
- Ross, Gail, and Joy A. Schwartzman. “The Dodd-Frank Act and the Insurance Industry: Strategic Considerations of U.S. Financial Reform.” Milliman, 27 Sept. 2010, www.milliman.com/insight/insurance/The-Dodd-Frank-Act-and-the-insurance-industry-Strategic-considerations-of-U_S_-financial-reform/.
- “Systemically Important Financial Institution – SIFI.” Investopedia, Investopedia, 21 Nov. 2017, www.investopedia.com/terms/s/systemically-important-financial-institution-sifi.asp.
- “The Impact of the Financial Crisis on the Insurance Sector and Policy Responses.” OECD.org, OECD, 2011, www.oecd.org/finance/insurance/45044788.pdf.
- “The Internet of Things: The Future of Consumer Adoption.” Accenture. 2014. Web. 12 May 2017.
- The Wall Street Journal, Dow Jones & Company, 2018, quotes.wsj.com/ANAT/financials/annual/balance-sheet. American National Insurance Co. Balance Sheet
- “What Is the Economic Function of a Bank?” Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, 1 July 2001, www.frbsf.org/education/publications/doctor-econ/2001/july/bank-economic-function/.
- Yu, May. Personal Interview. 28 November 2018.
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