ANRA Report 2013–In search of solutions

Innovation: Expect evolution not revolution Most large companies that carry out a proper ERM analysis find that insurable risks actually represent less than one third of the total estimated exposure faced by their business. This is supported by recent research among risk managers across Europe and worldwide by CRE. Many participants in our annual Risk Frontiers surveys have expressed frustration at the apparent inability of the insurance community to invest in expertise to find solutions to uninsurable risks.hideSome top insurance industry executives, notably Mike McGavick of XL, have publicly acknowledged in recent times that their industry runs the serious risk of becoming irrelevant in the fast-moving modern economy if it strictly adheres to the ‘rear view’ underwriting approach. But with dormant core markets in Europe, seemingly endless soft markets, poor investment returns and dwindling reserves, now does not look like the best time to take a punt on new markets. The question inevitably asked during the Anra debate was therefore: How can this particularly tricky nut be cracked? Andrew Kendrick, President of ACE European Group, conceded that if the insurance market’s rate of growth is compared to the growth of gross domestic product (GDP) it clearly fails to keep up. He also noted that global exposures faced by corporate risk managers have become more important for larger companies as they expand in search of growth. Mr Kendrick said insurers need to recognise and respond to this evolution in exposure more rapidly. Exchange of information is key, he added. “When you do not have the right level of information it is difficult to analyse the risk. It is about data gathering and analysis,” he said. The other key factor is for insurers to constantly improve their knowledge and skills and hire more experts. “We are hiring more industry experts to help understand the exposures better,” he said. But customers cannot expect miracles and have to contribute to the learning process themselves, continued Mr Kendrick. “Some risks you have to concede are not transferable. Though, in my view, most things are insurable so long as a reasonable margin is available. Customers have to be prepared to pay for the investment we make,” he said. But experts are not cheap of course and require new investment. With insurance prices so stubbornly flat in most lines and investment returns still poor, insurers do not have loads of cash washing around. Mr Kendrick agreed and said it is crucial therefore that investment made generates true returns and results. “If you invest in new expertise, risk analysis and the like then you need to create new products and generate sales. Something tangible needs to come out of it at the end of the day beyond discussion,” he said. Fredrik Rosencrantz, CEO, Global Corporate Europe at Zurich, said it is important to appreciate that innovation does not happen all at once as ‘one big waterfall’. “Innovation is evolving too. Also, do not forget that arguably one innovation is the track record of this industry to deliver on its promise. The insurance sector has proved reliable at a difficult economic time and this is a blessing for risk managers in itself,” he said. Dr Christian Hinsch, Deputy Chairman of the Board of Management of the Talanx Group and Chairman of the Board of Management at HDI-Gerling Industrie Versicherung, the industrial insurance arm of Talanx, pointed out that the corporate risk landscape has changed dramatically over the past two decades and all parties need to work hard to keep up. “We are not just talking about the old traditional risks. Reputational risk is on the corporate boardroom agenda. All these risks that were dealt with separately are being dealt with increasingly as a whole, in a holistic way. This is not a completely new development but it has intensified,” he said. Dr Hinsch said that he does not think that insurers should expand out of their core areas into different areas of risk such as banking. But he does see big opportunities in fast developing markets such as cyber and environmental. “These are areas where the insurance industry should move into because they are not fully covered yet. Every risk is an opportunity,” he said. Dr Hinsch added that exchange of risk information is critical. Information is king in risk analysis and it is the risk manager who holds that information. Even when information has been divulged to assess the risk often customers are simply not prepared to pay the price for transfer when coverage options are in their infancy, he explained. “I agree with Andrew [Kendrick] that some industry discussion blames the insurers for not being ambitious enough, which is not fair. Often this comes down to more or less a discussion about price because in my experience we offer industrial coverage for industrial risks that are evolving and it takes time for a market to mature and establish an accurate risk assessment and therefore price. It is just like cars 100 years ago when they were new and so the risk was difficult to model and price,” said Dr Hinsch. The German insurer also said that it is too easy to accuse the insurance industry of failing to invest in quality people. The truth is that the big insurers are staffed with many skilled professionals, said Dr Hinsch. “Our company is the house of 100 professions. We have engineers, lawyers, accountants, business people, doctors, all the professions and experts. So I do not agree that we do not have the right people. If an industry develops such as IT and cyber then yes you have to invest in new people to understand the risk and you have to do this for underwriting as well as claims handling,” he said. Anthony Baldwin, Managing Director, Country Operations and Distribution, EMEA, at AIG, stressed the need for true partnership in innovation. “In my view, clients need to become an integral part of the innovation cycle. At AIG, we recognise that this can only happen if we collaborate more closely with our clients and share our intelligence and learning as part of the process. We have therefore taken a firm-wide decision to invest in innovation and view it as an integral part of the way we do business,” he said. Mr Baldwin said that AIG has two areas that are particularly focused on innovation. These are its Science Office and Global Risk Solutions. “A key job for science is to provide us with the big data, along with accurate analysis and predictive modelling to empower the right decisions. Only then can we consider emerging risk, look at the insights offered by the big data and look to give intelligence back to our clients via innovation, and eventually help to mitigate losses,” he said. Like the Science Office, Global Risk Solutions is not linked to any one product line, but instead works with clients on a broad basis. “This unit identifies risks that customers see as difficult and outside traditional insurable areas, providing solutions to problems. One example would be brand protection for a food and beverage company in the case of a recall. We have to view risk outside of the conventional if we are to remain relevant in a changing world,” he said. It is clear that the big insurers are making efforts and positive strides forward to try and tackle the difficult area of innovation. The problem is inherently structural because the industry simply cannot underwrite new risks blind. It needs data and it needs experience to arrive at a fair assessment and price that works for customers. The logical solution is for insurers to hire the right people to identify and analyse the risks in the first place and adopt the latest technology to ensure that happens as quickly as possible. Couple that with a more bespoke, customer-focused approach and the nut will surely be cracked. The participants in this panel debate certainly agreed that they are on the right track. But unsurprisingly, and probably justifiably, the customers in the room would like to see them head up that road a little faster and with a little more urgency. More work needed if capital markets to enter corporate risk arena The main boards of large listed companies worry about all potential risks that may affect their organisation’s net financial position, outlook and stakeholder value—so not just the traditionally insured risks. There is currently a record level of capacity on offer from the capital markets for the risk transfer industry—catastrophe reinsurance in particular. The glut of hedge and pension fund capital in search of returns in the international catastrophe reinsurance market raised questions during the Monte Carlo Rendez-Vous in September about whether it could somehow be attracted to wider markets such as corporate risk. The reinsurers in Monte Carlo did not rule out the possibility. Those with dedicated large corporate business units such as Swiss Re, Munich Re and SCOR said that they are looking into the options, notably in the captives arena. But the capital markets like catastrophe reinsurance because it is short tail and thus easy to enter and exit. It is also relatively easy to measure on a parametric basis, giving the added attraction of relative certainty of loss. Complex industrial risks, particularly on the liability side, can take years to manifest and settle and indeed can be difficult to define in the first place. These are not the kind of risks that hedge funds like to take on. Pension funds by their nature carry uncertain long tail risks so presumably the potential for correlation is not that appealing. The panel of insurers at the Anra debate were asked how they and brokers could attract some of the new capital to help cover broader corporate risks and plug coverage gaps. This is not an easy question to answer, but, again, seems largely based on data, said Paolo Vagnone, Head of Global Business Lines at Generali. “Financial capital is risk averse to my thinking and will only commit to a risk when there is existing capacity and experience. I cannot see worldwide capacity for new and emerging risks. If it did arise then the risk would be very volatile and the capacity would soon disappear,” he argued. “I think investors are naturally cautious and need models to quantify the risks. For this reason we need more people gathering data and carrying out the analysis. But, as mentioned earlier, this represents a cost that you need to manage. Having said that, when this can be done cross-border, on an international basis, as we do, then it is more efficient and likely to be successful,” he said. Cultural shift underway according to insurers Risk managers regularly bemoan the apparently inflexible structures and attitudes of insurance company staff when dealing with complex corporate risks and feel that a shift in culture is needed to tackle emerging risks in the modern economy. Participants of the Anra debate were asked whether serious change is needed, particularly to weave together the front, middle and back offices more effectively. The insurers said that they are aware of this need and are already on the case. Christian Hinsch of HDI said: “This is not just about technical expertise but also wider awareness, especially in the front office which needs to clearly identify what the industrial customer needs and not just carry out the business the way it has always been done. To adequately deal with emerging risks our management has to strike the right balance between curious people with entrepreneurial spirit prepared to test new coverages and conservative internal forces focused on well-known risks and efficient processes,” said Dr Hinsch. Andrew Kendrick of ACE said it is important to note that the delivery of solutions to complex risks normally requires a team approach. “Claims will be more complex in emerging risk areas and it is important that we and the customers understand clearly how claims will work. You can never have too much intellect in a company but you need to work out who is best to be in front of clients so that results can be achieved. It is about achieving a balance,” explained Mr Kendrick. Frederick Rosencrantz of Zurich Global Corporate stressed the importance of attitude: “I always say that you should hire someone based on their attitude primarily and can use training for skills. I always focus on the attitude side.” Risk managers demand more data security Risk managers are increasingly asked to provide insurers with sensitive and confidential information to help tackle difficult risks. This has been a big topic of debate all year at risk management conferences. During the insurer panel debate at this year’s Anra conference insurers were asked if they really know what to do with this information, how risk managers can be sure such information is kept confidential and what kinds of confidentiality agreements and security measures should be used to ensure this occurs. Paolo Vagnone of Generali conceded that the industry is ‘hungry’ for information due to all of the reasons noted above. But he reassured customers that his company at least does all in its power to protect that information. “We sign non-disclosure agreements or whatever it takes to ensure utmost confidentiality and we are constantly seeking to improve internal processes to ensure that customers are comfortable with this,” he said. Andrew Kendrick of ACE reminded the customers in the room that basic levels of trust remain very important in the insurance market. “Any exchange of information needs a level of trust. The client is transferring a risk to us and using our balance sheet. The more information they pass over the better the risk presentation in the first place. Therefore I say that, as an industry, the better we share information the better the products will become.” Mr Kendrick also pointed out that this kind of constructive exchange can be done on a grander scale and that market cooperation to seek new transfer solutions is not impossible in the modern world. For example, the Lloyd’s Market Association, which represents the Lloyd’s managing agents’ community, has created a cyber working group to collectively improve what is on offer for customers, he pointed out. An important question that keeps cropping up at risk managers’ meetings and during CRE’s Risk Frontiers survey is could and should the risk management associations increase their role in the market by taking the lead in such collective efforts? Alessandro De Felice, Chief Risk Officer of Prysmian Group and board member of both Anra and Ferma, is a supporter of this concept. “For us to challenge the insurance market to establish such standards is sensible. But we need to ensure that the information we share is secure. We live in an era in which industrial espionage is common and maybe the best place to start if you are looking for secrets is on the desk of an insurer in the evening! The creation of an industry standard for the communication of such information would be a good place to start, but this is a challenge,” he said. Dr Christian Hinsch of HDI-Gerling pointed out that firms share secrets with other service providers all the time and agreed with Mr Kendrick that trust remains critical. “As a company you share information with many parties such as auditors, regulators and tax advisers and if a leak occurs from an auditor or tax adviser then you are penalised. It really is a question of trust that needs to be built up over time. If you have a long-term relationship it works. I do not see any other way of solving this other than trust backed up by confidentiality agreements,” said Dr Hinsch. “At the end of the day if a customer wants a better price for their risk because it is well managed then they have to exchange information,” he concluded. The cycle: Not quite ready for the scrap heap There has been much talk of late about the supposed death of the underwriting cycle. Scientific modelling, risk-based capital allocation and regulation, as well as experience-based underwriting on the back of high competition, has knocked the stuffing out of the beloved cycle, so the argument goes. But is the cycle really dead, or just dozing on a feather bed of excess capacity that will be blown to the four corners of the earth when the next big hurricane hits? This question was posed to the participants at the Anra debate and the overall consensus was that while the ride may be much smoother than in the past, there is life in the cycle, or cycles, yet. Anthony Baldwin of AIG stopped just short of saying the cycle has disappeared completely but believes it is on the wane. He said: “The cycle as we knew it in the past is dead because we have far better analysis, underwriting and pricing of risk at renewal.” Dr Christian Hinsch of HDI-Gerling enigmatically postulated that the cycle is partially dead. “In some areas it is dead, in others it is not and it will ever be the case. Some specialty risks are definitely on the way up. If you look at industrial risk generally I think that the hardening is happening. But there are many cycles nowadays and they are all different,” he said. Dr Hinsch added that one of the reasons for the flatter cycle may be that risk management efforts are better reflected in prices than in the past. “It is a much more complex process than it used to be and the price also does depend on the quality of the risk management carried out by individual companies,” he said. Andrew Kendrick of ACE subscribes to the dozing theory. “I think the cycle is sleeping and may not wake up for a while. There is a lot of capacity and results are good. We do see small spots of hardening but there is a not a wholesale movement. We do need to get better at mapping and understanding risks because we still need more clarity,” he said. Frederick Rosencrantz of Zurich Global Corporate Europe said that insurers have simply had to improve their underwriting because of the lack of investment income and this has affected the shape of the cycle. “The market is not as it used to be. Risk maps are better than in the past and insurers have to be better at underwriting because of the lack of investment income. This is, however, offset by the glut of new capital that has arrived, particularly on the reinsurance side,” he said. Paolo Vagnone believes the cycle is alive and kicking and driven, as ever, by capacity. “I don’t believe the cycle is dead. Capacity is abundant,” he concluded.

ANRA Report 2013–In search of solutions

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