The Insurance Sector and Financial Stability: an International Perspective and an Assessment of the Situation in Israel
This study examines the connections between the insurance sector and financial stability in Israel, against the backdrop of financial crises of the last two decades in many countries, in which insurance firms were involved. The point of departure is the knowledge and experience that has been acquired on the subject worldwide in recent years. I review the main reasons-structural and others-for the collapse of insurance firms in various countries in the world and the conditions in which their collapse endangers the financial system (the contagion effect). I then examine the structural and systemic risks embodied in the activity of the insurance sector in the conditions obtaining in Israel, as well as in the context of international comparisons, using indicators based in part on those developed by the IMF for measuring the financial stability of the insurance sector.
The conclusions reached on the basis of the knowledge and experience that has been accumulated globally are that the systemic risks in this sphere derive from three main factors: quasi-banking activities in insurance, such as saving in life insurance plans together with assured return, which exposes them to interest-rate, credit, and liquidity risks, just like the banks; business and ownership ties between banks and insurance firms, which create contagion between them; and regulatory and supervisory weakness (henceforth, regulation) in the insurance sector.
In Israel the quasi-banking activities conducted by insurance firms consist primarily of saving in the framework of old assured-return life insurance plans, albeit to a limited extent. There are also cross-holdings between banks and insurance firms, again to a limited extent. By contrast, regulation in the insurance sector in Israel, as is the case in many countries is not sufficiently strong - despite a marked improvement in the last few years - giving rise to implicit systemic risk. One of the expressions of this is under-reporting and lack of transparency hampering the assessment of exposure and risks.
A prominent feature in Israel is the fact that general and life insurance activities are undertaken within the same company, a feature which is not customary in most other countries. This situation creates a potential for contagion from general to life insurance, although the former embodies hardly any systemic risk in itself.
The return on equity of the insurance industry in Israel is high by international standards, because the capital adequacy requirements would appear to be too low.