Insurance and Collective Investment Arrangements
As with the banking sector, insurance and collective savings generate financial services on both the asset and the liability side. On the liability side, they provide investment outlets and risk-reduction instruments; on the asset side, they typically represent the most important block of professionally managed long-term funds. Both aspects need to be kept in mind in the assessment. Insurance and fund management industries often overlap, in that insurance firms often sell pensions or manage pension funds, other mutual funds and
unit trusts, and so forth. Some investments of those industries are in the form of bank deposits or other unit trusts, so that a measuring scale in a manner that adequately nets out intersectoral claims can be both important and sometimes difficult in the attempt to benchmark scale. In addition to one’s looking at the current position, projections of future developments, especially of pension funds, can be possible and relevant for a view as to the likely contribution of those sectors to funds availability.14
The range of products supplied, as well as their pricing (relative to actuarial fairness), is also an area where deficiencies may exist. It is important to determine whether such gaps are attributable to overregulation, to lack of competition (including restrictions on entry), or to lack of organizational capacity and skills in the industries. Because of the diversity of potential insurance products,15 a comprehensive analysis of cost and availability would be an extensive exercise. Absent such a study, information can, nevertheless, be obtained from market participants. Industry professionals will typically be vocal in identifying policy barriers (including regulatory failure to approve policy design) that inhibit their provision of particular services and products; users will be a better source for identifying others that are unavailable or overpriced because of industry inefficiencies or market power. A similar situation prevails with regard to other collective investment outlets. The tax and regulatory treatment of different insurance, pension, and mutual fund-type products has been a strong influence on the development of the insurance and collective investment sectors, and the whole market can be skewed by distorting incentives that should be avoided as a matter of sound development policy.16
Coverage of the subsectors also needs to examine market structure in terms of concentration and ownership. In countries where there is a mandatory private tier to pension provision, issues of competition become especially important, because the rules regarding
switching, fee structures, and the like can have a large effect on the net return to pension investors.
The investment policy of insurance firms, pension funds, and other collective savings entities is a key to increasing the availability of term and risk finance to domestic industry. This policy can be subject to severe restrictions (such as ceilings on permissible percentages of the portfolio that can be placed in certain broad categories of investment, such as property or equities), which must be examined for their appropriateness in the context of local capacity. While most of the restrictions are supposedly intended to be prudential in nature, in practice some can have the opposite effect, lowering the return on the funds’ overall portfolio without reducing volatility. This effect can be especially true with regard to requirements to hold government securities and prohibitions on international diversification.17 Requirements to cede reinsurance to a state-owned reinsurance company have similar effects.
The long-term viability of the social security and government employee pension schemes needs some examination. Their wider effects on the economy, including the effects of compulsory contributions, are generally fiscal matters that are beyond the scope of the financial sector assessment. However, it is necessary to be generally aware of those wider dimensions if one is to understand the likely evolution of the system. Some examination of the issues could strengthen the assessment of both the financial structure and development.
The health of the insurance and collective investment sectors is often intertwined with that of the organized securities markets. Those sectors are the major investors in securities, and the level and volatility of asset returns in the sectors depend on the microstructure and soundness of securities markets.