Insurance Is No Less Important Than Banking - Coursework Example

Order 284746 Topic: “Insurance is no less important than banking. The government should therefore be prepared to intervene to prevent the insolvency of an insurance company”. Discuss the validity of this assertion. Introduction: If the global economy is compared to the heart, banking and insurance are alternative beats of the same heart. During the last 2-3 decades, banking and insurance have gravitated much closer. This process is triggered by innovations of financial products, in keeping with the challenges and demand thrown up by the materialistic civilisation. Banking caters to the needs of the practical commercial world, insurance to a great extent, fulfils the social and psychological needs of human beings. It plays an intelligent, methodical and calculated game as for one’s future requirements, including that of the family members. Policy makers cannot think of banking, without applying thought on the insurance sector. The interrelated areas are, accounting reforms, prudential regulation and risk management. The coming decade will see commercial banks entering the insurance sector in a big way, without any tie-up arrangement with established insurance companies, as has been then practice hither-to. Insurance & Banking-backgrounder information: The challenges of the financial landscape of a country are many. They keep on changing depending upon the volatile economic scenario. The fundamental forces of economics and commerce will always make banking and insurance travel on parallel tracks. They can be compared to the scale of justice. Both arms of the scale are equally important. “There has been a major de-segmentation of finance, as regulatory and technological barriers have come down. Regulatory and legal restrictions on balance sheets, products and prices, which were so common in the old days, have been substantially reduced. Quantum leaps in information technology have spawned a much greater variety of insurance and banking products and made it easier for institutions to contest each other’s markets.”(Knight, 2005) This has created severe competition in the financial industry. Globalisation of finance has resulted in cross-border activity amongst the countries. The developments due to globalisation have not affected banking and insurance with the same degree. Banking industry quickly established the global network, but the insurance remained less international than banking. Competition between banking and insurance in various segments has intensified to such an extent that a consumer wonders what is happening, why this is happening and where is the line of demarcation! Severe competition exists between asset management and life insurance segments. “The establishment of banking-insurance conglomerates has been specifically aimed at exploiting synergies in the battle for the retail asset holder. ... Moreover, the broadening range of activities of The Geneva Association is testimony to the growing recognition in parts of the insurance industry of its increasingly international and global character. In other words, there is no doubt that the two worlds of insurance and banking have been converging, and will continue to do so.”(Knight, 2005) The similarities between the banking and insurance perspectives are evident in more than one areas. The only issue is which of these have more advantage in a particular area. For example, banks score over insurance companies in addressing and modeling risks over short horizons and also to develop derivative instruments, the tradition of the insurance companies have been to develop asset-liability management techniques. The insurance companies also score over banking in stress-testing and to link risk measurement and pricing policies as for their mainstream products. From the point of view of the consumer, banking and insurance companies speak similar languages. Financial libearisation and innovations have drawn them much closer, though from the point of view of competition, they try to maintain distance between themselves. The challenges for both the segments are almost identical and both of them operate in identical circumstances. The underlying principles for practitioners and policymakers are the same, and both have to depend upon fundamental and technical analysis of the financial market and the response of the consumer to the ever-changing volatility. Apart from all the technicalities, research and analysis, human judgement continues to play the important role. Insurance company and insolvency: What happens when an insurance company files for bankruptcy? The assets are frozen and a trustee or receiver is appointed to manage the distribution of funds. This is the normal procedure. Mostly, the assets of the company will not be sufficient to stay afloat or to meet the legal obligations of the customers in full. No company normally works for its insolvency deliberately and no one can say in advance when an undesirable event may occur and what would be its impact. Since insurance is a significant economic force in industrialised countries, it becomes the moral duty of the government to intervene to prevent the insolvency of an insurance company. Strict regulatory mechanisms operate in most of the countries to govern the insurance business. Yet failures do occur, for unspecified reasons, notwithstanding applying the best checks. One failure affects the industry as a whole, and if not rectified well in time, the flight of the capital will adversely affect the insurance segment as a whole that will result in a series of damaging consequences in industrial production and other areas. To rebuild the lost confidence of a consumer, is a difficult process and the intervening period of confusion is the most undesirable after-effect relating to the insolvency of an insurance company. Some of the important issues why the government must be prepared to intervene to prevent the insolvency of an insurance company are: 1. With the fall of national barriers, and with globalisation impacting every type of economic activity, the first and foremost duty of the government is to maintain and secure the trust of the international community. The failure of just one company may send the shock-waves through the entire economy, whether related to insurance or not, and the government has to act immediately and stand by the depositors of the company, as a confidence-building measure. 2. If immediate action is not forthcoming from the side of the government, the healthy companies may also suffer due to lack of confidence by the customers. The turnover of the insurance sector as a whole will be affected. If the rotation of the business worsens, if there is a drastic fall, it will set forth a chain reaction affecting the productivity and turnover of the company. In a serious situation, there would be flight of capital from the insurance sector, setting forth a chain reaction, which is not well for the overall growth of the economy. 3. A few key issues are involved. The perspective of an account holder in dealing with the banks in investing one’s funds is limited. It is to get a fixed amount of interest in case of fixed deposits and in case of savings bank account, to meet the expenses relating to the monthly expenses. As for one’s dealing with the insurance companies, an individual’s perspective is different and mostly it is specific goal-oriented! For example, to meet the expenses for children’s education, to purchase a residential property, secure expenses related to hospitalisation etc. in case of major health related problems, to make provisions for a peaceful retired life. A major insurance company services millions of house holders who have taken different types of policies, as per their futuristic needs. The social point of view comes to the fore first and the insolvency of an insurance company affects them hard. 4. Insurance cover serves a great social objective. The government-owned insurance establishments and the many private insurance companies spread the message of insurance relentlessly. No doubt their declared objective is to provide competitive and efficient insurance policies, but the insurance business is a big money-spinner and revenue-earner for the government. To retain the goodwill and keep up the development of the insurance sector is the avowed policy of any government. Insurance premiums are a great resource mobilization tool for the government. Such funds are generally utilised towards socially important and priority areas like pubic health, education, housing etc. The government, therefore, has the national interest in mind, to keep the insurance sector in good health. As for resource mobilisation, insurance sector is more important than banking. “Its socio-economic role is to transfer risks associated with individuals on to a larger group and helping the group in large share individual losses on an equitable basis….Insurance further plays a primary role with respect to international trade and national economy on the whole by reducing uncertainties in the economy. Thus, it can also be said to be a stabilising force in the economy with respect to trade and commerce… It has also been observed that there is a positive correlation between the amount spent on insurance and economic development.”(Chaudhuri, 2007) This goes to prove the importance of the insurance sector to the economy of a country and why is imperative for the government to come to the rescue of an insurance company to prevent its insolvency. 5. Though there are fundamental differences between banking and insurance sectors from the commercial point of view, the professed aim of both the sectors is the same, contributing to the health of national economy and playing their respective roles in the prosperity of the individual. Both offer, more or less, similar products to their clients. Their modes of operation are, however, governed by different regulatory authorities, as per the rules and regulations and the directions of the controlling authorities. The insolvency aspect of the insurance companies has been engaging special attention in many countries of the world. The similarities of the banking and insurance activities are many, the mutual competition to sell more or less identical products is severe, and the dissimilarities are mostly concerned with the operational aspect and disbursing the benefits to the clients. “While the insolvency of a bank could have systemic effects in the form of bank runs and contagion through payment and settlements systems, the insolvency of an insurance company is unlikely to have a significant systemic impact, not least owing to the lesser liquidity of its liabilities.”(Wihlborg, 2007)The importance of insurance as compared to banking gets a shot in the arm, from the point of view of technical considerations also. The latest thinking is to direct the banking and insurance companies to hold similar amounts of capital against assets with similar risks. Without going into the merits of this observation, it nonetheless, is a pointer to the importance of the insurance sector v. the banking sector. 6. An insurance company, due to cut-throat competition in its own sector and competition from the banking sector, is compelled to adopt the market-oriented approach. In the event of insolvency of the company, apart from the deep impact on the psyche of the public, valued clients as well as the general pubic that has no business relations with the company, in real terms, it will lead to job losses, unemployment, and many other related uncertainties. It will also lead to worsening social conditions. If a losing insurance company is allowed to suffer the pangs of insolvency, it will have the adverse effect on the insurance industry as a whole. It could end in a big capital flight, if the government were to watch the insolvency proceedings as a mute spectator. 7. The avowed policy of any government to cover as many risk segments for the benefit of the individual and for the greater benefit of the society through the insurance sector. Democratic governments are governments of the people. They stand more for social welfare of the people, than for the economic prosperity. In short, economic prosperity should not be at the cost of social welfare. The nation can not run like the shopping mall, where profiteering is the only objective with the thrust of advertisement gimmicks. Insurance sector, is, therefore, meant to contribute to nation’s prosperity, like the banking industry. Ideally, they are the agents of economic and social change in a country. Conclusion: The world economy is undergoing a period of depression. The health of every financial sector is important to the country where its network of branches exists. As of now, the poor and the middle class are at the receiving end and find it difficult to meet the health care needs, mounting domestic expenses, pay the gas and electricity bills etc. Insurance sector has a great role to play in the economic and social sectors of any country and therefore, any insurance company on the verge of insolvency needs attention and protection from the government. This, however, does not mean that frauds and inappropriate financial dealings done by the officials of the company need to be condoned. Proceedings should be initiated against such individuals, as per the law of the land. But the institution of insurance must be saved by the regulatory authorities and taken care by better management established through legal channels. List of References: Chaudhuri, Prof. Arindam (Noted Economist & Management Guru-Winner of the Louis Marchesi Fellowship of The World Round Table.)-Opening of the insurance sector- The insurance sector should ideally be viewed more as a national service –Retrieved on April 5, 2009 Knight Mr. Meeting worlds? Insurance and banking 2 Jun 2005 ...discusses how the worlds of banking and insurance are moving closer. -Retrieved on April 5, 2009 Whilborg, C:CEPS -2007- The Centre for European Policy Studies While the insolvency of a bank could have systemic effects in the form of bank ... in spite of the economic benefits of such risk shifting. .. European Shadow Financial Regulatory Committee - Statement n.2419 February 2007Print-Insurance Supervision in Europe: Is Solvency II Appropriate? Statement No. 24: Zurich, April 27, 2006 –Retrieved on April 5, 2009 Read More