As European players face a punishing schedule of rule changes, the trick will be for regulators to keep reinsurers focused on the main plan – protecting clients
The chief financial officers and chief risk officers of insurance companies are challenged by multiple stakeholders with differing concerns. This is creating an environment where compliance, regulation and rules are changing the way insurers do business for customers. European (re)insurers in particular face daunting expectations over the next few years:
• significant changes in accounting standards under the forthcoming phase two of International Financial Reporting Standards for insurance (IFRS 4);
• differences in how risk capital is measured and expectations around risk governance with the upcoming Solvency II regime; and
• the evolution of criteria and expectations from rating agencies, especially over enterprise risk management (ERM) and economic capital modelling (ECM).
The demand for accounting, actuarial and risk management expertise to help managers navigate these challenges is extensive.
It is true that the purpose of such standards is to foster an environment where the interests of policyholders, creditors and investors are the priority and, in turn, aligned with managers’ behaviour. Without guidelines and standards, there is a risk that the quality of products or services produced by an industry will fall to unsafe levels.
But regulation is only as relevant as the effort put in and its assessment by the regulators. There is likely to be a point at which the underpinnings of regulation begin to run contrary to their intent, inhibiting the creation of products or services or making the cost of production too expensive.
Extensive changes to insurance accounting and disclosure were proposed in the latter half of 2010. These include new methods to calculate insurance liabilities, assets and related revenue and earnings. In addition, statements of financial position and profit and loss will be structured in dramatically different ways than the industry is accustomed to. Ultimately, the changes inspire a more consistent and transparent understanding of insurance accounting.
However, (re)insurers will need to think of the risk and cost of insurance in different ways, which may make insurance more expensive to the buyer in some cases or less available in others.
The Solvency II regime addresses risk capital, risk governance and risk disclosure, setting out extensive standards and expectations for each, including documentation, testing and validation and controls. To address these requirements, both (re)insurers and regulators have had to employ additional accountants, actuaries and other risk specialists.
Accountancy firms and risk consultants have in a sense created an industry around advisory services relating to regulatory, compliance and governance standards.
All of this adds cost to the insurance risk transfer and risk management process.
Rating agency criteria
The ratings and related rationales provided by rating agencies provide signals to the market of the ongoing financial strength of (re)insurers. Those without a favourable rating are often put at a disadvantage.
Yet the criteria for rating conclusions are extensive. Standard & Poor’s and AM Best have raised the bar with their focus on ERM in the ratings process. In January, Standard & Poor’s introduced ECM review criteria that resemble Solvency II capital review requirements. These include standards the market may not currently be able to meet.
Meanwhile, AM Best is expanding its supplemental ratings questionnaire to include a full ERM section enquiring about risk governance, tolerances and risk modelling. Rated (re)insurers must be prepared to put resources into their ERM frameworks and raise awareness in many areas and in extensive ways.
Today’s financial and insurance markets and their risks are more complex than ever. Concerns over issues such as climate change and political unrest create a lot of unknowns that some industries may wish to avoid.
Recent catastrophes in Japan, Chile, New Zealand and Haiti are just a small sample of extreme events that show that insurance is needed to transfer risk to institutions with the capacity to assume those risks. That can only happen when (re)insurers believe the cost of regulation and compliance is not too high and the price for the risk is reasonable.
The rule-makers face a difficult mandate. They must make sure their requirements and criteria set meaningful standards while making them achievable. Otherwise managers may spend most of their time complying with standards rather than executing effective strategy and decision making, and providing the necessary risk transfer products and services to the market that the rule-makers are trying to protect. GR
Christopher Myers is global head of ERM at Aon Benfield Analytics