Geneva Association’s Fitzpatrick on Systemic Risks, Nat Cats, ILS, Cyber Risks

When the Geneva Association’s presentation on how and why governments and re/insurers need to work more closely adjourned, we were able to talk to the organization’s Secretary General, John Fitzpatrick, a former CFO of Swiss Re and currently a non-executive director of AIG.

He has introduced a number of initiatives designed to make the re/insurance industry more relevant to today’s realities – initiatives that closely parallel the views frequently expressed by its new Chairman, XL Group’s CEO Mike McGavick.

The GA concentrates on research, but it has expanded its influence beyond academic boundaries, staking out a role where it can have a broader influence on matters of vital importance to the re/insurance industry. “We continue to have as our objective to take this research and make it more visible and influential in the world,” Fitzpatrick said.

Systemic Risks
At present the GA’s primary focus relates to “the area of financial stability in insurance, specifically the issue of systemic risk in insurance,” he continued. The Financial Stability Board has named “28 global systemically important banks, and their intent is to also name so-called globally systemically important insurers.” As a result the GA has published “a significant amount of research in this area, to make sure that policy makers have a good understanding of insurance and its link and its support for the financial markets and into the real economy – its support for people after events – insured events.”

The research examines both the “conceptual and the mathematical” sides of the issue, Fitzpatrick explained. He pointed out that after the financial crisis hit in 2008, “most observers were considering insurance companies to be just another financial institution, like a bank.” In the intervening years, however, “policy makers have understood that there are significant differences, and that insurers, while they may have some limited amount of systemic risk, they don’t have as much systemic risk as banks.”

While the world’s economies need strong and well capitalized banks, the insurance industry doesn’t really create a lot of systemic risks when it issues “auto insurance policies, or homeowners’ insurance or commercial insurance; or in fact even reinsurance.” The IAIS [International Association of Insurance Supervisors] “concluded as much last July.”

The issue of systemic risks in the insurance industry is concentrated in business “that is non-traditional or non-insurance,” Fitzpatrick said. If such business has a “potential systemically risky activity in it [for example dealing in derivative transactions], then the policy makers want to set the capital requirements high enough, such that it will shrink that [risk] and contribute to a more stable financial world.”

The Global Stability Board is expected to announce which insurance companies come within the parameters of having systemic risks in July. When that’s announced the discussions will move on to determine “the consequences of being named.”

Climate Related Risks
Risks related to climate and the role of the insurance industry is the second main area in which the GA has conducted studies and released reports. The main concern is on “the risks of large events occurring because the climate is changing;” however, the studies also include earthquakes. They have looked at both insured and relatively uninsured economies, an area which was the subject of a detailed UN report presented at the conference.

The reports have conclusively determined that additional insurance coverage in conjunction, and more or less dependent on, measures to implement catastrophic risk reduction would mitigate the economic effects natural disasters create in poorer countries. The economic and social effects – political upheavals, lawlessness and government breakdowns – frequently follow in the aftermath of a severe natural disaster.

It is an area where, in cooperation with governments, “insurance can contribute dramatically to making the world more stable, when it comes to these large insured events,” Fitzpatrick said. “And the way it can be done is through collaboration with governments to figure out which actions could be taken that would protect areas or mitigate damage from floods, from hurricanes and from earthquakes – the three big events that occur.”

When such an event does happen, putting in place pre-event measures can “reduce the amount of loss for individuals and reduce the amount of loss for governments, because in the end the governments tend to have to pick up the cost of infrastructure and other uninsured losses that occur in these events.”

While taking pre-event measures is obviously a good idea – and one the insurance industry has knowledge of and would support – the devil as usual is in the details – in this case getting governments to begin implementing those measures. “There are very few governments that are even today fully recovered from the [financial] crash that occurred in 2008,” Fitzpatrick said. “Many governments are operating in deficit positions, and are struggling with recipes for austerity for their countries, whether it is in Greece, Italy Spain and many other places in Europe or in America, where austerity is just getting underway in terms of the federal government with the ‘sequester.’

“In an environment of austerity there isn’t a lot of extra money around for a project that protects you against a risk that happens only once every 20 years, 30 years or 100 years. So, people believe that they are being economically rational to deal with the ‘here and now.’

“The politicians also have – and they acknowledge – that the term of their service in office in most democracies is relatively short – 4 years, maybe 8 years over a period of time – but that does not really allow them to address these very, very long [term] issues.”

Fitzpatrick then noted the suggestion that countries – like banks and re/insurers – might profit from having a chief risk office [CRO]. There is “intense interest in every bank having a chief risk officer, which they do,” he said – “of every insurance company having a chief risk officer, which they have had for a long time, and every reinsurer of course has had a chief risk officer for a very long time.” Therefore “governments should have a chief risk officer as well.”

While at this stage the idea of governments having a CRO seems a bit far-fetched, Fitzpatrick is fairly certain that it will eventually begin to happen, “because it’s needed, and I think that that is a full time job for every government or country that’s out there.”

As an example he cited the ongoing debate in the UK on flood protection, which involves determining “what is insurable and what isn’t.” In that situation a CRO “would be a very helpful person in helping to determine what the trade-offs ought to be between the immediate needs of the fiscal position of the government and the long-term costs that could be many multiples of that if they don’t take actions to protect against these large losses.”

The GA believes that CRO’s acting on behalf of governments would be more than simply helpful, but, Fitzpatrick said, it is “essential. In 10 or 15 years from now we believe that people will look back and conclude that that position has always been essential, and needed to be put in place around the world.”

Insurance Linked Securities (ILS)
Fitzpatrick’s experience with ILS goes back a long way. They’ve been developing over “the past 15 or 18 years,” he said, but “it’s picked up speed in recent times because of low interest rates.” He also noted that in addition to a “good rate of return,” they – mainly cat bonds – have a fairly “good track record. Investors look at that track record and note that not only did it earn a good rate of return relative to bonds or equities, but it was not correlated to interest rates or the stock market or credit.”

This has led to increased investments in ILS instruments by pension funds. It has also acted as a stabilizing factor in the costs for ILS investments. “Prices in the business have stayed fairly stable for the real economy, despite the fact that 2011 was a record year for catastrophic loss,” he said. This situation is in contrast to past years when following big cat losses “prices would go up dramatically, and that has not happened to quite the same extent that, for example in 2005, after hurricanes Katrina, Rita, Wilma, and in 1992 after hurricane Andrew.”

Times have also changed. Fitzpatrick said: “In today’s environment there’s less need for entire insurance or reinsurance companies to be created, but there has been a need for capital to be available to absorb the large catastrophic losses like we had in 2011. What’s happening in the industry now is that capital is coming in through those forms [ILS], rather than new companies being created, for example in Bermuda.”

Cyber Risk
Fitzpatrick explained that his presence in London is also necessary as the GA is holding the “largest gathering of insurance and reinsurance CEO’s in the world [approximately 80].” It will also feature presentations, notably a panel on cyber security and risks, which discusses “the developments of what is occurring in the world, both in terms of the risk and also in terms of how can the insurance industry help protect people from the risks of cyber activity, whether you describe it as a crime or as a terrorist act, it’s still the same effect on a corporation or an institution or an individual.

“It’s a very difficult risk, but I’m sure in the 1600’s after the London fire people were struggling with how do you deal with? how do you insure? buildings in a city that can burn to the ground from one match at one end of the city?” There were similar concerns across Europe and eventually in the U.S., especially after the fire that destroyed a large part of Chicago.

“There’s no doubt that it [covering cyber risks] will require some ingenuity and some innovation by the insurance industry to be able to tackle the risks of these types of attacks, cyber-attacks,” Fitzpatrick said. The GA will undoubtedly play a role in finding some of those innovative solutions.

Topics Cyber Catastrophe Carriers Reinsurance Market