KARACHI: State Bank of Pakistan has suggested the privatization of the state-run insurance companies. These companies include State Life Insurance Company (SLIC), Pakistan Reinsurance Company Limited (PRCL) and National Insurance Company Limited (NICL). In its new Financial Stability Report, SBP said that one of the suggested reforms in insurance sector is the privatization of all the state-owned companies, which has been delayed for quite some time.
SBP observed the insurance sector is currently the only component of the financial sector with the largest proportion of government ownership, since most of the financial sector is now owned and operated privately on a market-based mechanism. Proponents of the free-market system advocate the need for firms to operate on the basis of the market mechanism to promote efficiency, competition and innovation. Interestingly, a branch of economic literature suggests that insurance is a unique component of the financial sector in which a high level of competition is actually undesirable. This is because insurance companies are in the business of circumventing the elements of moral hazard and adverse selection when providing insurance coverage, and excessive competition tends to cloud their financial judgment of these decisions.
Not withstanding the facilitating role of the government, the continued government ownership of these large entities has also impeded efficiency gains and product innovation in the insurance sector. In case of non-life insurance, high premium rates charged by NICL (in comparison with more competitive rates offered by private sector insurance providers) on insuring government assets not only impose an additional cost to the government, but are also indicative of monopolistic inefficiencies given that all public sector organizations can only avail insurance coverage from state-owned companies.
The lethargic pace of implementation of insurance sector reforms is another factor which has not received the attention it deserves, resulting in one of the lowest insurance penetration levels in the region. Highlighting the role of government, SBP observed that like other components of the financial system, the insurance sector is also affected by issues related to adverse selection, moral hazard, and market asymmetries and failures. Advanced economies, which had predominantly advocated a laissez-faire approach in the last few decades, eventually came to rely heavily on government intervention for the survival of its financial institutions in the aftermath of the GFC, in the form of bail-outs (capital injection, troubled assets rehabilitation and temporary financial support). The situation deteriorated to the extent that AIG and other leading insurance companies were given a bailout package of $130 billion in 2008, to meet immediate liquidity needs and to remain solvent.
In developing and emerging economies on the other hand, the insurance sector remained significantly unaffected from the contagion effect of the GFC, largely due to the low level of financial integration with international financial institutions and markets. Notably, the insurance sector in developing countries relies heavily on the government in terms of providing reinsurance and disaster/calamity coverage, as the private insurance providers are generally under-developed and lack access to risk financing (or reinsurance), raising issues related to solvency. This is evident from the fact that most of the reinsurance and large insurance (life and non-life) companies in developing countries are still owned and operated by the government.
Moreover, issues such as lack of sufficient historical statistics on disaster and calamity risk and a general lack of awareness of the significance of insurance as a financial product, impede the entry and penetration capacity of large insurance companies in the private sector. In case of Pakistan, the role of the government has been instrumental in the development of the insurance and reinsurance sectors since the time of independence. From safeguarding the interest of the policyholders by creating the office of the Department of Insurance, which was later changed to the Controller of Insurance, to the establishment of Pakistan Reinsurance Corporation (presently called Pakistan Reinsurance Company Limited, PRCL) in 1953, the government has actively promoted insurance services in the country.
