05 January 2010

Published in: Corporate strategy, Capital - models, Risk governance, Insurance risk, Investment risk, Market risks, Catastrophe - weather, Software, Regulation - supervision

2010 will bring many challenges, warn risk experts

Among them: increasing regulatory burdens, a talent shortage, investment dilemmas and looming inflation. Our panel of industry soothsayers spell out their concerns.

Ed Easop, vice president, rating criteria and rating relations, A M Best

There is growing concern across the industry that there may not be a sufficient supply of trained and talented professionals to meet the growing demand for risk management skills. The demand is coming from regulators, insurers, consultants, software firms, investment firms, capital markets participants and rating agencies. In the coming years, this could impede real progress on the risk management front, and/or create an uneven playing field for those companies that are unable to obtain the professional skills needed to compete.

Andrew Harley, director, EMB

The hardest challenge facing risk management professionals is to embed a risk awareness culture within businesses as envisaged by Solvency II. Risk management is not a job for a few people within an organization; everyone has to understand how they contribute to risk so that they take appropriate levels of risk. The difficulty is that this involves an interconnected web of actions, for example, education, multi-layered communication and remuneration structures that reward the right kind of risk-taking.

Chris Waterman, managing director, insurance, Fitch Ratings

The increased burden of regulation will be the biggest challenge. It is likely that insurers will be subject to far greater regulatory oversight as a result of regulators responding to criticism of their supervision of the banking sector. Not only should insurers expect an increase in reporting requirements, but capital requirements are also expected to increase as higher capital charges are applied to investment risks.

In addition, the challenges posed by Solvency II are likely to be some of the most significant faced by current management teams during their careers.

Vicky Kubitscheck, partner, Independent Audit

"Making risk management real" for those who are expected to be accountable, i.e. the board of directors and executive management, will be the biggest challenge as they "operationalize" the requirements of Solvency II in an evolving regulatory environment.

For example, the financial services authority in the UK is already adopting a more intrusive approach to supervision in light of the events of 2009 while raising the standards of risk governance well ahead of the timescales required for the new Solvency II world. Most risk management professionals are technically equipped, but risk governance - which requires the technical elements to be joined up with the governance and decision-making parts of the business - is probably less well practised.

Justin Elks, associate director, risk, Just Retirement

Over the last year we have seen Solvency II move up the list of priorities for boards across the insurance industry. The challenge for risk professionals will be to seize this opportunity to add genuine value to their business.

This will involve: influencing the Solvency II debate to keep the implementation in line with the risk-based spirit of the directive; keeping a balanced focus on all three pillars, not just capital modelling; and maintaining effective risk management processes for the business during the transition to the new regime.

Elliot Varnell, principal advisor, financial services, KPMG

The scale of the changes required by Solvency II and the transformation it will bring to the business model will make Solvency II the biggest challenge. Insurers need a plan for how they are going to be profitable in a post-Solvency II world where regulators appear to be more risk-averse and regulatory standards are still evolving.

For proprietary insurers there is also the question of how they will compete for funding with the less opaque and seemingly higher returns offered by the stock of some other industry sectors. This becomes more important when one considers that Solvency II currently has a strong preference for equity funding.

Neil Cantle, principal and consulting actuary, life practice, Milliman

As the immediate threat of economic instability fades, there is a danger that the desire for improved risk management also passes. While many firms have taken some steps to improve their risk frameworks, there will inevitably be many who turn their attention to business- generation activity and other priorities.

In implementing Solvency II, the initial focus on risk management was an opportunity to ensure sufficient thought was given to the risk framework and that it added real value. As attention moves elsewhere, however, the danger is that it reverts back to being a tick-the-box exercise.

Margarita von Tautphoeus, head of solvency consulting, Munich Re

Preparing for Solvency II in both an efficient and practice-oriented manner will be the overarching challenge for the industry. In particular, firms will have to assess the impact of the fifth quantitative impact study on the solvency capital requirement and embed internal modelling approaches into the business and day-to-day functioning of the company.

Reinsurance will become a key capital and risk-management tool. The challenge for reinsurers is to be in a position to support their clients at an advanced level. They will have to constantly discuss the development of cedants' risk and capital situations to provide the best possible risk transfer solutions. They will need exceptional experience in all aspects of risk - early identification, assessment, databases and an organization and culture adapted to handling risks.

George Stylianides, risk and capital partner, PricewaterhouseCoopers

Solvency II is the single largest challenge for insurance risk professionals across Europe. It is a complex and difficult exercise to get right and companies need to ensure they have confidence in their capital models and ensure that these models add business value.

Companies need to be aware that resources are scarce and they will become scarcer as we progress through 2010 and talent gets sucked up by the industry and the regulators.

Finally, many companies are currently building or refining their capital models, connecting them to pricing engines, measuring risk-based performance and basing reward on these measures. However, risk management will only get buy-in if the end product is stable. Companies that have the required level of stability have been developing and evolving their models for years; this is not a two- or three-year exercise.

Martin Sher, managing director, SolveXia

A big challenge for companies is the need to run and maintain existing actuarial models and respond to ongoing external uncertainty while simultaneously moving the models and their infrastructure forward to meet Solvency II internal model requirements. Both are pressing and both call on the same resources.

Colin Ledlie, chief risk officer, Standard Life

Solvency II represents a massive regulatory change for the insurance industry. Ongoing uncertainty regarding the calibration and detailed requirements will make it operationally challenging to deliver, and there will remain uncertainty about the capital and strategic implications for much of 2010.

Graham Fulcher, actuary, Towers Watson

The biggest challenge for risk managers will be to free some time from Solvency II preparations to focus on the management of risk in their companies. This year has lots of potential risks: stock market volatility, uncertainties regarding economic recovery prospects, sovereign debt issues, forecasts of a return to above average hurricane activity and an uncertain path for the insurance and reinsurance market cycle.

Jacob Rosengarten, chief enterprise risk officer, XL Capital

The consequences of continued market turmoil and soft pricing (driven by economic weaknesses) will probably continue to play an important role throughout 2010. The massive amount of borrowing undertaken by major governments has raised the spectre of inflation, with all of its uncertainties. Uncertainties are also driven by regulatory reforms which are, in part, a response to economic turbulence and perceived financial abuses. A likely consequence of all of the above is that markets will undergo material transitions this year and beyond until new levels of operating equilibriums are reached.

Charl Cronje, partner, Lane Clark & Peacock

The challenge for insurers is to achieve Solvency II compliance by 2012 while keeping the implementation manageable and aligned with the goals of the business. In the short term, the most difficult part of this will be resourcing - finding people with the right skills and experience to deliver.

Gregor Pozniak, secretary general and Silvia Herms, senior advisor, Association of Mutual Insurers and Insurance Cooperatives in Europe (AMICE)

The biggest challenge this year will be preparing for Solvency II. Until now many players have preferred to concentrate on pillar I. The main effort companies will have to make will be to ensure that they also comply with the non-financial (pillar II & III) requirements: developing an appropriate system of governance is absolutely essential.

The implementation of good governance, both in terms of structure and procedure, takes time - it cannot be done within a few months. The process includes the training of employees charged with, and responsible for, key functions; it may include the hiring of staff with particular competencies and/or the identification and hiring of appropriate service providers to whom functions may be outsourced.

Peter McGloughlin, director, insurance solutions, financial markets, Lloyds Banking Group

Low interest rates may continue well into 2010. Many insurers in the non-life sector are still very short duration and uncertain in their views for global interest rates and credit markets. As such, the outlook for investment returns is low and there is still a risk of achieving 0% or worse on short-duration investment portfolios in the near term.

Investment risk will continue to be one of the major challenges this year. Although insurers who went back into corporate bonds early in 2009 have been handsomely rewarded with 20% gains in some cases, the outlook in 2010 is not clear. The Dubai debt situation has given the market a reminder that a double dip in the credit markets is a real possibility.

However, given that insurance rates have still to harden significantly, many firms will be under increasing pressure to generate investment income and may choose to become more active in deploying risk on the asset side in 2010.

The danger of rising inflation looms large in 2010. The last year has reminded us that government bonds are not risk-free and many triple-A sovereigns lie on the edge of a rating downgrade. Government borrowing has exploded, yet bond yields remain relatively low. It is unlikely this situation can continue for the longer term. In the UK, for example, quantitative easing propped up the gilt market in 2009 but risk managers must be alert to the unwinding of quantitative easing in 2010 and beyond. At least £200bn of gilts will need to find a home when the Bank of England starts to unload its positions.

While insurers can be exposed to rising inflation on the investment portfolio, they can also be particularly exposed to rising claims inflation - especially for casualty excess-of-loss and longer-tail business lines. While the life industry is well used to hedging longer-dated inflation exposure in the swap and bond markets, the non-life sector has been used to a fairly benign inflation environment and has not been that active in hedging this risk.

 

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