INTERNATIONAL UNDERWRITERS ASSOCIATION OF LONDON
CHURCH HOUSE, WESTMINSTER – 13 MAY 2003
John Tiner
Managing Director, Financial Services Authority
Limits of insurability

Good afternoon ladies and gentlemen. It is perhaps fitting that we gather here at the home of the governing body of the Church of England for a debate about Armageddon. It was, afterall, the Book of Revelations in the New Testament that brought us the battle of armageddon between the forces of good and evil and so brought about the end of the world. God against the kings of the earth. I wonder who we would regard as the actors on either side of the battlefield in our modern day debate about the insurance industry. Fortunately, the dictionary brings us a more useful definition of the word armageddon "a catastrophic and extremely destructive conflict". Regulators tend not to talk of the armageddon scenario, but of systemic risk. This principle of global risk management is a familiar one to the world’s central bankers and policymakers, as it has been debated in the context of the banking industry for many years. It is true to say, however, that concerns about the possible systemic risks brought to the financial system through the insurance sector, and in particular the reinsurance sector, are relatively new arrivals onto the agenda of politicians, central banks and regulators. This, of course, has come about because of the financial consequences of 9/11 on the reinsurance industry.

Estimated losses from WTC range from $30 billion at the bottom end to $75 billion at the top end. So an average estimate might be in the order of $50 billion of which analysts predict some 60% will be picked up by the reinsurance industry. AON, estimates that reinsurers have lost $200 billion in the 18 months since 9/11. The point of restating these numbers with which I am sure you are all familiar we indeed have your own versions, is to illustrate the huge dispersion of estimates which are bandied around about the reinsurance industry. And yet as risk passes from risk - averse individuals, corporations and governments to insurance companies and on to reinsurance companies, each of whom presumably has the appetite for assuming some element of the risk, the quantum and locations of losses that emerge from this risk transfer are barely known. This issue of data quality, call it lack of transparency if you like, is a matter I will return to shortly. What is clear is that the insurance and reinsurance industries have aabout crucial role to play in the efficient allocation of risk, capital and resources around the economies and corporations of the world, andas well as the directly impacts society through the ability of individual citizens to protect themselves against unpredictable events.

It is encouraging that $30 billion in new capital has come into the industry since 9/11, presumably chasing the significantly harder rate environment. I wonder how permanent or how flighty this capital will be. As Stephen Cane, Chairman of the IUA, wrote in a recent article, it is also encouraging that insurers and reinsurers have, by and large been able to meet the claims arising from 9/11, although many may have thought that a bill of $50 billion might have been beyond their reach.

Although some pessimists might say that it's too soon to call time on WTC, it falls to me as an optimistic regulator to speculate about the next disaster, with the obvious dire consequences for economies, businesses and citizens. There are various points of view on this. Some think that the WTC has moved the goalposts in respect of catastrophe risk and that the next big event will involve approach losses for the insurance industry approaching in excess ofof $100 billion. Others worry that the aggregation of attritional losses, where individual loss events are much higher than has been experienced in the past, could cause major liquidity problems and substantially reduce the resilience of the industry to absorb a major loss event. A recent report by KPMG quotes research suggesting that the insurance bill for extreme weather events and rising sea levels will increase tenfold from $20 billion per year to $200 billion per year by 2050. Once again, these are very big numbers indeed and I will not here get into the likelihood orf probability of any of these scenarios emerging. But while I imagine that the focus of this debate was intended to be on the potential systemic risks arising from escalating liabilities on reinsurers balance sheets, it is, perhaps, worth considering this in combination with a meltdown on the asset side of the balance sheet which could be brought about by collapsing equity markets and/or credit losses arising from exposures the reinsurers have picked up through the credit derivatives market. As we are talking today about scenarios rather than the reality, I would not want you to think that the British regulator is saying that this is going to happen, but it does need to be introduced as a further element of scenario planning, particularly if a major loss event was itself to cause major bond issuers to fail and/or stock markets to collapse. Once again it is far from clear how much credit risk has been transferred to reinsurers from, mainly, investment banks, and this reinforces the arguments for operator transparency.

So what is being done to better understand the systemic risks and to manage against the armageddon scenario. Well of course from a market perspective premiums have risen, in some cases substantially and I hope that firms will use these favourable market conditions to rebuild reserves. In addition, policy terms have become increasingly restrictive. The big question for me is are these long term structural changes in the market or simply the hardening stage of the traditional underwriting cycle, which will turn as competition intensifies enabled by the new capital coming into the market. It is to be hoped that firms learn their lessons from their underwriting during the soft market of the late 1990s. That is that acceptance of risk, pricing and terms are based upon proper technical analysis and more forward looking modelling including realistic disaster scenarios, stress testing of assumptions and correlations in the aggregation of risk. I would also hope that reinsurance firms continue to strengthen their processes and controls over credit risk, the human element of underwriting risk and asset liability management. A few words on each of these:

  • credit risk (both in their purchase of reinsurance and in their management of investments and related hedging and structural positions, both on balance sheet and off balance sheet),
  • controls over underwriters to minimise the risk that they write business of a type or for a counter-party or at a price which is inconsistent with the Board’s strategy; and
  • management of the matching of assets and liabilities, especially where reinsurers discount their reserves.

It is important also, to recognise that the rating agencies are a major force in the reinsurance market. In particular, the capital that insurance firms actually hold to maintain a rating is usually well above any minimum amount that would be required by an EU regulator. Since 2001 the rating agencies have downgraded many reinsurers. It is not difficult to see that this could lead to business increasingly gravitating towards those reinsurers with a higher rating. What will this mean? Will it increase risk concentration and therefore increase the risk of systemic failure or, because the larger companies are themselves better diversified, will it mean that vulnerability is reduced? What probably can be said is that increased concentration will magnify the impact of any failure.

My final point covers the role of regulators. Regulators around the world recognise the important contribution reinsurers make to the stability of insurance markets. However, there is a very wide variance in the regulatory oversight of the reinsurance industry in different countries. Here in the UK, reinsurers are required to be fully authorised by the Financial Services Authority and are regulated in a similar way to mixed writers and insurance companies. This is also the case in the US. In some other countries, reinsurance companies do not fall within the scope of regulation, and in other cases we regulated indirectly through the ceding insurer. One of the most important effects of this patchy structure is that market information about the reinsurance industry – the business flows, concentrations of risk and so on - are not adequately captured. TThe International Association of Insurance Supervisors published in October 2002 its principles on minimum requirements for supervision of reinsurers. Each member country of the IAIS has effectively agreed to implement these principles, although there is no mandate which could enforce their application. Having said that, the [Financial Services Action Plan] process, whereby the IMF/World Bank review compliance of a countries regulatory system with standards promulgated by official bodies such as the IAIS. TThe IAIS Rreinsurance Ssub committee is also working on a specific standard of supervision of reinsurers which, if adopted, would drive greater consistency and harmonisation in the approach to the regulation and supervision of reinsurers, including technical provisions, investments and liquidity, capital requirements and systems and controls. In addition, the Ffinancial Sstability Fforum and IAIS has formed a joint task force to bring forward proposals on arrangements for the collection and dissemination of relevant market data and on enhanced disclosure by individual reinsurers. And finally, the EU is working on a fast track reinsurance directive, which again, will establish common standards among EU member states in the regulation of reinsurance. I mention each of these regulatory initiatives because it is clear that greater transparency of data, consistency of regulatory approach and closer collaboration among regulators is central to the management of systemic risk and the avoidance of the armageddon scenario in this large, complex and pivotal sector in the stability of the global insurance market.

So a few concluding remarks. The reinsurance industry has demonstrated its resilience time and time again in the past. Piper Alpha, Hurricane Andrew and it seems as though it will, to a great extent, once again with WTC. But nobody in the sector can afford to be complacent. On the contrary, the Armageddon scenario post WTC has concentrated the minds of the rating agencies, brokers, regulators, finance industries and I am sure, also, business leaders. Through tragic experience, firms have witnessed a shift in the boundary of the unthinkable and will need to build this in to their stress tests. Regulators have a lot of work to do and I hope firms will come willingly to the table in the interests of market compliance and market stability and to fend off the Armageddon scenario. Thank you.

More Speeches: