European Insurance Forum Examines Industry Changes

The 10th edition of the European Insurance Forum wrapped up proceedings on Tuesday night. The two-day conference, held at Dublin’s Four Seasons Hotel and sponsored by the Dublin Insurance & Management Association (DIMA), focused on some major issues of worldwide concern, as well as the state of Ireland’s insurance industry.

The imminent changes in European insurance regulation – Solvency II (SII) – was a leitmotif that ran through the entire meeting. While regulation isn’t usually a hot button item, SII’s far reaching proposals will not only change the way insurers conduct their business in the European Union (EU), but will also have far reaching effects around the world – notably in the U.S.

The first presentation and panel discussion concentrated on what’s happening and why it’s important. “2008 is the year of delivery,” said Karl van Hulle, Head of the European Commission’s (EC) Insurance and Pensions, who is directly charged with formulating SII’s provisions. Without going into a detailed discussion, SII aims to change the way the insurance industry – both life and non-life – is regulated by implementing a more principles-based system, which concentrates on the level and nature of risk, rather than capital requirements.

To do so the EC has called on the industry to provide “Quantitative Impact Studies (QIS) as to how the regulations should be formulated. Many conference presenters reminded delegates of the importance of participating in the process. Van Hulle described SII as “a great leap forward,” and noted that it presents one of the rare occasions where Europe has taken the lead in addressing the need for fundamental changes in regulations.

There’s a pressing need to get all of this information together now, even though the official date for SII’s implementation is 2012, as the time required to actually complete the project will take that long.

A.M. Best’s Vasilis Katsipis noted that the main beneficiaries are likely to be “larger companies with more sophisticated capital models and reinsurers.” Smaller companies, notably mutuals and some captives, may have problems.

Outgoing Taoiseach (Prime Minister) Bertie Ahern (he’s stepping down May 8) welcomed delegates after lunch with a keynote speech highlighting the progress Ireland’s economy has made over the last 10 years, notably under his leadership. The island is now the world’s 13th largest financial center. “The Irish economy is relatively solid,” said Ahern, “employment is still O.K. and our banks are healthy,” with little exposure to the subprime lending crisis. He stressed that Ireland’s progress came from a sound educational system and a dedication to being business friendly. He warned that the country shouldn’t be too complacent, however, as there are always competitors, especially in Asia. This can present both a challenge and an opportunity.

Ahern closed his remarks with a strong plea for a yes vote in the upcoming referendum on the adoption of the EU Treaty, noting that it is “crucial to assure future growth and protect Irish jobs.”

Ragnar Lofstedt, Professor of Risk Management and Director of King’s Center of Risk management at King’s College London, explained why public entities – notably regulators and the insurance industry – are among the least trusted by the public, citing some numerous and frequently nonsensical examples.

Dr. Jan White, Chief Executive of New Zealand’s Accident Compensation Corporation, explained how that country’s rather unique system works. Basically everybody, even tourists, are covered, and the emphasis is on preventing injuries in the first place and then rehabilitating the injured. Its self funded, and oh yes – it’s completely no-fault, as New Zealand abolished the right to sue for damages when it adopted the law over 30 years ago – that should send a shiver down the spine of the U.S. trial bar.

No conference is complete without a discussion of climate change, but the EIF offered some refreshing candor on the overheated subject. As a matter of rote we all know it’s very complicated. Just how complicated was extremely well demonstrated by Dr. Mike Lockwood, Professor of Physics and Astronomy at the University of Southampton and Merit Scientist at the Appleton Laboratory.

He presented the sun, then volcanoes, clouds, the sea (surface and deeper), wind, rain, ice, greenhouse gasses and cosmic rays. Each individual phenomenon acts on the others and is in turn acted upon – often forming feedback loops that enforce other reactions. Clouds for instance trap greenhouse gasses, a warming effect, but they also reflect sunlight, a cooling effect.

Lockwood’s diagram of all these forces interacting resembled nothing so much as a deranged and overloaded pinball machine gone completely haywire. While it might have been hard to understand, it elegantly demonstrated just how complex the earth’s climate system really is, and therefore how hard it is for scientists to make accurate predictions of future events.

The same panel then heard from Karen Clark, former CEO of AIR, who now heads her own firm. Clark established the concept of catastrophe models and has been in the forefront of their development, but she told the delegates that they aren’t substitutes for risk analysis. She also noted that the current concerns over climate change don’t necessarily mean more or bigger hurricanes. There have been similar events to Katrina in past years, notably the 1926 hurricane that devastated Miami, and is still, when adjusted for inflation, the costliest hurricane in U.S. history.

“Cat models are guides,” Clark said, noting that the use of computers is still subject to the “garbage in, garbage out” rule as the results are only as good as the data, which is analyzed. In too many cases this has now become “garbage in, gospel out,” Clark continued. Different scenarios and independent information should also be considered in making decisions. One area where real progress can be made is in passing and then enforcing adequate building codes for areas at risk. “Engineers have given us the means to build hurricane resistant buildings since 1981,” she said.

Professor Peter Bofinger of the Institute for Economics at the University of Wuerzberg picked up on the similarity of dealing with hurricane risks and the current storms roiling the financial markets as the credit crisis deepens. Most of the financial world had “no experience and insufficient data” to analyze what they were buying in the form of CDO’s and ABS’ (collateralized debt instruments and asset backed securities),” he said. They relied on the rating agencies. The disconnect between banks knowing their clients, and their ability to assess risk, and the sudden onslaught of anonymous debt instruments that promised high short term returns combined to create the crisis.

Despite the rather ominous presence of the credit crisis, the losses suffered by banks (and some insurers), the housing market slump and the floundering attempts by regulators to get hold of it all, most speakers and delegates do not feel that the insurance industry – apart from the monoline insurers – is under threat. Most companies did not go heavily into the CDO/ABS market, and their balance sheets are strong after two years of good profits. If there is a concern, it’s mainly what the potential D&O and E&O claims will amount to. Negotiations are ongoing, and so far there’s no indication that an avalanche of lawsuits is imminent.

DIMA CEO Sarah Goddard closed the conference with a “Future Shock” Q&A session assisted by a blue ribbon panel. Some of the questions/answers:
No, the credit crunch won’t put any big insurers or reinsurers out of business.

Regulation will never be perfect, but we can at least make it better.

From Karen Clark – “risk models are out of control, as they are all essentially based on historical data that doesn’t take into when new things happen; they should be subjected to ‘stress testing’ to see how they work.

Yes, the world’s reinsurance market could handle a $250 billion loss event.

Basel II failed to regulate the banking industry properly, but Solvency II is based on different principles and will better serve the interests of the insurance industry.

And lastly, from Mike Lockwood, “water resources are the biggest threat from climate change,” as small changes in weather patterns reduce precipitation over wide areas, and this potentially leads to wars.

In true Irish fashion, the remaining panelists, delegates and at least one journalist, repaired to the bar for refreshment after two long and very interesting days.