Insurers must address needs of current not past generation–Risk Frontiers

Adrian Ladbury (AL): What are the big risks currently? Helen Hayden (HH): Low interest rates are clearly a risk for a company like ours. Also a worryingly large percentage of UK and US citizens are not planning for retirement currently and that, combined with the potential impact of Solvency II, is a worry and of course the eurozone situation. We don’t have a large exposure to sovereign bonds but it is not an environment that is conducive to positive outlooks. There is not a feelgood factor and, combined with the low interest rates and falling investment income, it means that it is difficult for everyone. Our good news is coming from Asia where we have been present for a long time, since the 1920s. The challenge to the Asian business now is to start making a more meaningful contribution to the group profits given how difficult it is in the UK and US. AL: Why are people not planning for retirement? hideHH: Constraints on family income and a lack of understanding as to what the state will provide. A Prudential study has revealed that one in six people (16 per cent) planning to retire this year will depend on the state pension to fund their retirement as they have no other pension. Women are more than twice as likely as men to have no pension; 20 per cent of women retiring in 2012 will depend on the state pension compared with just 8 per cent of men. The Prudential research also shows that one quarter (26 per cent) of people retiring this year either overestimate by more than £500 a year what the state pension pays, or simply do not know. We are also dealing with difficult annuity markets and of course the impact of falling mortality rates and rising longevity. The same pot of money has to basically last for a longer period. AL: What about your own environment, the insurable risk part of the business. How is that changing? HH: Certainly from a financial services perspective our market is hardening, there is no doubt about that. We had the recent court decision on a dispute between Standard Life and its professional indemnity insurers which has huge potential implications. Standard Life identified a fund that was at risk during the financial crisis as the trade in asset backed securities and floating rate notes had dried up. The fund was re-priced resulting in the fund falling 4.8 per cent overnight, a loss of about £100m. Additionally the fund had been marketed as a ‘cash fund’ and had potentially been mis-sold. Standard life chose to deal with the problem up front and reversed the effect of the fall by proactively restoring the value of the fund at the cost of about £100m. The subsequent FSA investigation concluded that the marketing literature around the fund had not been ‘clear, fair and not misleading’. Standard Life submitted a claim for £100m against its professional indemnity insurance which provided cover for civil liability and mitigation costs. The claim was rejected by the insurers who claimed that the mitigation costs were not ‘reasonably and necessarily incurred’, that injecting money into the fund was not legally necessary to avoid/reduce claims, the payment was not solely aimed at those perceived to have a legal claim and that the dominant reason for paying the payment was to avoid £300m of uninsured brand damage. A further rebuttal alleged that if the costs were mitigation costs they should be apportioned between brand damage (uninsured) and liabilities (insured) in the same way that they would be in marine clauses or under insurance. The judge found for Standard Life stating that as long as one reason for making the payment is to avoid or reduce claims it does not matter if there are others and that there is no general principle of apportionment in liability policies. However, on this latter point insurers have been given leave to appeal. The implication for the financial services industry is that regulators want financial service companies to acknowledge their own mistakes and put them right rather than wait for individuals or the FSA or FOS to bring claims against companies; despite a hefty fine, Standard Life was given credit by the FSA for the proactive way in which it handled the claim. This marks a step change in the way such matters now proceed in the UK and needs to be recognised by insurers and reflected in policy wordings as a legitimate head of claim. The ability for insurers to appeal on the apportionment issue has far broader implications and effectively introduces ‘average’ to a liability policy, a concept which has up till now been confined to marine and property policies. AL: What about Solvency II? HH: This is a very significant issue for us because of the way we are currently structured. As a UK-headquartered company the regulations have to be applied to all our businesses worldwide. Currently, the EU has not granted equivalence to the US solvency regime and potentially this means we would have to hold more capital on our balance sheet against our liabilities in the US than our competitors. We do have a captive but as a subsidiary company of an insurer it is already bound by Solvency II. The carve out for captives does not apply to us because the definition of a captive excludes any subsidiaries of an insurance company so the kinds of simplifications and exclusions that ECIROA is fighting for are not relevant to us. AL: What about cyber risks? HH: We have done the work on this and looked at the risks and what controls are in place and at the existing coverage that it is in place and have decided that actually a fair percentage of the risk is covered already. We are looking at the gaps and deciding whether the cyber products that are available currently fulfill our needs and undertaking the analysis. But generally speaking I have to say that I do not believe that a lot of this is new and it does feel a bit like Y2K. I am not saying cyber risk does not exist—it does—but you have to bear in mind that the insurance industry is very good at creating products which don't specifically fit with the risk exposure. What I would like to see are outcome-based policies where it does not matter (within reason) what the cause is. This is particularly pertinent to business interruption where you have a focus on things like political violence, riot and the like. If underwriters say that risk managers want their risks to be siloed like this that is not correct. If one of my offices has a fire I just want it rebuilt, not a discussion about whether it was accidental fire, terrorism or civil disorder. In this sense the insurance industry has to be one of the only industries in the world that is supplier-driven. As insurance manager with a big company of course I have a certain amount of leverage. But currently I cannot take my operational risks to an insurer and say: “This is what I have got, this is what I would like to transfer and agree what is to be transferred and at what price.” AL: What can you do about this and how should the brokers and insurers be reacting to this kind of demand? HH: This requires a fundamental change in the whole industry. In my mind the insurance industry is currently addressing the needs of the previous generation. Think of the global spend of members of Airmic, Ferma and RIMS and you would think that we would have more leverage. Possibly this is too big to change and I am not sure that Solvency II will help either because it sets charges for capital against certain lines and could drive some capacity away from certain (higher risk) lines. AL: And do you think that the EC’s renewed focus on broker remuneration, transparency and disclosure is a good thing? Would you like to see the introduction of a system by which all brokers are only paid by the risk managers and not the insurers too as in parts of Scandinavia? HH: To do this would require a change in the insurance setup in the UK. I think, as long as there is transparency and as long as insurers address the conflict of interest appropriately, there is no reason why brokers should not undertake work for insurers. But transparency is the key. AL: What about the global programmes project that Airmic is undertaking with Ferma to try and build a global database to benefit all risk managers. Are you pleased with progress? HH: This is good news because we have the backing of three of the biggest brokers. We put the RFP [request for proposals] out before Christmas and had 14 responses. These came in three different categories—companies that offered almost the complete solution, companies that offered the platform but not the data and legal firms offering the data but not the platform. We have had to spend time working out the model and the structure which is the boring behind the scenes part but fundamental to the success of the project. It has taken us a long time to get to this position but I am confident that we will have something in place to assist risk managers.

Insurers must address needs of current not past generation–Risk Frontiers

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