06 January 2009
Published in: Corporate strategy, Risk governance, Insurance risk, Investment risk
The risks multiply for insurers in 2009
The fall-out from the banking crisis could ensnare the insurance industry this year -- unless it rises to the challenges highlighted by the experts below. Jessica Baylis reports.
Prepare for a rough ride through 2009. If people in the industry are right, it looks like insurance, having been on the periphery of the financial market turmoil last year, will be dragged into the mess this year. So expect an impact on everything from insurers' balance sheets to their reputations.
"One of the biggest single risks for 2009 is the changing risk profile of the insurance industry," says Tony Blunden, director and head of consulting at Chase Cooper. This is partly as a result of the credit crunch and partly because of the increased impetus of Solvency II. "There will be a shift from focusing primarily on underwriting risks to a more balanced holistic view of a firm's risk profile which will include further consideration of the non-financial risks."
Don't focus too much on the short-term
Top of the list of risks in 2009 for Marc Beckers, Head of Aon Re Services UK & EMEA at Aon Benfield, is too much focus on short-term earnings. In a downturn, he explains, "Companies will want to reduce expenses to meet earnings forecasts. They should, however, be looking to spend what is needed to survive and what is needed to protect their capital base as long as it makes economic sense."
He adds, "Economic value creation should be favoured over earnings preservation. Most companies did not buy more reinsurance protection for 2009 out of earnings considerations and this is a mistake in my opinion."
Being too focused on the short term is something Blunden also stresses as a risk in 2009. For Blunden, however, this is as much a risk for human resources as it is for the balance sheets. "There is a human resources risk in a recession, which is that as firms retrench staff, they need to keep the staff who have the corporate memory.
"During downturns, people remove staff that, with a bit of forethought, they should be keeping. There will be an upturn, and then you will need the people who have been there and done that. Keep an eye on long term."
Understand and implement ERM
Management will be key in 2009 for Beckers as well. He sees the failure to understand and implement enterprise risk management, ERM, as a key risk. "Most insurers are now aware of ERM and have either established a risk department or have appointed a risk manager," he says. "However, this is not sufficient for implementing ERM as can be seen from the number of companies that obtain an adequate rating from Standard & Poor's. And even those that are strong seem to struggle with what it means."
In a similar vein, Blunden highlights poor communication as a big risk factor in 2009. Referring to the report issued by the Senior Supervisors Group in March 2008, Observations on Risk Management Practices during the Recent Market Turbulence, he notes, "It was interesting that the report showed that those that were better at sharing information fared better than those that didn't.
"It's extraordinary how many firms recognise communication as a risk but actually then say they don't have much to control that risk. Communication is entirely within the management ambit to control. This applies to communication with stakeholders, with staff, or with the investors; all will be vital in a downturn."
Why will this be particularly relevant in 2009? "Whether you have good communication or not depends on the underlying culture of the firm, and that is emphasised during a downturn."
Repair balance sheets
On insurance risk, Watson Wyatt's Philip Brook, global head of insurance consulting, says, "Insurers' balance sheets have been significantly weakened. For most companies we can expect less expansionist activity while management looks inward and takes action to repair some of the damage."
For analyst, Vasilis Katsipis, general manager at AM Best, the big insurance risks this year will be on the asset side of the balance sheet, just like in 2008. "The decline in asset values has impacted both the life and non-life market," he says.
"On the life side, we are expecting the decline in products like unit-linked for most of next year. That is likely to mean that any growth opportunities that life insurers have will be on more capital-consuming products. But it is not a time that they can do this because of the depressed capital positions."
Mark Chaplin, global head of risk and value consulting services for insurers at Watson Wyatt, agrees that capital constraints will affect strategies, "Insurers will seek to repair or strengthen balance sheets through risk reduction/hedging and releasing or raising capital. However, continued capital constraints on banks and a widespread aversion to counterparty risk will necessitate the development of innovative solutions and require close attention to understanding the residual risks."
On the non-life side, Katsipis continues, "Investment losses are creating a very interesting scenario." There will be an increasing demand for reinsurance, he explains, but at the same time, reinsurers will be scaling back, "There will therefore be a slightly reduced supply but increased demand. We will see reinsurance rates, if not going up, then at least remaining stable."
Capital pressures
Indeed, a report released on January 1 by Willis Re found that primary insurers are facing capital pressures and therefore are increasing their demand for reinsurance. Chief executive, Peter Hearn, says, "Reinsurers, while not currently impaired, have recognized that in the current financial market climate, obtaining new post-event capital will be both difficult and expensive. As a result, reinsurers are seeking to optimize returns on existing capital bases via constrained risk appetites and elevated risk charges."
For Katsipis, the next few months will differentiate the different investment strategies used in 2008: "For a lot of insurers who have had a more aggressive investment strategy, we are already seeing that they are holding on to assets that have value according to their models but which are not realisable in the short term. So we could be seeing some companies having significant liquidity problems."
A recession produces opportunities for some, however, "2009 might turn out to be a very good year for those insurers with relatively strong balance sheets and access to capital who are able to take advantage of current market conditions and acquire distressed companies at low prices," says Watson Wyatt's Brook.
Be cautious on acquisitions and growth
Martin Pike, European head of insurance consulting at the firm, agrees that weak balance sheets will allow opportunities for stronger insurers but warns, "acquisitions and growth strategies will need to be judged carefully against a well-articulated risk appetite."
And will we see many casualties this year? "It depends what you mean by casualties," says Katsipis. "If you are talking about insurers that will be going into run-off, I don't think so. If you're talking about companies that will have to re-examine their business model and adopt something that, until recently, was considered drastic then yes, I think there will be."
Reputation risk is a concern highlighted by several in the industry including Ron Hayes, head of the global risk solutions division at brokers and consultants, JLT. He says, "One of the risks will be around reputation and the confidence of clients in their insurers. As the security of a number of insurers is downgraded, there is definitely a confidence issue. The treasury and finance function within clients are reviewing the amount of capacity that they are prepared to accept with an insurer, with the analysis linked closely to their internal counterparty credit limits."
This, he believes, will have interesting implications for the style of placements in 2009. "There will be a move away from the trend of the last 10 years which has seen a small number of insurers taking 100 per cent of a layer, or offering large capacity with clients wishing to spread their risk. Instead I believe that we will begin to see the shape of programme structures change where more insurers are used on a placement, with clients utilising their capacity vertically on a placement (quota share) rather than in large blocks horizontally."
Three issues to watch in 2009
Elliot Varnell, head of insurance for Europe, Middle East & Africa at Barrie and Hibbert in London, highlights three areas likely to provoke debate within the industry this year.
The French pensions conundrum
Pensions in France are traditionally held in life insurance wrappers so unlike the rest of Europe, French pensions will be subject to Solvency II and the solvency capital requirement (SCR).
The French could argue that there is not a level playing field for pensions as the UK and Germany, for example, will not have their schemes subject to Solvency II. This could make it more expensive [for France] to offer the same perceived level of pension benefits without increasing the contribution rates.
This point doesn't seem to have been debated widely yet and instead appears to have been played out through a financial economics debate over whether or not equity markets mean-revert.
Marketing of guaranteed products
There is likely to be a need for guaranteed products so how they are communicated through brokers and to individual customers will be important. In the UK we tend to communicate products using three deterministic scenarios and sell products under those very limited scenarios.
When you're talking about very simple products, that's fine. But with a lot of complicated products, until you actually do a multi-period stochastic analysis of them, it's very difficult to really appreciate the downside risk and indeed the full nature of the upside benefit too.
You don't want to find that your money wasn't guaranteed after all because the eventuality that the investment bank providing the guarantee goes bust wasn't considered in the scenarios.
Progress of Solvency II
The FSA and a lot of the regulators are now starting to engage with companies on their internal models. In the UK firms are having to make decisions as to whether or not they will use an internal model by June 2009. And the German regulator BaFin is also discussing internal models with its industry.
It will be very interesting to see what sort of process the regulators are going to put into place and what sort of hoops firms will have to have to jump through to get their model validated. Once companies see what is going to be required for getting internal model approval, how many are going to just use the standard model?
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