The question of whether insurers would increase the length of their cover to prevent banks from facing a portfolio of endangered properties in technical default has resulted in most insurers responding that it is not likely.
“Newsflash banks – insurers are in it to make money,” said one anonymous interviewee, speaking to Insurance Business. “Take some responsibility for your own lending decisions.”
However, it is worth noting that historically the relationship between banks and insurers, with their different business models and roles in the economy, is not coercive but close and mutually beneficial as banks have need of underwriters and underwriters appreciate the business.
Still, the core activities of insurers and reinsurers is risk pooling and risk transformation by providing individuals and businesses with protection against negative events, whereas the core activities of banks are the collection of deposits and the issuing of loans, together with the provision of a variety of fee-based services.
According to
Apex General managing director
James McGhie, talk of extending the length of insurance contracts brings to the fore the question as to how reinsurance would work.
“Reinsurance only covers an annual period, thereby rendering the insurer with the risk after the one-year period expires,” he said. “There would need to be a method to it and it would have to be thought out in detail.
“I’ve always worked though on an annual cycle for the business and customers.”
He pointed out that in the past “people at times wanted to lock it down in hard cycles” in the form of “multi-year deals” and that they could come back into vogue for a two or five-year period.
“But it’s hard for a business to manage and price - I can’t see it changing myself,” he said.
According to IASB board member Darrel Scott, the issue could be looked at from various angles, even though undoubtedly extending the duration of insurance contracts increases risk.
“Essentially the advantage of a one-year contract is that the insurer can enter and exit quite quickly,” he said. “If the insurer is stuck with a longer contract, it’s stuck with risk for longer.”
He explained that if insurers extend the duration of their risk, or are forced to do so as a result of regulatory pressure, they will increase their pricing in order to be compensated for their increased risk.
“They will mathematically estimate the risk over the longer period and ascertain how the risk is likely to change over a given time period and increase premiums in accordance with the risk,” he said. “A change of this nature can’t be seen as five one-year contracts but as a fundamental change in the nature of what the insurer is providing.”
Related stories:
Will insurers extend duration of cover?
Endangered property risk puts banks under spotlight
