A strong reinsurance sector is key to protect small businesses from future crises

Last week, research released by Bibby Financial Services revealed that many small businesses in the UK are struggling to cope with rising prices and supply chain disruptions, with just under two in five reporting they were “just about breaking even”. According to the survey, the dominant concerns for small businesses stemmed from rising inflation, supply chain disruptions and the knock-on effects of Russia’s war in Ukraine. It is a problem that is not limited to the UK, as the surge in energy prices and cost of materials have started squeezing the returns of small businesses across Europe.

More generally, the pandemic has shown us just how vulnerable small businesses are to major shocks and crises. With other existential risks on the rise, such as climate change disasters and cybersecurity attacks, it is imperative for small businesses to have greater certainty and protection against any potential losses. The solution may lie in a growing reinsurance sector that, by covering part of the risk and liabilities of primary insurers, provides a stronger safety net for small businesses to claim back their losses.

A challenging time for small business

It’s never easy starting a new business. Once aspiring entrepreneurs overcome the hurdles of transforming a concept into a viable company, they must carefully manage limited finances and keep aside sufficient capital to cover any potential liabilities. But while managing these risks are par for the course, extraordinary disruptions and major crises can suddenly sink nascent and healthy businesses. Had it not been for generous state interventions and support packages, for instance, the COVID pandemic would have had precisely such an effect. Indeed, according to the UN’s International Trade Commission, one in four small businesses were three months away from shutting down during the height of the pandemic.

Despite surviving the repeated business interruptions caused by endless lockdown cycles, entrepreneurs are still contending with the economic damage caused by the pandemic. Many small businesses are now struggling to deal with inflation, high costs of materials, global supply chain disruptions and a shortage of available labour. Multiple surveys published this year have shown that small businesses are struggling to hold on, as they face both pay and price hikes across a variety of economic sectors. In the United States, one survey found that 60% of small businesses are struggling with labour shortages while another found that the number of business owners raising their prices hit 61% – the highest since 1974. The last two years have therefore been a uniquely difficult time for small business owners and entrepreneurs looking to set up shop.

Handling growing risks

The current challenges experienced by small businesses highlight the need to build resilience and risk management strategies that can better equip them to deal with crises, especially when these cause major business disruptions. One of the ways small business owners have traditionally sought to do so is through insurance. But just like many other parts of the economy, however, the primary insurance sector was initially caught off guard by the scale of disruption caused by COVID. Indeed, if the entire burden of compensating pandemic-related damages had fallen on primary insurers, they would have soon exhausted their cash reserves. Small businesses, even if covered by specialised policies, would have therefore been left in limbo.

What is perhaps most concerning is that, while the challenges of the pandemic may be behind us, other major existential risks are becoming increasingly frequent and their potential impact for small businesses could be equally severe. Climate change, for instance, is resulting in more powerful and frequent extreme weather events that severely impact small businesses. Even the digital space carries with it extreme risks, with small companies being three times more likely than large firms to experience crippling cybersecurity attacks. As these risks increase, so does the potential for massive business losses. It is therefore crucial to build better ways of distributing risk, which can protect both primary insurers and, consequently, the small businesses they are supposed to cover.

The rise of reinsurance

The solution for both small businesses and the insurance market lies in the growth of the reinsurance sector, which manages the risks and losses that primary insurers face from major catastrophic events.

By taking on some of the potential liabilities faced by primary insurers, reinsurers prevent insurance companies from being over-exposed to major risks. For ordinary businesses, this has important indirect impacts: if a major disaster were to happen, reinsurance reduces the possibility that primary insurers will be unable to pay out their claims. Transferring part of the risk to reinsurers also has the effect of lowering the costs of primary insurance premiums, making it more affordable for small business owners to buy coverage. But reinsurance also has directly beneficial effects for the economy as a whole.  Indeed, reinsurers invest a large amount of their insurance premiums in financial markets, which – in turn – pour money back into producing goods and services that stimulate job growth.

Unsurprisingly, the sector has seen impressive growth and attracted major investors, many of whom have announced or completed several high-value acquisitions in the last twelve months. For instance, Covéa – a French mutual insurance company – recently received approval by the European Commission for its acquisition of international reinsurer Partner Re in a deal worth €9 billion. Another recent deal saw global asset manager Apollo complete a $11 billion merger with reinsurance and retirement firm Athene Holding.

The pandemic has shown just how vulnerable our economies are, and why it’s important to have redundancies in place. As small businesses face a slow recovery and growing risks, they need greater certainty that their losses will be covered. The growth of the reinsurance sector is therefore welcome news, as it provides an extra layer of protection for entrepreneurs that a sudden major crisis will not force them to pull the plug on their businesses. With extreme weather events such as floods and wildfires becoming more severe, the reinsurance sector will have an increasingly crucial role to play in affording both primary insurers and the small businesses they cover a greater degree of protection and certainty.

Image credit: Pictures of Money

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