Insurers: Get your thinking caps on

This is because, despite pathetic investment returns, escalating combined ratios and fast-dwindling redundant reserves, the French and wider European industrial insurance market is not really hardening that much at all. Certainly not enough to have risk and insurance managers screaming foul from the podium, brokers wringing their hands in mock despair and insurers blathering on about the rising cost of capital and the catastrophic effects of global warming. For most risk managers this is very good news indeed. As the year end renewals neared, most risk managers will have surely only half-hoped that the impact of last year’s catastrophes would be mopped up by the insurers’ and reinsurers’ ‘excess’ capital and high competition witnessed in recent times for industrial business.hideBut the evidence from AMRAE suggested that this is exactly what has happened and is borne out by the words of Philippe Rocard, CEO of AXA Corporate Solutions, France’s biggest corporate insurer, at the end of this report. It is also good news for risk managers that coverage terms and capacity is the main focus of debate rather than price. Peter den Dekker, former President of Ferma and now Risk Manager at Amsterdam-based Russian telecommunications firm VimpelCom, always used to criticise CRE for focusing too much on rates and too little on capacity. Well Peter, it seems your wish has finally been granted. The CBI debate was kicked of by AXA Corporate Solutions executives during their annual press lunch on the opening day of the meeting as they said that they expect a reduction in the insurance capacity available to meet the demand for CBI going forward. They also warned that supply chain risk is being poorly managed by both risk carriers and business. To be fair on AGCS they did not seek the debate and headlines and only responded to questions from CRE on the matter. But the response was interestingly robust and got us off to a good start. Philippe Jouvelot, newly appointed Chief Operating Officer at AGCS, played down fears raised by certain sections of the reinsurance industry that capacity could be withdrawn altogether in as little as eighteen months if suitable solutions are not found. He said that he believes that ‘mature dialogue’ between the two sides of the risk transfer divide will provide suitable answers to the current problems. But, echoing the rising theme from the carriers, he demanded that risk managers increase their supply options and provide insurers with better information on their supply chain risks. The topic of CBI coverage has become a hot topic of debate of course as risk managers and insurers realise the extent of their vulnerability following the major catastrophes in Japan and Thailand and reinsurers assess exactly how much of this coverage they can offer on the current basis. Last week rating agency Fitch said that it believes the Thai floods will cost upwards of $20bn as CBI losses in particular continue to mount. The risk transfer industry is demanding far greater transparency on supply chains and, critically, how important suppliers would be replaced following an event. Munich Re warned in December that risk managers have eighteen months from the start of this year to provide more detailed answers. Otherwise cover could be limited or withdrawn as accumulation risk, because of CBI exposures, mounts for the risk transfer industry. “Accumulation is not really under the control of the underwriter. It’s like driving in the fog at 200 miles an hour and people need to slow down and put the lights on so that they can understand the risk,” said Mr Jouvelot. “Today there is too much of a naïve situation where the capacity is granted with unknown and uncontrolled accumulations within the portfolios. When this happened with catastrophe insurance a few years ago we saw a decrease in capacity and that is our expectation on contingent business interruption—an overall market reduction of capacity,” he continued. “We trust dialogue is always the best way. Entering into dialogue with the customer when everybody understands the situation we will be able to take the appropriate measures as one,” urged Mr Jouvelot. Risk managers and their businesses must simply better manage their supply chain risk and ensure they have multiple suppliers, continued Mr Jouvelot in what seems like a very reasonable request. “The ultimate solution is to find alternative suppliers. There is no other way than to make sure that one plant is not stopped because it has only one supplier. The diversification of suppliers is to us the key task for risk management,” he said. Mr Jouvelot suggested that particular focus must be placed upon what he called ‘concentrator’ markets or sub-markets such as the automotive parts supply industry where worldwide producers can be reliant upon a small number of suppliers, often in the same catastrophe-prone regions. Next up was Thierry van Santen, CEO of Allianz Global Corporate & Specialty (AGCS), former Risk Manager with Groupe Danone, President of AMRAE and the European federation Ferma who, in an interview with CRE during the conference, said that industrial insurers clearly need to change their model to help rise to the challenges of the global economy, not least supply chain risks. Mr Van Santen, who took part in the closing debate about the state of the insurance market during the second day of the AMRAE conference along with XL’s Paolo Ribotta and Mr Jouvelot, said that insurers must invest in new systems and talent to properly model supply chain risk. Just before going on stage for the debate, Mr Van Santen told CRE that the old methods of approaching risk transfer by lines of business such as property fire is no longer relevant for modern companies that operate in the global environment. Insurers, brokers and risk managers must rise to the challenges presented by the global economy, fast-evolving supply chain and vulnerability of emerging nations to natural catastrophes in order to properly identify, measure, manage and price the risk, said Mr Van Santen. “The existing business model of large corporate risk insurance is an old model which is not designed for the economy today pricing for large corporates based upon the old traditional insurance model of fire and the like. Fire is not 100% under control but it is close and in the DNA of the insurance market. Look at what happened in the last decade when roughly 40–50% of overall [property insurance] costs were accounted for by natural catastrophes whereas in the past it was negligible, perhaps 5–10%,” said Mr Van Santen. “This change has not been caused by global warming but by the changing economy. International programmes in the 1990s were mainly for Europe with one or two countries outside of Europe, probably the US and perhaps one in Asia. Thus perhaps 80% of the business was based in countries where the knowledge of natural catastrophes was very good. But since 2000 the economy is now global and now up to 80% of revenue comes from new territories where knowledge is very limited and insurers have limited understanding of accumulation risk,” continued Mr Van Santen. This problem has been clearly exposed by the recent events in Japan and Thailand where contingent business interruption coverage has triggered big losses and revealed the lack of understanding of the exposures, said the insurer. “The market needs to rearrange the model of large risks. People need a much better understanding of the true exposures. Today’s pricing models, which are roughly the same for all companies, don’t really consider whether factories have been adequately built in a high risk earthquake zone for example or where the risk of earthquake is low but the impact of first shock would destroy factories,” he added. Mr Van Santen said that the industry needs new dedicated capacity and expertise to deal with such risks. New tools and models will clearly help, but it is the dedicated knowledge and capacity provided by the insurers and, of course, more information and better understanding of the risks among the risk managers, that will make a difference, he continued. He said that AGCS has begun the investment in such a process but believes that this has only really just started for the industry as a whole. “There is a long way to go, there is a lot of room for progress. I think that 99% of the industry has not really taken this decision yet. It needs commitment from insurers, brokers and risk managers,” concluded Mr Van Santen. Not surprisingly perhaps, the top insurance bosses who took part in the big insurance debate at AMRAE expressed concerns about pressures on capital and the parallel fast-rising demand from customers for ever-greater innovation, such as new CBI coverages. None of them disagreed with Mr Van Santen’s analysis but stressed the bit he mentioned about needing more from the buyers if they are to offer more themselves. The CEOs reminded the risk managers in the crowd that the insurance industry has coped remarkably well with the recent threats posed by the credit crisis and subsequent economic and financial stresses plus huge catastrophic losses last year. Regulatory developments such as Solvency II can only lead to a higher cost of capital, they added. The insurance industry leaders reminded the audience that they have to deliver decent returns to investors if they are to maintain a healthy flow of capital in order to help their customers rise to the challenge of emerging risks with innovative solutions and meaningful capacity. But this can only be achieved if customers are prepared to contribute to the development of newer coverages, pointed out the CEOs, in a thinly veiled hint that price increases are required to secure the desired pipeline of capacity. One of the key problems faced by insurers when they attempt to respond to customer demands for innovation is that new products are so quickly and easily copied by competitors. This provides a natural barrier to innovation in the insurance market because it makes it more difficult for insurers to justify the investment in new products, as advantage can be quickly lost. The rising ‘capital intensity’ of the business imposed by new rules such as Solvency II exacerbates this problem, argued the CEOs. The main theme of the debate, which was hosted by CRE’s editor Adrian Ladbury, was the changes that the insurance market has experienced since AMRAE organised the first Rencontres some 20 years ago. Dennis Kessler, CEO of SCOR, said that, in this period, the ‘universe of risks’ has expanded considerably, and that insurers and reinsurers have made huge investments to accept risks that they could not imagine taking 20 years ago. Financial innovation has helped the industry to interact with capital markets, and more strict capital requirements represent a positive development for clients, he pointed out. But the outcome of all these factors is that the capital intensity of the industry has almost doubled in the past 15 years. “When you needed one euro of capital for each amount of premium then, you need two euros today,” Mr Kessler remarked. “It is a fact that, to carry new risks, we need more capital,” he added. The point was reinforced by Evan Greenberg, the Chairman and CEO of ACE, who reminded everyone that the insurance industry has to deliver acceptable results to investors. He said that if insurance buyers want their providers to continue to deliver solutions to their growing risk transfer needs they should be prepared to pay the appropriate rates for their coverage. “The industry [historically] has a lousy return on capital,” he said. “We want capital that is more fungible, that can come in and out. But it needs to be attracted by the returns that we can offer, otherwise capital will be allocated to some other business,” he added. According to Mr Greenberg, the need to attract investors has clear implications for the ability of insurers to come up with new solutions. “Innovation can only go as far as clients are willing to actually pay for it,” he said. The subject of innovation, a present concern among risk managers, occupied much of the attention of participants during the debate. “Our industry is maybe less innovative than other industries,” conceded Axel Theis, CEO of AGCS and Mr Van Santen’s boss. But he added that this could be because of reasons that are intrinsic to the nature of the insurance business. “It is very difficult to develop something new and then reap the benefits, because it is so easy to copy [insurance solutions],” he pointed out. In any case, the incentives for insurers to innovate are not always there, he said. “Sometimes innovation is just another word for more coverage for the same price,” Mr Theis said. “But it is a normal negotiation process, I have no problems with that,” he added. But Greg Case, the Chairman and CEO of broker AON, said that, in the current market, the industry cannot afford the luxury of not coming up with creative ideas. “The onus is on us—the brokers and insurers—to be ahead on innovation,” Mr Case said. “We have to be ahead on understanding risk.” But this is a tough task because, according to Christian Hinsch, the CEO of HDI Gerling, insurance buyers increasingly have particular needs and require tailor-made solutions from their providers. “The most important thing for us, insurers and reinsurers, is to increasingly individualise our services,” Mr Hinsch said. “Companies are becoming more and more differentiated, and we have to specialise in certain industries and services, according to their needs,” he added. During this debate, participants also expressed concern about the forthcoming Solvency II directive, in what is becoming something of a mandatory mantra during such discussions. “Solvency II was developed with good intentions,” Mr Hinsch said. “But now it has become a real administrative burden,” he added. Mr Greenberg, for his part, pointed out that the notion of a global standard for the insurance industry that encompasses all countries and cultures is an academic idea, unlikely to work in practice. “I don’t think that one size fits all,” he said. “But I applaud Solvency II in the sense that the European Community came together and created a system that, given your culture and system of government, makes sense to you.” But Mr Greenberg stressed that the notion of solvency in the insurance industry is very different in the United States. “Solvency II is too capital-oriented, too focused on the models. It is really designed so that insurers will never fail. The regulators want to protect policyholders, bondholders, shareholders, employees, everyone,” he remarked. “In my culture, the regulatory regime is meant to protect policyholders, and policyholders only. It is acknowledged that in a market economy insurers can fail,” he explained. Mr Greenberg also criticised the mark-to-market accounting system that is expected to become the norm for insurers under Solvency II. “A long-term viable business should not have a capital regime that marks to market assets and liabilities on a quarterly basis,” pointed out Mr Greenberg. Excessive capital levels could also be an outcome of this development, he concluded. Aside from capital concerns and innovation, another challenge for insurers, according to Mr Hinsch, is to find the right people to help them expand in the emerging markets in Asia, Africa and South America. “What is limiting us to achieve appropriate growth and to deliver nice returns to our shareholders is not capital, but actually talent,” he said. Mr Hinsch stressed the growing demand for people who understand the insurance business, speak languages and are keen to move to the parts of the world that can deliver growth. “There are great opportunities everywhere. But the question is: are we able to attract the talent that will drive the industry and help our businesses to go forward?” asked Mr Hinsch. The insurance bosses were also invited to say whether anything has really changed in the insurance industry since the first Les Rencontres, back in 1993. But maybe the question should have been whether anything has not changed in the past 20 years? Participants described an industry that has deployed much energy in an effort to cope with a fast-changing risk environment and the evolving needs of their clients. And they argued that, for all the difficulties insurers have faced, they have been quite capable of meeting the challenges. “The universe of risk is expanding for the last 20 years,” said Dennis Kessler of SCOR. “The severity of risks is increasing too. There are more risks, and they are more severe and more interconnected,” he added. “The market is more difficult now than 20 years ago,” agreed Jean-Laurent Granier, the CEO of AXA Global P&C. According to Mr Granier, the shape of competition has changed, with a few global players currently disputing the market with a number of specialist companies that focus on particular segments. As a result, companies have invested much in technology as they seek to boost productivity and become fully proactive with their clients, he said [See Philippe Rocard interview on page 20]. “Insurance companies have become much closer to clients,” stressed Axel Theis of AGCS. But to follow the evolution of clients, they have also been forced to globalise their businesses. “It is not enough to internationalise, you have to globalise,” he said. “Otherwise you won’t be able to cope with complexity and the other challenges we are facing,” added Mr Theis. The sheer size achieved by many leading companies as they seek to increase their international interests presents its own set of challenges for the industry, according to Evan Greenberg of ACE. “Clients’ balance sheets have become more significant, and they have globalised their businesses,” he said. “Clients can take on more risks themselves. They are taking all kinds of risks, and I believe that the industry is responding fairly well to that,” said Mr Greenberg. One French risk manager, Philippe Vienot, a member of the AMRAE board and the risk manager at BNP Paribas, told Commercial Risk Europe in an interview before the event that he is not so sure that the insurance market is doing all it can currently to help customers such as himself. Mr Vienot said that there is still some way to go for the insurers and for risk managers at banks to reach an acceptable common ground. He said that he is worried, for example, by the fact that insurers have inserted many exclusions into wordings for financial firms in recent times because claims against banks are potentially systemic. “Systemic is antagonistic to insurance. When a claim becomes systemic it becomes very difficult for insurers,” he said. “I understand the concerns of the insurance industry. But, for us, it means that we keep purchasing programmes for fraud and professional indemnity which are not transferring risks very efficiently.” And he also believes that the market still has some way to go to improve the global programme offering. “For banks, it is very difficult to find carriers that can be the lead underwriters on international programmes. There are maybe three of them only. And even these few players don’t have the policy wordings available in all the countries we would like,” he explained.

Insurers: Get your thinking caps on

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