Question

Consider the following two events: (a) a bank loses $1 billion from an unexpected lawsuit relating to its transaction with a counterparty and (b) an insurance company loses $1 billion because of an unexpected hurricane in Texas. Suppose that you have the same investment in shares of the bank and the insurance company. Which loss are you more concerned about? Why?

Answer 1

One should be concerned about the bank loss, since the loss affects that particular bank alone, and not the banking sector as a whole. Therefore, it would be difficult for the bank to negate or trim the loss by raising its product prices, as that is going to affect its competitive position in the market, resulting in probable loss of market share and future business.

On the other hand, the loss of the insurance company affects the insurance sector as a whole. Therefore, all the insurance companies have the flexibility to increase the premiums for their products, and recoup the loss in the near to medium term. So one should not be too concerned about that.