The theme of the European Insurance Forum 2003 was 'insurance markets in turmoil'.
This year's European Insurance Forum generated lively debate on the major challenges confronting the market today. Under the heading "Insurance markets in turmoil: what does the future hold?"the event heard a wide range of often contrary views on how insurers and reinsurers can overcome the toughest market conditions in decades.
Insurers worried that tougher regulation was stifling entrepreneurial flair and driving up costs; regulators raised concerns that insurers and brokers were unprepared for the challenges to come; risk managers aired a lack of confidence in the industry; and intermediaries warned that assets were in meltdown. All agreed the industry would be transformed over the next few years in the face of mounting uncertainty on a range of issues and a global retreat from risk.
Undoubtedly the main theme to emerge from the Forum was the challenge of insurance regulation. The insurance sector's response was broadly pessimistic. The reality of globalisation is causing major problems for insurers and regulators as risk traverses national boundaries. Factors such as corporate failures in the US and Europe and the increasing incidence of major catastrophes are driving an unprecedented pace of change in a hitherto lightly regulated sector. The European Insurance Intermediation Directive and Sarbanes-Oxley, the implications of which extend far beyond the borders of the US, will result in fundamental changes in accounting for life and non-life companies. Some jurisdictions are moving faster than others. The UK, for example, is significantly more advanced than the EU in the regulation of insurers.
In the US, meanwhile, as Mike Pickens of the National Association of Insurance Commissioners (NAIC) explained, different state regulators are required to work more closely than ever before and a single federal regulator is now being considered. Pickens argued that a one-size-fits-all mentality would be counter-productive, as different states with different problems (for example, hurricane risks in one state, earthquakes in another) require different solutions.
The conference heard that regulatory change would be fast and furious, and insurers expressed concern about being caught off-guard. Regulators will be looking to insurance company directors to take on more responsibility for their fiscal obligations. Regulation of brokers is also a big issue. The objectives of the European Insurance Intermediation Directive, issued in October 2002 for implementation by January 2005, are to maintain confidence in financial markets and reduce financial crime. The UK is now deep in financial papers on this topic. CP159, CP160 and CP174 are all weighty documents coming in at 200 pages or more. Alan Punter, the CEO of Aon Capital Markets, warned: "Some brokers are going to have a bit of a shock. The path to ultimate convergence will not be steady."
Meanwhile the age-old issue of tax continues to bubble away as companies depart the US to re-register in Bermuda. Eyebrows were inevitably raised at the recent example of a US corporation with 240,000 employees that opened a Bermudian office with two employees and thereby avoided paying 35% tax. The new model is for a US corporation to set up a captive in Dublin, an office in London for its international insurance centre, supported by a call centre in India. The era of globalisation is well and truly upon us. Consequently a number of market participants are calling for an international approach to regulatory and accounting issues.
Although recent corporate scandals have provoked calls for reform, there are many in the industry who fear heavy handed regulation will significantly reduce the ability of companies to generate future profits in a risk-averse era. Brian Duperreault, the chairman and CEO of ACE Group, warned delegates that US regulatory reform would stifle "entrepreneurial spirit"as power moved from an "incentivised"management to "inherently risk-averse"board members.
At the other end of the spectrum, some delegates pointed to senior management failures as a major cause of the industry's current turmoil. David Wharrier, a director at Fitch Ratings, said: "Causes of failure are under-pricing and under-reserving. There is no one single reason; but it all comes down to management."
On the positive side, Mr Wharrier noted that the sector was starting to see some better quality management. However, he said it was frustrating to hear that "no one was surprised"by the failure of UK insurer Independent. Various market practitioners had "vital information"and "it is individual policyholders who suffer as a result."Better communication was needed between underwriters, brokers, and ratings companies, who should all be prepared to share information and work more closely together.
Nick Eddery-Joel, a director of Axiom Claims Consulting, agreed: "The overall message is that we need to manage our way through the current crisis."The key causes of insolvencies were "management failure and incompetence, an inability to do the job, lack of integrity, excessive appetite for risk, and lack of autonomy from a parent company."Senior personnel should possess a full range of key skills and continue enhancing those skills. Performance-related remuneration could play an important role and bonuses should not cloud underwriting judgment.
The importance of good management also featured prominently in discussions on achieving effective corporate governance. According to James Grennan, a partner at A&L Goodbody: "Corporate governance is the new black."Mr Grennan said he believed insurance regulation was taking a new direction, moving away from its traditional straightforward focus on capital adequacy. The risks facing an organisation today could include operational risks, legal risks, regulatory risks and damage to reputation or brand. An example of regulatory risk was the pensions mis-selling scandal in the UK. "Good managers have never been so important," he said.
Recent events have clearly illustrated that the adequacy of internal structures is a vital factor in allowing companies to report a clean bill of health. Regulators in different jurisdictions are focusing on different areas. For example, the Sharma Report, focuses on capital adequacy while the Krahnen Report, in Germany, looks at insurance companies' exposures to risks that are greater than they appreciate. There is a renewed emphasis on assessing the adequacy of the internal controls that companies use to anticipate and control problems as corporate governance exposures arise in unfamiliar contexts.
The Barings Bank debacle was an obvious example of corporate governance going horribly wrong. Guest speaker Nick Leeson, the infamous rogue trader portrayed on the big screen by Ewan McGregor, quipped: "I'm the only person who writes a cheque and the bank bounces."Leeson went on to note widespread and unreported incompetence leading up to the Barings fiasco - something, he suggested, that may still persist in other similarly respected organisations. More ominously, findings from a 1995 survey of risk managers found that rogue traders were third on the list of biggest fears - whereas in 2001 rogue traders were relegated to 24th on the list. How easy it is to forget.
Looking ahead, however, the Sarbanes-Oxley Act is emblematic of a new era of corporate governance in the US. Some believe the act will have little discernable effect. Others believe it is the most powerful legislative act passed since the 1930s Securities Act. Joe Monteleone, vice president of Hartford Financial Products, is in no doubt: "We are definitely in a new era. The act has swung the pendulum back the other way. Sarbanes is clearly investor-oriented, giving regulators such as the SEC and the self-regulatory bodies more power to enforce good corporate governance procedures."
The implementation of the right technology can reduce risk and help manage the corporate governance and internal controls issues facing insurers today. According to Jan Gonnissen, global solutions director at SunSystems, insurers can make their lives easier by automating compliance processes and ensuring that CFOs become more effective strategic players. The answers lie in "the technical accuracy of real-time data, and insurers need scalability so that organisations can be managed effectively as they grow."
The issues thrown up by globalisation will lead the insurance sector to develop pan-national approaches to challenges such as insolvency. Focusing on new capital adequacy proposals laid out in Solvency II, Aidan Cassells, the executive director of AXA Ireland, commented: "Work is going on towards developing international accounting standards. We need to develop a more common system and extend any review to encompass management risk, key financial risks and key operational risks."
Solvency II will pose a major challenge for regulators. There has been a huge change in the external environment, and the present system does not cater for a wide range of risks, which is why Solvency II is on the agenda. In Cassells' words, Solvency II should "be simple, transparent and effective." However, he warned: "We don't want to take it too far in case regulators start doing companies' jobs for them. Let managers do what they're paid to do, which is to manage."
The other major theme of the forum was the threat of asset depletion and disappearing capacity in the insurance business. Capital surpluses are very much a thing of the past and insurance companies are getting used to a new environment in which premium income has dried up. About $250bn has left the market and only $30bn has entered it. And, according to Dennis Mahoney, the chairman and CEO of Aon UK: "Future prospects are worse."
A wide range of potentially devastating liabilities could cause even more sleepless nights for CEOs around the world. With many insurers and reinsurers now looking under-reserved, cigarette-related diseases, magnetic fields, stress in the workplace, and cyberexposure could have a major impact on balance sheets.
Following September 11, insurers are also trying to come to terms with the US Terrorism Risk Insurance Act 2002, which provides up to $100bn catastrophe coverage against terrorist attack on US soil. Fears have been expressed that there is insufficient income in the market to cover exposures.
Other more or less familiar headaches for insurers include asbestos, fraud, tort reform of medical malpractice and mounting concern over the excesses of the civil justice system. One solution suggested for medmal claims was a liability cap of $250,000 for 'pain and suffering' damages, and there were calls for the US government to intervene in the asbestos fraud crisis.
Delegates expected continued rate increases, at least for property business, and a further tightening of terms and conditions. Risk management will therefore assume an increasingly important role. According to Schlumberger corporate risk and insurance manager Chris Lajtha, risk management tools would be essential in "saving the industry", while brokers would be important providers of "quantitative and qualitative advice".
Looking to the ART sector, Ian Clancy, the managing director of Marsh Management Services (Dublin), commented: "If ART is not a success now it never will be."The biggest growth area is the credit side. However, this has recently been the focus of scrutiny from the regulators following the transfer of bad risks from the banks to the insurance market. The overall impression is that activity has been tailing off and there has been a retrenchment in the issuance of catastrophe bonds.Some reinsurers have focused on the traditional market at the expense of ART, reducing their activities in this sector. This move back to traditional markets is the precise obverse of what some pundits predicted. It appears that the $30bn of capital entering the insurance market has gone into traditional deals. However, there has been a moderately regular flow of catastrophe bonds issued over the past 12 months.
The theme of this year's forum was that the insurance market is in turmoil. The exchange of views between insurance carriers, intermediaries, risk managers and regulators certainly supported this view. In the long term we can expect more risk retention, more group captives and more industry-wide pools. Brokers will need to work hard to manage clients' expectations more effectively. And regulatory issues across Europe and the US are causing major headaches. Different jurisdictions will need to work closely with one another - and with the insurance community - to establish a common framework that works effectively without imposing over-burdensome costs and hindering underwriting creativity.
By Chris Don
Chris Don is a director at insurance-specialist marketing company Signum Marketing Communications and a specialist writer on re/insurance issues.