Trust, security and regulation

The basis of insurance is trust. How many other contracts does a company enter into on the basis that they’re not going to get payment for their products and services within an agreed period of time but they will get paid compensation if a defined event occurs within a certain timeframe? It’s a fairly unique agreement.

And because it’s a unique agreement, the trust element is all important. A promise to pay is somewhat different to cash in the hand. What happens if something untoward happens to the party giving that promise? History shows that, while regulators will do all they can to protect individuals uninsured as the result of an underwriter’s collapse, they are less concerned about corporate losers who often must be prepared to fight their own battles.

However, in Europe much is changing. European banks were first of the financial institutions to be scooped into the EC regulatory net with the Basel regulations. Now European insurers are faced with the demands of Solvency II, albeit that the compliance date has been delayed until 2012.

The EC’s focus is on security. It is clearly in no-one’s interests for a major financial institution to go to the wall and Solvency II is designed, among other things, to ensure that insurers’ risk management is comprehensive and effective.

Business advisers have welcomed the launch of the Solvency II Framework Directive. According to Steve Taylor-Gooby, managing director of Tillinghast, a business of Towers Perrin, ‘If successfully implemented, the new regime will lead to more efficient capital allocation across the industry, giving consumers better protection against insurance company failures. It will also create a common standard across Europe, encouraging more competition and ultimately lower prices.’ That has to be good news for risk managers.

Under Solvency II, capital requirements will be based on a thorough analysis of risks and set to allow companies to withstand improbable events such as those that occur only once every 200 years. ‘This will provide an improved standard of policyholder protection leading to fewer insurance failures,’ says Tillinghast.

However, Rick Lester, insurance partner at Deloitte, cautions that the new framework generates a number of challenges for insurers trying to adhere to the rules. ‘Solvency II will be a significant step-change for many jurisdictions and the cost of compliance for insurers is likely to be high.’

And Lester is less sanguine than Taylor-Gooby about potential cost savings for insurance buyers. He says, ‘In the short-term the implementation costs of Solvency II may be passed on to customers. However, over time, customers will find they pay even more for the risk being insured. Those with low risk profiles will pay less but those in high-risk areas, such as earthquake or flood zones may find their property becomes uninsurable, or the insurance unaffordable.’ So maybe not such good news for risk managers in high risk areas.

Ernst & Young believes Solvency II’s emphasis on risk management, corporate governance and responsibility will reward those insurers that are managing their business well and will lead to greater international competitiveness for the European insurance industry. ‘Together with the proposed IFRS accounting standard, Solvency II will fundamentally reshape the European insurance and reinsurance industry, increasing competitiveness and making the EU insurance market a center of innovation and excellence.’

In all this demand for best practice, the rating agencies are playing a key role. At a recent insurers’ round table discussion held by StrategicRISK and consultants Tillinghast Towers Perrin, one participant commented that ‘rating agencies are the new regulators’. Compliance with Solvency II may have been delayed but rating agencies like Standards and Poor’s are already requiring that the companies they assess demonstrate good enterprise risk management as one of the factors which influences the rating provided.

Finally, in respect of this Guide, it should be noted that insurers’ results are notoriously difficult to compare. One of the effects of globalisation is that large European groups have formed subsidiaries in various countries and the results of each of these are necessary in order to obtain a true reflection of the total business they write in Europe. Some incorporate their European corporate business results within their head office figures which also include non-European business. Some have set up divisions exclusively for multinational business which report separately. We have endeavoured to extract the most meaningful statistics for European risk managers.

Sue Copeman

Editor, StrategicRISK