Ferma stepping up to the plate as risks multiply

Ferma has a lot on its plate currently as it promotes and defends the position of European corporate risk and insurance managers in the face of difficult macroeconomic and financial conditions, a tough insurance market and ever-broadening regulatory, reporting and compliance requirements. So, CRE editorial director Adrian Ladbury discussed the big themes facing the European risk and insurance management community with Ferma president Dirk Wegener ahead of the federation’s forum in Copenhagen.    

Adrian Ladbury (AL): What are going to be the main themes of the forum?

Dirk Wegener (DW): Transitioning together and risk leadership in a fast-changing world. We see this as a natural progression from our previous theme, from risk to resilience. We are living through a period of great change, including our business models. More uncertainty is a natural consequence and we need to make it more measurable. This is what risk managers do.

Transitioning together is also an acknowledgement that sharing knowledge is the way we make our societies and organisations more sustainable in this new period of disruption. Risk leadership in a fast-changing world is our compass to achieving what we want for our greener and digital planet.

We are expecting a high number of attendees and inspiring speakers and exhibitors. The forum is an ideal environment to meet and share with more than 1,500 professionals across Europe and further away. It will be about inspiration, learning and development. 

AL: It’s been a dramatic three years, first with Covid-19 and then the Russian invasion of Ukraine and all the implications. How has the risk profession evolved over this period?

DW: Twofold. First there is the insurance management piece. For insurance managers, it was a hard time as they had to communicate disappointing messages to their boards. Covid-19 revealed an enormous gap in insurance cover for non-damage business interruption policies. The insurers denied the vast majority of claims for losses. So, there were a lot of disappointing messages to deliver. Since then, insurers have restricted coverage, tightening wordings and adding special exclusions, and this makes it even less attractive to buy insurance. This is a difficult message to communicate.

Second, for risk managers, crises like these are an opportunity to demonstrate their capabilities and how important they are for companies. After the pandemic, a McKinsey survey revealed that 90% of business leaders viewed risk management as more important to their organisations. So, from a risk management point of view, it was an opportunity to show capabilities and demonstrate the importance of risk management.

I think the war in Ukraine has had a similar outcome. You had to report to your management that war-related losses were not insured. At the same time, there are opportunities, not just for risk managers but also for production, procurement and the like. You can show how a proper risk management system can actually contribute to keep things going and manage the consequences.

AL: Do you think the current hard market is truly justified? Have insurers actually used the turbulent political, social and economic situation to push for more than really needed, especially in cyber and D&O?

DW: The hard market was certainly accelerated by the pandemic and it’s again been accelerated by the war. However, the hard market started before. Insurers constantly argued that the losses were too high to allow this to continue. We have gone through hardening markets before. It’s not a new experience.

However, as clearly documented in Ferma’s European risk management survey this year, the frustration with the insurance market is very high. Some 78% reported a significant impact from increased insurance pricing and 71% in terms of reduced capacity. So, this time it was about a double dip – reduced capacities and increased premiums. We have also seen limitations and further exclusions in the renewals. This makes the value of the insurance cover less than it was before. In that respect, it was really tough. 

But when it comes to cyber, there’s more frustration because it is a newly introduced product that was heavily promoted by insurers in the early years and we heard complaints that it was not well received by clients, the penetration rate was not very high.

When the buyers started to buy the coverage, it was then restricted or taken away, and some insurers have even left the market entirely. This is not good if you, as a risk manager, have promoted the coverage as something you want your company to buy and then have to say that it’s no longer available.

Even though we hear that cyberattacks are increasing in numbers and impact, when you really look into the details it is not really the case. Amrae’s Project Lucy, which investigates the cyber market, shows that on the basis of premiums versus claims the coverage is not dramatically underpriced. It looks as if the former pricing was ok.

As to D&O, this is not an official Ferma position, but it seems to be almost the last resort for everything. Whatever happens – pandemic, the war, supply chain issues – it takes minutes for someone to say things will be a huge D&O problem. You really wonder if this is helpful.

Of course, management has to manage all issues and they can make mistakes in doing so. But, likewise, just because there is a risk does not mean that it automatically triggers a liability for the management. There is much ground inbetween. This, in my mind, is not rightly communicated. When it comes to D&O, there’s a lot of talk and it remains to be seen if all these theoretical exposures will turn into insured losses.

AL: If we are to assume the new obsession with exclusions is going to continue because of the inflationary and economic outlook, what do you advise risk managers to do?

DW: The market continues to harden and buying insurance might not be as favourable as in the past. You have a protection gap, in the sense that your risks are evolving, going into different categories that have not existed in practical terms in the past. We have the sense that the insurance market is not keeping pace, so there is a growing protection gap. Risk managers are willing to pay a decent premium but often there is just not capacity available. Going back to our survey, some 41% of the surveyed risk managers expect that some of their locations or activities will become uninsurable in the future because of natural catastrophe exposures. This gives you a hint of how confident the risk managers are that the traditional commercial insurance market has the answer.

We appreciate the fact that the market is working hard to try to find new solutions. Parametric is one of these potential solutions and insurance-linked securities (ILS) are another. But ILS solutions for the individual commercial insurance buyer are difficult to organise and achieve. Time will tell.

Retaining more risk is something that’s widely used already. Again, in the survey, risk managers said they were considering higher risk retentions.

The use of captives is understandably widely discussed in the market currently. But it’s quite burdensome to set a captive up. If you have a captive already, for sure it’s a tool that can be used more to respond to the hardening market. It’s a question of your own priorities and financial capabilities.

It has to be said, however, that most of these measures are in reality limited to very large corporates. For SMEs, the situation is therefore more difficult. We must not rest here. We must try to push and make sure that the offerings of the traditional commercial insurance market are improved going forward.

AL:  SMEs are obviously critical, the backbone of the European economy if you like. At the height of the pandemic, when forced into lockdown, there was talk about public-private partnerships because of the failure of BI to respond, particularly for SMEs. Is there any progress to report on discussions with the EC in this critical area?

DW:  I think it’s fair to say that the momentum has been lost because of other crises. The commission is dealing with things like the war in Ukraine, the energy and inflation crisis and so on. We are still pushing with this. Just recently, I was invited to participate in a round table discussion hosted by the OECD to discuss what the insurance market can contribute in the future to resolve or balance the impact of the pandemic.

The discussion was limited to the pandemic only and there was a broad consensus that such a scheme would be better than the pure spending of government money to help individuals or corporates after an event.

There was consensus also that a system like the one Ferma had suggested to the EC – a European risk framework first focused on risk management and then supported by the private insurance industry – would work best. Under such a system, individuals and corporates would be incentivised first to do what they can to avoid or limit the impact of a systemic risk.

The capabilities of the insurance industry to assess and price risks, and its ability to then transfer those risks and deal with claims, would be critical. There was also consensus that the private insurance sector cannot bear the financial consequences of a pandemic or systemic risk, and therefore there is a need for the public, the government, to support them financially on top of a certain layer.

The conversation is ongoing and hopefully, at a later stage, the policymakers will find the time to look at it and see the advantages and take concrete steps to make this real.

There are national solutions for risks like terror, and in some countries for nat cat exposure. But we are living in a global economy so these national solutions are just not fit for purpose for corporates whose activities are cross-border. So, a European solution would be much better and Ferma will need to argue in this direction.

It is positive to see that the EC is looking into the climate protection challenge and is launching a climate resilience dialogue to discuss this with policymakers and other stakeholders. Ferma has been invited to participate in this working group. This shows that we have gained a lot of credibility within the EC. Discussion at the European level is still ongoing for the climate protection gap.

AL: It’s easy to get caught up in the short term and forget about the big picture, and the legislative process continues despite the crises. The EC is carrying out a consultation, for example, on the Environmental Liability Directive (ELD). What are Ferma’s key messages on the ELD and does it actually need updating?

DW: It does not need to be updated. We are not in favour of the EC pursuing a line of action that will require companies to take out mandatory financial security, which often means a mandatory insurance scheme. Then we are back to the old debate of whether mandatory insurance is a good thing. This will discourage firms from taking the necessary prevention measures and possibly disincentivise the pursuit of enterprise risk management. We don’t think that kind of an update will be helpful.

The problem with the current ELD it that it has not really come to life. The level of applicability across the EU is very diverse, which makes it difficult for cross-border operations. We would be more in favour of having the EC focus on a level playing field across Europe.

AL: There are also the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence (CSDD) proposals for Europe’s risk managers to deal with. What is Ferma’s view on both initiatives?

DW: Ferma’s view on both is positive. We agree that sustainability is a big issue. The idea that corporates have to deal with that and report on it is not the wrong idea. However, as often, the devil is in the detail.

We think the concept of value chain within the CSDD is not clearly enough defined, it’s very broad. So, it’s not limited to a certain tier level, neither upstream or downstream, which makes it almost impossible for companies to really comply and make sure that in their entire value chain there is absolutely no wrongdoing. This creates an unacceptable level of potential liability.

The other thing is that again the liability within the civil liability framework among the member states is also problematic, because it’s not completely harmonised. This is a more dramatic problem as the directive doesn’t really give a clear definition of damage.

The damage of the third party considered wrongdoing within the value chain if you like, or caused by a wrongdoing, creates a liability. If this is not clear, it becomes a risk from the view of the corporates that is almost impossible to manage and to mitigate.

With the CSRD, again the devil is in the detail. The directive is promoting this idea of double materiality in a sense that an act has to be reported if it happens, if it has an impact on the corporate itself or on the environment including personnel and so forth. The problem here is that materiality is not clearly defined and as this reporting has to be audited, or in certain industries to be disclosed to external stakeholders, their consent needs to be signed off.

You will end up in endless debates that will, of course, be controversial about whether or not an event was material either for the corporate or for the environment. This is not good and it is not fit for purpose at this time.

These two directives clearly closely interact and this will be something risk managers will have to deal with going forward, but hopefully based on clearer guidance from the Commission.

AL: This is a complicated area and again seems to shift the focus of European risk managers away from core insurance risk management towards more enterprise risk management, which does not seem tenable from the outside. Is this going to form a split from core to enterprise risk management, so we have two very different sets of members of the national associations?

DW:  I think we already have members who have a different focus in their daily work, who consider themselves ERM people, and we have people who consider themselves insurance risk managers. Then we have people saying they are risk and insurance managers in combination. 

I would argue this goes way beyond ERM. You need to work with procurement, with legal, production etc. It comes back to the point that risk managers are risk conductors. Their role is to know where to go to seek information and likewise learn from their colleagues what is required by law, by reporting standards and so on.

They need to be able to adapt and broaden their skills. I think that the link between risk and transfer of risks is still very strong and therefore, despite what I said in the beginning, I think that we will not see a clear cut between risk management and insurance management going forward.

It will depend on which industry you are talking about. Time will tell. But my personal projection is that we will not see a complete cut between these two professions.

AL: Ferma members are looking to use their captives more, or to create a captive to cope with the tough market. What should be done to promote captives, raise understanding of their value and make them easier to create and manage? 

DW: It’s not an easy task to set up a captive and it’s not an easy task to operate a captive. In the EU, captives are fully exposed to Solvency II and it’s very burdensome, not just financially but also because of the administration, reporting and the like. We are to some extent used to it, however we are still fighting for a more proportional implementation of the rules for captives.

It is always the same argument that captives are a less risky operation than commercial insurance companies and they do have the full financial backing of their mother companies.

We think we were successful to an extent because we managed to convince the French presidency in the first half of this year that captives should be classified as low-risk undertakings and should get some relief on reporting requirements. This was a big step forward in the effort to promote the idea of more proportional regulation for captives as originally laid out in Solvency II but not followed through.

It is fair to say that the deal is not yet done of course, but I think we managed to get the discussion in the right direction. This took a lot of effort in several meetings with the French treasury and of course European Parliament members.

We consider this to be a bit of a breakthrough in the perception of what captives are doing and what distinguishes them from other traditional insurers.

AL: This is good news that you have made progress with the EC. But the OECD still refuses to classify European captive insurance companies as “regulated financial services” in its latest consultation on base erosion and profit shifting (BEPS), which makes it difficult to gain those proportionality benefits. What needs to be done here?

DW: The latest consultation on BEPS is a bit of a setback because the OECD is a bit suspicious of captives and denied that captives are regulated financial services operations. This means that we will not enjoy certain advantages that other regulated financial institutions receive. We are disappointed with this because for the European captives that are fully exposed to Solvency II, it is very difficult to understand how the OECD could come to this conclusion.

All in all, captives are important and we will continue to promote them as a risk management tool, and likewise fight for more appropriate regulation in the Solvency II framework.

As I stressed earlier, given the complexity of setting up and operating a captive, it is not a perfect tool for SMEs and that means that we must not forget to focus on, and strengthen, the traditional insurance market to meet their needs, so that proper risk transfer solutions are available.