Managing a (re)insurance business today requires a different level of sophistication than it did five, certainly ten years ago. Since new business tools, such as asset liability modelling, are widely available, (re)insurers will be expected to use them. Investors and their proxies the analysts will start to look more critically at those who do not, especially if they do not have a good results story to tell.
The internet adds another dimension completely, which has to be exploited and managed. For instance, the group underwriting manual can be held on an external server and accessed from all offices throughout the world using web browser technology. In our IT commentary Régis Delayat describes eight different ways in which SCOR is using the internet and electronic communication.
New and improved forms of communication mean that management has much greater ability to monitor how the business is being done and to communicate policy throughout the group. The business of a maverick agent, for instance, should be spotted and stopped much more quickly than in the past.
Then, there are new products. While easily understood, legally tested conventional (re)insurance policies will remain important, companies will need to be able to demonstrate ART capabilities or risk being perceived as missing growth opportunities and marked down.
Somewhat analogously to the high prices paid for internet stocks, it is probably less important if ART type products are actually losing the company money now because of the cost loading than if others have the perception that it has the necessary skills.
As our roundtable discussion on corporate governance shows, shareholders in Europe are becoming more assertive, even if they do not reach the US level of litigiousness. At the same time, however, the development of tougher regulations affecting financial services companies is aimed at consumer rather than shareholder protection.
If, in the name of consumer protection and to please rating agencies, insurers write only low volatility risks and invest only in government and investment grade paper, they are likely to be putting their shareholders at a disadvantage. Regulations which say that insurers can only use derivatives to hedge their own exposures (risk management) and that trading for gain is ultra vires, again may be in the best interests of solvency but not necessarily of profitability.
Bermuda's many friends say that this more flexible regulation is, if anything, more attractive than the absence of tax that makes the island attractive. Commercial Risk Partners, for example, is an active trader in the weather derivatives market.
In theory, reinsurance anywhere does not need the same type of regulation as insurance which is marketed to unsophisticated buyers. In practice, the more sophisticated and opaque the solutions offered by reinsurers, the less easy it may be for regulators and rating agencies to judge the potential impact of failure of the contract to achieve the insurer's objectives. It may be that, in fact, they have less cause for concern, but more transparency would do the industry no harm. None of this is so critical when the economy is buoyant. One point our roundtable discussion of corporate governance has highlighted is that, at the moment, shareholders in the UK almost never sue directors of public companies. Partly it is because of the law and legal system. However, even if the profit they are making is less than hoped or less than a competitor or another sector, it is still a profit. It is when the profits stop and the losses come in that writs start to fly.
The same applies to many classes of business which (re)insurers are writing. A recession increases claims in direct and indirect ways. For instance, a sharp fall in commercial property values, as we saw in the last recession in the UK, leads banks with foreclosed property to try to recover any short-fall from the loan from the valuer, whose professional indemnity insurer will pay defence expenses, at the least.
More losses are widely predicted in (re)insurance. Consider the views of run-off specialists who believe that there will be a growing market for their skills as the underwriting fabric woven over the last few years unravels to reveal a fine crop of moths and some very bare patches.
Our roundtable participants suggest that there is a difference between taking a risk and taking a chance. Risk taking, no one would deny, is the proper responsibility of (re)insurers but at what point do the shareholders decide that underwriters were taking a chance, making a decision based more on wishful thinking, than on reasoned assessment or putting commercial relationships ahead of shareholders' interests? To what extent would their directors be regarded as personally accountable for such a failure of management?
Less than a year ago, it was estimated that there were 180 or so companies in run-off in the London market, of which 40 were insolvent and that altogether they had estimated liabilities in the region of £25 billion, not including the Lloyd's run off vehicle Equitas. One case only, that of London United Investments (generally known as the KWELM companies), generated an independent inquiry by the then regulator, the Department of Trade and Industry (DTI) and the administrators of the scheme of arrangement successfully pursued legal action against former directors.
Despite the gloom which the industry traditionally relishes, the process of consolidation and flight to quality does mean that insolvency on a similar scale is very unlikely. Our morticians, the run-off specialists, do not expect the same level of growth in business that they saw in the late 1980s and early 1990s. What failures do occur, are, however, likely to attract more attention.
At the same time, greater shareholder activism could have considerable influence. Major players may make strategic policy decisions, say withdrawing altogether from a sector or territory, that has a material impact on availability and continuity of cover because of their market share. US companies have shown themselves willing to do this in the past, as Liberty Mutual's abrupt decision to close down its London market reinsurance subsidiary in 1999 demonstrates.
In the United States and United Kingdom, numerous (re)insurance companies have failed. In continental Europe, it is rare. As Wolfgang Eilers and Hubertus Labes of Chiltington International explain, in Germany companies have not become insolvent. Either a reinsurance has been arranged or the shareholders have put up more capital and they have been willing to do this partly thanks to the very generous reserving policies of German companies. This may not be the situation for much longer. Thanks to a change in the tax situation, excess reserves will be run down and, as shareholders become more assertive of their rights, the reinsuring company may find it more difficult to take on a rescue mission purely for the good of the market as a whole.
While western economies remain buoyant, there is probably enough cushion for the sleeping losses of the last few years (so eloquently described by Chris Hitchings of Commerzbank as the oh, **** factor in underwriting) to emerge without doing great damage to the fabric of the market, although it is hard not to forecast some changes.
The need to deal with constant changes and balance competing interest is going to continue to test senior management, particularly since some of the material has certain intractable needs, like sleep. Who will come out on top?
In this issue
In this issue of Global Reinsurance, we concentrate on Europe and look at its diversity from Dublin's first securitisation deal and the London market's ambitious re-engineering project moving east across France, Germany, Switzerland and Scandinavia to Poland, the Baltic and developing markets in Eastern Europe. We also report on European and Asian captive domiciles.
As an international publication serving a global industry, we are this year carrying a selection of article in German as a pilot project. In this edition, we cover the implications of research and developments in genetics for life and non-life industries and a review of run-off issues with a spotlight on Germany. Among topics we have planned for future editions are European catastrophes and agricultural reinsurance. If successful, we hope to extend our coverage to other subjects and other languages, such as French and Spanish. We would appreciate comments on this project.
We talk to the chairman elect of the UK risk management association AIRMIC, Alan Fleming on the eve of the association's annual conference in Birmingham. We look at aspects of the growing ART market, such as weather products and catastrophe bond triggers, and consider the effect of contraction in the retrocession market and future of run-off.
Our aim is to reflect something of the universe of opportunities and issues that management in the industry has today.