Why insurers differ from banks

However, their functions are different. An insurance company ensures its customers against certain risks, such as the risk of having a car accident or the risk that a house catches on fire. In return for this insurance, their customers pay them regular insurance premiums. Insurance companies manage these premiums by making suitable investments, thereby also functioning as financial intermediaries between customers and the channels that receive their money.

For instance, insurance companies may channel the money into investments such as commercial real estate and bonds. Insurance companies invest and manage the monies they receive from their customers for their own benefit. Their enterprise does not create money in the financial system. Operating differently, a bank takes deposits and pays interest for their use, and then turns around and lends out the money to borrowers who typically pay for it at a higher interest rate.

Thus, the bank makes money on the difference between the interest rate it pays you and the interest rate that it charges those who borrow money from it. It effectively acts as a financial intermediary between savers who deposit their money with the bank and investors who need this money.

Banks use the monies that their customers deposit to make a larger base of loans and thereby create money. Since their depositors demand only a portion of their deposits every day, banks keep only a portion of these deposits in reserve and lend out the rest of their deposits to others.

Banks accept short-term deposits and make long-term loans. This means that there is a mismatch between their liabilities and their assets.

In case a large number of their depositors want their money back, for example in a bank run scenario, they might have to come up with the money in a hurry. For an insurance company, however, its liabilities are based on certain insured events happening.

Their customers can get a payout if the event they are insured against, such as their house burning down, does happen. Insurance companies tend to invest the premium money they receive for the long-term so that they are in a position to meet their liabilities as they arise.

It is unlikely that a very large number of people will want their money at the same time, as happens in the case of a run on the bank. This means that insurance companies are in a better position to manage their risk. Another difference between banks and insurance companies is in the nature of their systemic ties.

Banks operate as part of a wider banking system and have access to a centralized payment and clearing organization that ties them together. This means that it is possible for systemic contagion to spread from one bank to another because of this sort of interconnection. Insurance companies, however, are not part of a centralized clearing and payment system. This means that they are not as susceptible to systemic contagion as banks are.

There are risks pertaining to both interest rates and to regulatory control that impact both insurance companies and banks, although in different ways. Changes in interest rates affect all sorts of financial institutions. Banks and insurance companies are no exceptions. Considering that a bank pays its depositors an interest rate that is competitive, it might have to hike its rates if economic conditions warrant. Generally, this risk is mitigated since the bank can also charge a higher interest rate on its loans.

Insurance companies are also subject to interest rate risk. Since they invest their premium monies in various investments, such as bonds and real estate, they could see a decline in the value of their investments when interest rates go up.

And during times of low-interest rates, they face the risk of not getting a sufficient return from their investments to pay their policyholders when claims come due. In the United States, banks and insurance companies are subject to different regulatory authorities. In the case of state-chartered banks, they are regulated by the Federal Reserve Board for banks that are members of the Federal Reserve System.

As for other state-chartered banks, they fall under the purview of the Federal Deposit Insurance Corporation, which insures them.

Various state banking regulators also supervise the state banks. Insurance companies, however, are not subject to federal regulatory authority. Instead, they fall under the purview of various state guaranty associations in the 50 states.

Financial Statements. International Markets. Risk Management. Actively scan device characteristics for identification. Use precise geolocation data. Insurance companies are mainly exposed to underwriting risk, market risk and the risk of mismatch between assets and liabilities, whereas the most significant risks to which banks are exposed are credit risk, liquidity risk and market risk.

Importantly, the risks faced by an insurer depend on both assets and liabilities and the way they interact. From a macroprudential point of view, the core insurance business model does not generate systemic risk that is directly transmitted to the financial system. There is far lower contagion risk, higher substitutability and lower financial vulnerability in insurance compared to banking. The financial position of insurers deteriorates at a much slower pace than that of banks and even if an insurer does run into trouble, an orderly wind-up is much easier, since insurers strive to match expected future claims by policyholders with sufficient assets; this facilitates the transfer or run-off of their portfolios.

Insurance Europe supports appropriate improvements to regulatory and supervisory standards for insurers that will maintain a sound and competitive industry and that will foster consumer confidence.

But the all too common assumption that regulation which is valid for banking must be valid for insurance is wrong. Rules applied to insurance should fully reflect the profound differences between the business models and risk profiles of the two industries.

Applying banking-inspired regulatory frameworks to insurers would have a materially negative impact on the sector and on the whole economy. Full publication. Log in. Username: Password: Remember me This website, like most others, uses cookies to give you a great online experience. Forgot your password?

Follow Us. Public Information Expand. European Commission EIOPA announces resu Fitch: Weak profits, Bank of England: Pru Reuters: EU's financ Commercial Risk Euro Insurance Europe: Eu Vox EU: How insurers EIOPA publishes cons Default: Change to:. A significant number of reforms have been introduced by policymakers as a response to problems in the banking sector which have negatively impacted the entire economy.

These efforts to foster sound and stable financial markets are fully supported by the insurance industry. Comments: No Comments for this Article. Add new comment Show name and company details. Public Information. Graham Bishop Consultancy. Friends of GrahamBishop. Brussels 4 Breakfast. Graham Bishop - Biography.