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For the insurance industry, global controversies tend to obscure some equally important debates going on in smaller forums around the globe. The principal controversy in the U.S. revolves around state vs. federal regulation of the industry, which poses fundamental questions. Should there be a national insurance charter? Would this preclude state regulation of the industry? Should the federal government regulate class actions, medical malpractice awards, workers’ compensation, etc.?
While the U.S. debate has been a fact of life since the founding of the Republic, a similar, though more recent, discussion of the same problem has been taking place on the old Continent. The European Union after all only goes back to the ’50s; so the idea of imposing E.U. wide regulations on financial services and insurance is a relatively new, and not altogether popular, idea. The E.U. also faces an internal dilemma. The bigger it gets the more it needs harmonization of the rules affecting cross border transactions. However, as it grows, it’s gotten harder and harder to achieve that end. Last year’s rejection of a proposed E.U. Constitution by French and Dutch voters was the most high profile setback.
Nevertheless Europe soldiers on, and, while the big controversies get most of the press coverage, the insurance industry goes on about its business as well. Most of the E.U.’s major insurers (Aviva, AXA, Allianz, Generali) and reinsurers (Swiss Re, Munich Re, Hannover Re and SCOR) made good profits in the first quarter of 2006. They’re approaching the rest of the year with confidence–at least until the hurricane season starts.
So when A.M. Best Co. convened a panel to discuss the current state of the European insurance market in Paris in May, the outlook was generally optimistic. The wide ranging mid-year review covered the French market in depth. Similar revues in Cologne and London emphasized the German and U.K. markets. But all the discussions included a general review of where European insurers are with regard to earnings, ratings, premiums, reserves, compliance with Solvency II and other industry loadstones. It was a snapshot of the present that included both the past and the future.
Booming French life market; PL concerns
In France, Best’s analyst Vasilis Katsipis described a booming life market–the fourth largest in the world–that increasingly sells “unit linked” policies (returns are tied to investments) and is moving away from guaranteed returns, which are still a large majority. His P/C counterpart, Michael Zboron pointed to “significant growth from 2002 to 2004,” which “is now leveling out after strong rate increases.”
French P/C companies share the same concerns as their contemporaries in Europe, the U.S., Japan and elsewhere. Will the premium increases cover the underwriting losses? Will higher compensation awards further reduce profits? Will competition from direct writers, mutuals and banks cut into their business?
Most of the concern centers on personal lines–automobile coverage and homeowners. Zboron pointed out that the 10 largest French mutuals control around a third of the personal lines market, but they write 55 percent of the auto coverage. “Tied” or captive, agents write around 35 percent–including some of the mutual business–while brokers account for 18 percent and banks for 8 percent.
He also noted the decreasing accident rates on French roads following a government campaign to reduce speeding and dangerous driving. However, Zboron indicated that “despite lower claims frequency, motor liability remains unprofitable as higher court awards from bodily injury claims have offset this positive development.” Claims inflation and its counterpart, the “compensation culture,” as it’s called in the U.K., continue to erode profits. This has resulted in the need for most carriers to increase loss reserves and has raised combined ratios well over 90 percent.
However, one should not draw the conclusion that damage awards in Europe are going to eventually equal those in the U.S. Social services and medical coverage are standard in the E.U. This significantly decreases the actual losses any given accident victim suffers. Damages for pain and suffering are much lower than in the U.S., while punitive damages and lawyers’ contingent fees (except in the U.K.) are forbidden. The French government is currently considering the introduction of a “set scale” for bodily injuries to reduce divergence between awards for the same injury.
Banks pose little threat
In France, as elsewhere, the threat bancassurance actually poses for P/C insurers is somewhat ambiguous. Walk into any French bank and there are dozens of brochures touting all kinds of coverages and investment products. But, as a number of analysts have pointed out, banks don’t like the types of risks inherent in P/C coverage, so, while a bank will gladly sell insurance as part of an auto loan, it doesn’t assume the risk. That’s transferred, frequently through a broker, to a P/C insurer.
The arrangement benefits everybody. Banks are always more willing to lend money to people who don’t need it rather than to those who do, so their loan customers are usually better credit risks, and perhaps better insurance risks as well. They in turn benefit from one-stop shopping and premium volume discounts. The banks don’t have to set up and run an insurance subsidiary–including the claims department. The broker gets a commission (as does the bank). At least in this context bancassurance poses no threat.
A rather unique institution, France’s Caisse Centrale de Reassurance (CCR), is an example of how one government handles the economic losses caused by natural catastrophes. “CCR is a state-owned reinsurance company that provides reinsurance cover to primary insurance companies for natural perils such as floods, landslides, wave-driven floods and hurricanes, both in France and French overseas territories,” said a Best Special Report. Carriers are required to insure against those perils. But in exchange they receive what Best describes as “a unique ‘two-fold cover.’ The first cover provides a 50 percent quota share to its cedents while an unlimited stop-loss agreement protects the primary insurer’s net retention.” CCR has returned some $1.95 billion in profits to the French government.
Accounting standards
If U.S. businesses worry about Sarbanes-Oxley, especially since it’s apparently going to be applied to smaller companies, E.U. insurers worry about the impact of Solvency II, which is somewhat analogous.
Solvency II mandates new accounting standards and its impact will also fall more heavily on smaller companies. Fady Khayatt from consultants Mercer, Oliver, Wyman gave a coherent revue of the subject at Best’s session.
He pointed out that the current rules, designed primarily to protect policyholders, aren’t all that effective, as they basically rely on the amount of capital a company has, but don’t “reflect the level of risk” the company may carry. “Solvency II is designed to align capital requirements with risk,” Khayatt said. In order to achieve that goal it’s necessary to “improve risk management capabilities.” The ultimate goal is to create a level playing field and assure transparency.
That’s proving harder than the E.U. may have imagined when it began formulating Solvency II. Fresh from is success with Basel II, which defined accounting procedures for banks, it seems to have underestimated the complexities involving “risk” in the insurance industry.
“Insurance turns out to be more wide reaching with bigger and more varied risks,” Khayatt continued. Even though the deadline to formally apply the new rules has now been extended to 2010, Khayatt said working on becoming fully compliant should be an immediate priority.
Same issues everywhere
Most of the other trends and concerns discussed at Best’s E.U. conference could just as easily be heard elsewhere. These included the impact of new Bermuda companies; improving capital positions leading to higher retentions; the reduction in retrocession capacity when Swiss Re absorbs GE Solutions; higher layers for catastrophe cover; the continued need for underwriting discipline; setting the proper pricing/premium levels; the need for better cat models, and inevitably the upcoming hurricane season. Turns out it’s a small world after all.