Careful monitoring of insurers’ links to financial system needed

The insurance sector’s linkages with the rest of the financial system in India need careful monitoring, to reduce the risk of any possible systemic shock triggered by its core activities, says the Reserve Bank of India (RBI).

This word of caution from the central bank is carried in its half-yearly Financial Stability Report (FSR), released this week. The report is the third to be issued since March last year, and for the first time covers the insurance sector. This follows news that IRDA is planning to allow banks to tie up with two sets of insurance companies each in the life and non-life sectors to sell insurance products via bancassurance, doubling the current number of insurers.

The report notes that insurers are big investors in equities and government securities, and can considerably affect stock market movements. Similarly, exchange rate movements may be affected when premiums ceded by non-life insurance companies to foreign reinsurers are significant.

“Unlike banking, where a fall in value of assets significantly below that of liabilities causes failures immediately through bank runs, insolvency in the insurance sector plays out in slow motion over several years,” RBI says. This is due to the longer term claims and the much more dispersed payout dates on insurance products.

“In the case of insurance companies being part of a financial conglomerate, their bankruptcy can trigger systemic risk by casting doubt on the creditworthiness of the conglomerate’s commercial bank, particularly if the bank is of sufficiently large size,” RBI says. However, the report notes that prohibition of multiple use of capital within a financial conglomerate effectively reduces this source of systemic risk.