Risk Management in a Recession

You might think that a recession is bad for insurance companies. I thought so too. But I was wrong.

How does a recession affect insurance companies?

It’s got to be bad, right?

  • Fewer companies exist to insure.
  • Life assurance is a harder to sell to people worried about their finances.
  • Cases of arson and other types of crime increase.
  • People and companies become more likely to sue to recover damages.
  • Credit protection polices have to pay out as firms go out of business.

It can’t be good, can it?

That’s what I thought. But it turns out I was wrong. I just read an interesting little article on the effects of recessions on the insurance industry in The Economist.

Recessions also decrease certain types of claims and therefore reduce the risks an insurance company is liable for:

  • People drive less, so have less car accidents.
  • There is less construction and manufacturing, so there are less claims for workplace injuries. (These are the riskiest types of jobs.)
  • Although damage to premises increases, the cost of replacing business premises falls.

In addition, most insurance policies (other than life-assurance polices) are non-discretionary: you can’t cancel your business, home, or car insurance to save money.

The net effect, apparently, is that it is a wash. According to a Munich Re study, the profitability of America’s non-life insurers (measured as a percentage of business written) shows no correlation with the economic cycle. This was even true during the great Depression of 1928-1931.

It’s easy to see only one side of things, especially when the press wants to fill our heads with stories of recession and depression.

But as the old proverb says, it’s an ill wind that blows nobody any good1.

1 Incidentally, the related proverb every cloud has a silver lining was first penned by Milton in 1634, with its modern wording coming from the great showman Phineas T. Barnum in 1869 2. There’s also an interesting form of cognitive bias known as the Barnum Effect, but sadly it’s not the form of cognitive bias mentioned here so the only excuse I can find to mention it is to put it in this footnote.
21 January 2009

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