I.I.S. Conference Highlights Prospects/Pitfalls in a Changing World

No European City has changed as much as Berlin (with the possible exception of Dublin). Since the fall of the wall in 1989, its 3.4 million residents have experienced an unprecedented building boom, as the German government and city officials worked overtime to restore Germany’s historic capital to its former glory. The city offered a perfect venue to the recently concluded International Insurance Society’s 43rd Annual Conference, as changes are also sweeping through the insurance industry.

The Seminar Program – “Redefining the Industry: Regulation, Risk & Global Strategy” – examined the major areas of change. AIG Executive Vice-President Nick Walsh noted, “global expansion is an ever larger factor, as Brazil, Russia, India and last but not least China – the ‘BRIC’ countries – assert themselves on the global stage.” Compared to the saturated and highly competitive markets in Europe the U.S. Japan and Australia, the rest of the world offers new opportunities for growth, but not without risk.

Some of them are specific to the industry, but many are not. Marvin Zonis, Professor Emeritus of the Graduate School of Business at the University of Chicago, described just how scary some parts of the world have become. Even as total gross domestic product rose to nearly $54 trillion in 2006 (the US and the EU account for almost half of that figure), 20 percent of the countries in the world (which Zonis numbers at around 160) were going backward. He described more than 20 countries with a total population of 1.221 billion people as “failing states,” including Iraq and Iran. The current waves of war, terrorism and violence have their origins almost exclusively in those states. The violence, as the U.S., the UK and other western countries have learned, frequently strikes them directly.

Europe’s insurance community, however, is more focused on the often delayed Solvency II regulations – now set back to 2012 (from 2010) – which will alter the way European insurance companies are regulated. Upon implementation the current “rules-based” system will be replaced by a “principles-based” format – the “Three Pillars” approach.

The first pillar – “Solvency Capital Requirements” – will continue to assess capital adequacy, but measured by the level of risk as well as assets. The second requires greatly increased risk management, and the third requires transparency or full disclosure of the company’s risk-based financial position. Companies that fall below these standards will become subject to increasing levels of regulatory supervision.

Both on their own behalf and to prepare for Solvency II, Europe’s insurers and reinsurers are placing new and significant, emphasis on enterprise risk management (ERM). They are adopting a holistic view of what their product offerings, distribution channels, reserves and investments should be, including an increased emphasis on securitizations and the capital markets. Decisions based on those parameters will determine the types of products they sell, where they sell them and their premium levels.

Some things don’t change, however, as “taming the cycle” and sticking to “underwriting discipline” remain primary concerns for industry leaders. ACE’s former Chairman and CEO Brian Duperreault, said that while he agreed that the capital markets could help moderate the cycle, “it cannot be avoided.” Ideally there is a “technical price,” which is more or less the ideal rate for balancing premiums against risk. Trying to achieve the “technical price promotes discipline,” he continued, “but it can’t always be done. However [by staying as close to the technical price as possible], you lose less money in bad times and make more money in good times.”

At a press conference Partner Re’s CEO Patrick Thiele noted that the ongoing presence of the cycle reflected a fundamental of economics, i.e. “when there’s an increased supply of capital, there’s less demand, which in turn creates pricing pressures.” As a result “containing losses becomes more difficult.”

The impact of Solvency II, if and when it comes to pass, will be substantial. Yann Le Pallec, who heads Standard & Poor’s European Insurance Practice, described it as “a revolution.” EU leaders see risk based regulations as offering the rest of the world a blueprint for regulatory standards.

Companies and regulators are actually committed to the same process, as are the rating agencies. Although they might not acknowledge – in Hannover Re’s CEO Wilhelm Zeller’s candid terms – that “S&P and A.M. Best are the de facto regulators,” they nonetheless wield enormous power. Get in trouble with the regulators and you may face fines and other unpleasantness; get in trouble with A.M. Best or S&P and you may be out of business.

This could explain why the attendance for S&P’s Director of Insurance Ratings Rodney Clark’s presentation of S&P’s ratings criteria might well have been the most attended session of the conference. He opened his remarks with a reminder that “we [S&P] focus on global consistency,” i.e. the same criteria are used to rate companies wherever they are located.

Clark described S&P’s approach as “non-quantitative, as well as an analysis of [relative] strength.” It strongly emphasizes ERM, and the degree of sophistication and implementation a particular company has achieved in integrating those practices into its everyday business culture. “Those who understand the risks are in the best position to know what business their company should be in, or not; where to best allocate assets,” he continued. “As recently as 2001 there was virtually no holistic analysis of risk. Today more highly structured ERM is bringing it together.”

The I.I.S. conference featured a great many more insights on securitization and the role of the capital markets, as well as the role of government: More, in the face of terrorist and huge nat cat threats. Less, in the life, pensions and general “longevity” sector, where private insurers will be called on to play an increased role.

The industry may not really appreciate that it is “living in interesting times,” as the ancient Chinese curse describes situations where changes in the status quo occur, but then it really doesn’t have a choice. Fortunately organizations like the I.I.S. are there to give the industry a bit of help along the way.