The US$575bn reinsurance market could be heading for a banking-style collapse, according to the authors of a new book. Making a Market for Acts of God warns that changes in the way cover is bought and sold are putting this vital global safety net at risk.
Reinsurance is how insurance companies insure themselves against the risk that claims will exceed their reserves. It ensures societies can get back on their feet in the wake of a major disaster.
The book’s authors – academics Dr Paul Spee, Paula Jarzabkowski and Rebecca Bednarek – spent three years shadowing underwriters and brokers in the three major global reinsurance hubs, Lloyd’s of London, continental Europe and Bermuda.
They found that as insurance companies have grown bigger, they are buying less reinsurance cover on the grounds that their portfolio is more diverse, and what cover they do buy is increasingly for the most volatile risks.
Insurers are also bundling together risks and selling them on in a similar way to subprime mortgages before the financial crisis. In some cases they are bypassing the reinsurance market altogether and using new sources of cover such as alternative risk transfer (ART) products, which are typically offered by pension funds or hedge funds and traded in the wider financial markets.
Dr Paul Spee, a strategy expert with the University of Queensland Business School, says insurers and reinsurers may find that they have insufficient cover, as risks are underestimated or obscured within bundled deals. Reinsurance cover is increasingly being concentrated in the hands of a limited number of players, while ART products which are replacing reinsurance work in a different way and are largely untested as a way to provide cover for major disasters.
Worringly, the changes come at a time when disasters are becoming more frequent and more costly. “Reinsurance is a market for Acts of God—those unpredictable events that result in enormous personal and financial loss,” says Dr Spee. “We remain skeptical that these new practices will be able to meet the fallout from such events. If they cannot, the systemic implications, socially and economically, will be profound.”