Insurance business diversification and systemic risk

Risk diversification regarding business lines with imperfectly correlated cash flows can reduce the financial distress risk of an institution due to coinsurance effects. Therefore, business diversification might also lower systemic risk from a “domino” perspective, in which the financial distress of an institution causes financial contagion risks to other institutions that result in systemic risk. The underwriting of risks by insurers is typically considered not systemically risky by itself, providing the basis for the diversification of insurance business lines to potentially reduce systemic risk. Since life and non-life insurance lines generally show substantially different underwriting characteristics, this paper studies if the diversification of both insurance business lines can create a financially stabilizing diversification effect, therefore reducing systemic risk. By means of a theoretical portfolio model and empirical analysis, the findings suggest that diversified insurers engaging in both insurance lines have, on average, a lower contribution to systemic risk than monoline life and non-life insurers. More specifically, insurers with a business allocation in the range of 54% life insurance are, on average, associated with the lowest contribution to systemic risk. These findings have practical implications for the design of macroprudential insurance regulation, which currently neglects the financially stabilizing potential of the diversification of both insurance business lines.