ACTUARIAL FUNCTIONS UNDER SOLVENCY 2

Solvency 2 is a risk-based capital regime being introduced across Europe. It is intended, among other things, to bring a uniform way of determining capital requirement for insurance entities.
 
In semblance to Basel II, Solvency II is organised into Pillars.

• Pillar 1 regulates the capital requirements. Insurers should be capitalised adequate to the risks of their undertakings, especially regarding their asset allocation and their liabilities, based on mark-to-market accounting. Companies could create internal models to calculate their requirements on an individual basis.
• Pillar 2 demands a higher level of risk management and governance. Besides the capital requirements, this is likely become the biggest challenge for smaller firms.
• Pillar 3 establishes higher standards of transparency.

S&P publishes criteria for rating insurers

Standard & Poor's Ratings Services today published its criteria for rating insurance companies.
The company comments "The criteria are intended to enhance the transparency of our ratings on insurers worldwide by creating an integrated, globally consistent framework that builds on our existing criteria. The ratings framework includes business risk and financial risk profiles, as well as new rating factors and subfactors to assess the impact of industry and country risks, prospective capital adequacy, and risk position.
Our aim is to transparently disclose rating factors and clearly specify how we use them to evaluate the creditworthiness of insurance companies and arrive at ratings outcomes. Consistent application of these criteria is intended to enhance the forward-looking nature and comparability of our ratings across industry sectors and geographies.

The criteria documents published today are: 

Deal or No Deal – Has the claims industry lost the art of negotiation?

An insurance policy is a contract like any other

The purchase of an insurance policy is a commercial transaction. Businesses buy insurance to protect themselves from unwanted events which would otherwise have a damaging effect on their profitability. Insurers sell each policy hoping to make a profit from the sale and myriad others like it. It’s about the success of each party’s enterprise, a success measured on the profit and loss account. In that respect it’s no different from the many contracts that businesses enter into, be they vehicle leases, IT purchases, consultant contracts, or staff hires.

Much thought goes into these contracts. Each side of the transaction measures the costs and the likely benefits, negotiations are conducted, prices and terms agreed and hands shaken. That, too, is how insurance contracts are sold and bought, with the broker as an intermediary; in that three-cornered relationship deals are done and each party is satisfied with them. Of course, no contract has any value until the time comes for it to be performed. Staff must work diligently and conscientiously to their job specifications, cars must run properly and be well serviced, IT shouldn’t crash. When those things don’t happen, the buyer of the goods or services has to address the problem with the seller.
Businesses want to reach solutions not disputes
Very few businesses believe in litigation as the first step in any such resolution. Any formal dispute procedure is damaging to the continuity and comfort of the parties, it carries an element of uncertainty and costs time and money. Businesses want to get on with making their profits, they want to get rid of any disputes as quickly and amicably as possible and they generally want to maintain their commercial relationships. That is the very essence of entrepreneurialism, its central reliance on cooperation and working together. Problems are solved by discussion and negotiation leading to the eventual handshake. Deals are done pragmatically, relationships are preserved and the financial welfare of each party is assured. With most contracts performance can be readily measured in the normal day-to-day workings of the business but insurance is different: it’s only when a claim arises that what the seller has to do becomes apparent. It’s at that point that the buyer of the policy has a chance to assess what has been bought and to do so against the everyday standards of commerce.

Insurers have every good reason to make proper evaluation of claims: they have underwriting books and profit and loss accounts to protect; they are guardians of their shareholders’ and policyholders’ interests in the prevention and detection of fraud; they may themselves want to make the settlement of the claim the subject of subrogation, and none of what follows dismisses the importance of these objectives. It is the methods adopted in pursuit of these aims that could lead business policyholders to believe that insurers don’t understand business and don’t know how to deal with the commercial community. Almost by definition entrepreneurialism is the art of deal-making. But business owners and managers may not perceive insurers as interested in making deals, or in flexible negotiation or in pragmatic and quick closure of a claim. Instead, the perception can be of unnecessary precision, more akin to an audit trail than to an opportunity to strike a deal advantageous to each party. It’s not difficult to assess the approximate value of a transaction to each party and to negotiate around that in broad terms: it’s what businesses do all the time.

Commercial policyholders want a commercial approach to their claim

Insurers are required by the FSA to treat their customers fairly yet the experience of some business claimants is that settlement of claims is bureaucratic, prolonged and, adversarial. If the requirements of the Policyholder are not met Insurers risk Claimants believing that insurers do not
have full awareness of the manners and practices of the commercial environment. So Claimants could think insurers see little evidence of the advantages that can accrue to each side of the transaction by doing the deal. Any such deal carries risk, and carries it for each side. Businesses are adept at measuring risk and benefit and running their enterprises accordingly. Insurers, the specialists in risk at the time of issuing the policy, seem to some to be more risk-averse when it comes to claims. Essentially, any business that has a claim has but one imperative, and that is to maintain its financial stability by getting cash in for its profitability and its cash flow. To do that it will generally assess the risks of discounting its claim for such as early settlement, a reduction of management and staff time in meeting insurers’ demands, and restoring the continuity of smooth operation, but they often find no reciprocal appetite.

Responding to the requirements of the Policyholder is the art of good claims handling and Insurers should guard against an unnecessarily complicated and forensic claims process. This will help Claimant businesses to feel that their needs are being met and they are being treated fairly in the claims process.

Source: Claims Focus published by Chartered Institute of Loss Adjusters (CILA)

Common investment myths debunked by Linda Eedes

When it comes to investing, a number of myths continue to endure that have the potential to negatively affect the decisions of ordinary South Africans.

Myth 1: Positive economic growth equals positive investment returns

Often, investors link positive economic growth to positive investment returns, which is not always the case. Investors should be wary of basing investment decisions too heavily on the plethora of economic data they are exposed to on a daily basis, such as GDP growth rates, inflation data, manufacturing and production numbers, various confidence indexes and rating agency and economist outlooks.

A recent study, which analyses 83 countries over a period of the 30 years, confirms that areas of highest growth do not necessarily generate the best investment returns. Rather, the report reveals that the best investment returns were generated from the countries that experienced lowest economic growth.

It is therefore not really about what happens in markets, it is about what happens relative to expectations. Stocks are often priced cheaply in regions where low economic growth is expected, and these low prices however often lead to good investment outcomes.

Investors also tend to think that poor economic returns lead to poor investments, which is certainly not the case. An example of this is RE:CM’s investment in Carrefour, the second largest retailer in the world after WalMart. We started investing in the company during 2012, at the heart of the Macro-economic recession in Europe. Carrefour is a high quality business and when we invested, it was trading at less than its property book alone. Since the initial investment in early 2012, the share price has increased by 35% in US Dollar terms.

Myth 2: Uncertainty should be avoided at all costs

Investors also often tend to avoid areas of near term uncertainty at all costs, which is not always best when making long-term investment decisions. A good example of this is Greece. A year ago, Greece faced a lot of uncertainty and everyone was unsure as to what would happen in the region. This led to investors shying away from the region as they were concerned about the impact of this uncertainty on short-term prices.

Because of the uncertainty and negativity surrounding Greece, RE:CM were able to invest in high quality businesses trading at exceptionally undervalued levels to invest in. RE:CM purchased high quality businesses such as Coca Cola Hellenic and Hellenic Exchanges at exceptionally low prices around the start of 2012. Both have performed exceptionally well and produced returns in excess of 40% in US dollars since then.

This confirms that sometimes, uncertainty brings about an opportunity to invest in high quality businesses at substantially reduced prices where the proverbial baby has been chucked out with the bath water.

Myth 3: A good company is always a good investment
A common myth amongst investors is that a good company is always a good investment. There is a mindset amongst most investors that if they purchase a good, solid company’s shares, it will without a doubt be a good investment over time. This is however not always the case.
A key example of this is the performance of the Microsoft share price. Microsoft has always been a good, high quality business. During the lead up to the technology boom, Microsoft was very popular with investors given the soaring share price.

However, when the tech bubble burst, the share however fell 63% from its peak. This is not because it was a bad company – in fact it was still delivering good fundamental results. But, at the top of the market, its popularity translated into impossibly high expectations and a price to earnings ratio that peaked at 84 times. Despite being a good company, it was a poor investment at that point simply because the price was too high.

Today, Microsoft is trading at a normalised price to earnings ratio of around 10, which is below the world average. Microsoft remains a good company but is now also a good investment at these levels.

It is therefore very important to place significance on the price relative to the value of the investment. By carefully selecting stocks of high quality at reduced prices, we believe that positive investment returns can be generated over time. Unfortunately, high quality businesses don’t become cheap when everything is going well.

REINSURANCE CAPACITY GROWTH TO OUTPACE DEMAND IN 2013

According to Reinsurance Market Outlook published by AONBenfield in January 2013, global reinsurance capacity growth is expected to outpace its demand.

The summary of the report is presented below:

Reinsurance capital reached USD500 billion in 2012. The lack of significant reinsured losses from catastrophes in 2012 was a reasonable departure from the building view of a "new normal" higher level of global catastrophes. Substantially lighter global insured catastrophe losses have restored confidence in both insurers and reinsurers. The new record level of reinsurer capital however, creates what is likely the widest gap between reinsurance supply and demand. Reinsurance supply, measured by capital, grew more than ten percent while reinsurance demand, measured by capacity placed was stable in catastrophe lines and declined in nearly all non-catastrophe lines.

 We expect much further work in the transition toward reinsurers managing more non-equity sources of capital to improve the value proposition to reinsurance buyers during 2013. Larger buyers of reinsurance are already accessing less expensive non-equity based capital to lower their weighted average cost of underwriting capital. This rotation will lead to more reinsurer share repurchases, consolidations and the creation of more reinsurer managed funds businesses. In five years, more than half of the top reinsurers will manage insurance-linked funds for investors.

Reinsurers will also begin to manage their own tail risk with better matched sources of non-proportional retrocession capacity from investors that will continue to find the diversification dynamics of the industry attractive for the foreseeable economic future. Insurers have benefited and will continue to benefit from these dynamics.

 Demand for insurance continues to grow globally but at a slow rate as mature economies continue to show low growth as excesses from the most recent growth years are worked-off and refinanced. There is hope for improved demand growth for insurance and reinsurance.

 While rating agency models and the expected solvency requirements now have insurers and reinsurers taking less risk per unit of capital than they ever have, if similar stress tests are eventually applied to corporate insureds the value of insurance would be more tangible. Lessons from recent events could also drive new demand. These experiences show that insured properties are repaired faster, cost governments less, don't threaten lenders' capital and provide communities continuity. The fact that such considerable efforts globally could be devoted to banking reforms without considering simple measures as insuring mortgaged properties is surprising (e.g. U.S. banks still don't require earthquake insurance on mortgaged properties).

 Economic realities for many governments that finance these risks today point to less premium subsidization and more privatization over time. The reinsurance market is well positioned to meet the additional capacity needs of private insurers should insurance utilization grow. Reinsurer capital has grown to levels far beyond what many governments considered possible when many of the existing government schemes were crafted.

 

While the aforementioned dynamics are in play, we believe global reinsurance supply will continue to be in excess of reinsurance demand for the next important renewal dates in April, June and July 2013. Barring very significant events, we expect our clients to find an orderly and competitive market for their risk transfer needs.

The Rise of Online Social Insurance – Embrace the Change

By Yves Colomb and Charles Wolstein, U.S. based consultants with Towers Watson

Online insurance communities are expected to emerge due to new technology and promise to revolutionise the way insurers do business, making it prudent for insurance leaders to evaluate the impact of online social insurance.

Fifteen years ago, it would have been far-fetched to predict the fall of certain iconic multinationals that consistently broke new ground in their industries. And yet, because they did not keep up with the technological pace, that is exactly what has happened, with some going bankrupt and others being bought at fire-sale prices or simply fading into oblivion. These are compelling reminders that new technologies have transformed business models and reshaped entire industries.

Relevance to insurers

Technology has already significantly changed the insurance industry. Most, if not all, insurance companies are now present and sell their products directly online, and insurance price comparison websites have upset many mature insurance markets and put pressure on profitability. Telematics motor insurance, or usage-based insurance (UBI) as it is known in North America, promises a revolution in individual risk behaviour and insurance purchasing patterns.

But these changes – however disruptive – are still part of an initial phase of the industry’s transformation which started in the early 1990s and has brought immense variety, transparency and choice to many aspects of people’s lives, and empowered them to make more informed decisions. Price comparison websites merely apply Expedia’s business model to another industry, providing consumers with top-down, one-way information flow. Telematics motor insurance, although a dramatic departure from traditional insurance models, is essentially a product of the individual empowerment age: Policyholders trade information on their vehicle usage for the promise of lower premiums and a fairer, more accurate assessment of their risk.

If the empowerment of individuals represents this initial phase of the insurance industry’s evolution, the next stage will see insurers’ top-down, vertical relationships between entities and individuals supplemented with horizontal and bottom-up activity (including peer networks, both social and technological). In other industries, this second phase of ‘social recombining’ has already led to the emergence of multiple layers of online social groups.

People, businesses and organisations sharing similar economic interests have banded together to purchase insurance coverage (or provide it to their peers) for as long as insurance has existed. But current technology encourages new associations to form. It is now relatively easy for individuals sharing similar interests to identify one another and associate online. Indeed, technology enables these previously unconnected people or organisations to identify their peers in ways that were never possible before. For instance, Groupon helped households save money during the last recession by offering group discounts. Importantly, participants were not connected in any way before joining the platform and would probably never have identified their shared interest without the help of technology.

In the near future, people or organisations seeking insurance could meet online and decide to form potentially large, grassroots online social insurance groups (OSIG). These groups could, for example, comprise all the good risks of a specific insurance product or people seeking to insure similar risks. Or it could be a large group from, say, the worst 10% of drivers banding together to obtain better coverage or lower premiums. Individuals would gain more clout and increased bargaining power by becoming part of a group of homogenous (and ultimately more desirable) risk profiles.

Finding favourable conditions

Challenging macroeconomic conditions can increase the perceived value of bargaining power. Sustained economic hardship would accelerate the transition to alternative insurance, as the demand for UBI in the United States after the 2009 global downturn illustrated. The insurance cycle can also push groups of insureds to seek alternative solutions. A strong hardening of insurance rates would provide a compelling incentive for favourable risk profiles to segment themselves away from other insureds. This is routinely observed with corporate captive formation and usage.

Risk profiles historically treated as either marginal targets by traditional insurers or niches by specialists (due to their inherent risk or their low volume), or ignored by both, also have incentives to form social insurance groups to build scale and increase their bargaining power. This is similar to the affinity-group strategy that senior drivers in the UK have used to make coverage more affordable over the last decade. An OSIG could also benefit would-be drivers pushed out of the market by prohibitive premiums and may even help reduce the number of uninsured drivers.

Preparing for online social insurance
Insurers have always worked with interest groups but have not always succeeded at regularly signing or sustaining profitable deals with them. In preparing their online social insurance strategies, insurers may need to:

♦ Counter the inherent volatility of online groups. Technology fosters the emergence of OSIGs, but also makes membership volatile, even though maintaining cohesion is essential to preserve its benefits. Online ‘games’, effective communication and frequent introduction of new features can help prevent member attrition.
♦ Anticipate where OSIGs will flourish, and position themselves to be the insurer of choice. For some groups, the insurer might try to be the moderator (although brokers will compete hard to own this space).
♦ Review their sales capability so that they have the right number of well-trained, properly focused people pursuing opportunities. Most insurers have some very good people in this area, but often their expertise is thinly spread.
♦ Recognise that sales may depend on meeting wider needs than just price. If OSIGs emerge, they are likely to have a common interest and may well prefer a provider that has some link with that shared interest. For example, a supporting wiki website aimed at motorcycle enthusiasts in the UK has proved to be an effective tool.
♦ Balance underwriting and sales. Sales are important, but should not dominate the process, because deals done primarily to grow top-line results often generate sustained underwriting losses.
♦ Recognise the potential impact on margins. If customers organise into groups, they will be better positioned to drive hard bargains and reduce profit margins. Efficiency, a firm control over expenses and a clear, realistic understanding of the economics of such arrangements will be especially important.

The online social age is already a major part of our daily life, but the insurance industry is not a front-runner in this evolution, and it could be several years before it enters phase two. Even if the next phase is not imminent and differs from other industries’ experience, insurers would be prudent to consider the emergence of online social insurance and how their companies would react.

Drawing lessons on transformational market forces from front-runner industries requires keeping an open mind to all possible futures, even if seemingly far-fetched. Some formerly great companies probably wish they had done more of that.