Insurance companies are termed as the largest investors in capital markets, in addition to being characterized as the sole suppliers of insurance business to reinsurance companies. The insurance sector fosters financial stability by enabling economic agents to undertake various transactions with the facility of transfer and dispersion of risks. As a crucial component of the financial system, insurance plans are an important source of savings and long-term institutional investments essential for the development and growth of capital markets. The role of insurance as a financial intermediary is particularly important in countries like Pakistan with low levels of financial penetration.
The asset structure of insurance companies shows that the assets of the non-life business are increasing at a faster pace than the life insurance business. This is due to the increased activities in the areas of international trade and commerce and bank borrowing which also creates a sizeable demand for non-life insurance, whereas life insurance is either dependent on corporate management practices or on the preference of individuals. Moreover, the composition of assets shows a gradual shift in the ownership structure from state controlled to the domestic private market. The share of assets of the state-owned insurance company have decreased substantially and this shift in demand is being met by the private insurance suppliers.
Investments are generally the largest asset of an insurance company’s balance sheet. The investment portfolio of insurance companies usually consists of listed shares, corporate debt bonds (TFCs) and money market instruments as insurance companies have been barred from investing in National Savings Schemes. With the change in ownership structure from public to private market, a gradual shift has also been observed in the investment strategy as well. Although government securities continue to have a disproportionately larger share, the exposure to stock market (as percent of overall investment portfolio) has also surged significantly which results in dividend income. The increase in the share of equity market investment was primarily at the cost of investment in government securities. Besides high returns in the stock market, this change was primarily driven by sharply declining yield and scarcity of long-term government securities i.e. PIBs. State Life Insurance Corporation Pakistan is perhaps the only insurance company in public sector which, apart from financial investments, also earns a huge amount on investment in property in the form of rental income.
Claims and premiums are important constituents of the insurance business: premiums are the primary source of revenue for an insurance company, while the honoring of claims mitigates the losses incurred by the customers. Risks in the insurance sector can be categorized broadly as Technical risk, Credit risk, Market and Liquidity risk, in addition to other risks such as operating, managerial, and control structure risk. The magnitude of these risks varies in line with the nature of business in nonlife and life insurance. The most important risk factor in insurance arises from the technical assessment of the underlying transaction for which insurance cover is required. Inaccurate actuarial calculations and errors in associated parameters can potentially result in a situation where the assured returns are not commensurate with the given amount of insurance claims.
Life insurance provides the facility of financial intermediation in generating long term financial savings. In this context, the main threat to the stability of the life insurance companies arises from the mismatch in the return assured and the returns generated by investments made by the companies in a risk-bearing portfolio. About 80 percent of these investments are in risk-free government securities, while around 19 percent are in the equity market, such that the potential probability of occurrence of market risk is low. However, in pursuit of higher returns, smaller private companies tend to invest in equities rather than government securities and other fixed return securities.
Although there has been significant increase in the investment and assets of the insurance companies, when compared with the banking sector, their share in the total financial assets is still very small. This indicates a weak interconnectedness between the banking and insurance industry. One of the major reasons of the low share of insurance sector assets in total financial assets is general public awareness. There is a general dearth of information for prospective life insurance policy holders to use it as an investment instrument. The education of prospective insurance consumers would result in a rise in the demand for insurance products. In this connection, loans in cash against the security of life insurance policies may be extended to the policy-holders to the extent of a partial amount of the policy value provided the policy has been in-force for over two years. Another way is through bancassurance which is an ingenious way of using the outreach of banks to sell insurance products. In this method, a bank and an insurance company mutually agree to use a bank’s distributive channels or branches to sell insurance products in collaboration with an insurance company. This agreement is mutually beneficial; for the bank, this provides another avenue for generating profits, whereas, the insurance company benefits from the bank’s established distribution channels.