What were the big issues for North American CROs in 2012?
The Council spent a lot of time last year studying and responding to the changing regulatory landscape. We had a lot of requests to provide input on emerging risk-based (US) state regulation, international regulation, and the emergence of federal regulation for some insurance companies in the US.
At the state level in the US, the Council has been heavily involved in the introduction of ORSA
The introduction of Federal Reserve supervision (for some Council members) and the introduction of the Federal Insurance Office were also areas that a large subset of the Council has been following. We similarly have focused our attention on providing the CRO perspective into emerging federal risk and capital standards.
When the Council was formed two years ago our intent was to focus on the development and promulgation of sound risk management practices within the insurance industry. Given the breadth and pace of regulatory change, we have been (understandably) preoccupied with the changing landscape, maintaining a more “external” focus. Over time we have turned our focus back to internal practices, becoming more introspective and prioritising, discussing, and debating internal sound practices. Here we have sharpened our focus on issues including model governance, stress and scenario testing, and emerging risks.
Are you happy with the way regulation is developing in the US?
I view ORSA as a generally positive development thus far. If implemented properly, I think ORSA could prove to be equally useful to both companies and regulators alike. The danger exists, however, for ORSA to turn into a high-cost, low-value exercise in regulatory compliance. This is an outcome we have all worked hard to avoid, although we are in the early stages. We have a good start, but implementation and operation will be the key. If this evolves into a “tick-the-box” exercise or a “one-size-fits-all” practice, ORSA will have failed to deliver on its promise.
While I feel there has been a productive collaboration resulting in meaningful progress on the state front (with ORSA, for example), there has been considerably slower progress and less engagement at the federal level. With respect to the regulations regarding the federal supervision of insurance companies, our input has not demonstrably resulted in meaningful change. However, again, we are early in the rulemaking process and the Council hopes to continue to provide valuable input that will be reflected in final rules. To date, the companies subject to federal supervision are largely living with a banking risk and capital model transposed onto the insurance industry. It is the proverbial square peg in a round hole. The proposed capital framework that these companies could be subject to is broadly perceived to be ill-suited for the risks of the industry. Furthermore, it could have a variety of unintended consequences. The capital models that have been proposed to gauge insurer financial strength have very little to do with the liability-based risks that most insurance companies are in business to take (which even within the industry can be dramatically different). The proposed capital model really only looks at market risk, and only from the asset perspective at that.
With an incomplete and insufficiently tailored risk-based capital framework, one could envision unintended industry impacts and perhaps even an exacerbation of systemic risk — not necessarily a reduction. Providing a framework that encourages insurers to act like banks from a capital perspective could have all kinds of unintended consequences. The collective industry feedback has at best delayed the implementation — but it hasn’t (yet) meaningfully influenced or enhanced its design. Again, these rules have been put forth in proposed form, and we are hopeful that our feedback will be reflected in final rules that adequately tailor capital models to the business of insurance.
How will another term for the Obama administration affect the insurance industry, from a CRO perspective?
I won’t venture to speak for the Council on this one, and I’m not sure you’d find a consensus view. From my perspective as CRO, in the near term I think one can largely expect a continuation of the progression of regulatory change from the past several years (perhaps with a slightly diminished focus on financial services more broadly as the political agenda moves on). Practically, not much will change over the next four years. There may be a tail wind on changes already in the pipeline at the federal level, but the focus of the administration is likely to shift as well. The chance of any substantial changes to Dodd-Frank
In the longer term (particularly beyond the next four years) there’s likely to be more debate over what risk should be borne by the consumer, by businesses, what gets transferred to the private sector and what risk gets socialised via the government. This is a longer term question (where the answer is likely to evolve over time) about where risk resides (e.g. flood risk, TRIA
What will be the main impacts of Super Storm Sandy on the industry?
Sandy, while unexpected, wasn’t an unforeseeable event: there were certainly events similar, if not exactly comparable, to Sandy in the modelling scenarios used by the industry. Notwithstanding that, it reinforced the need for insurers to have a balanced portfolio and to continue to look for diversification (both in terms of geography and risk exposures).There is only so much reliance one can (or should) place on models — in the long run, risk diversification and a strong capital cushion really do matter to be able to absorb these unexpected loss events. In my opinion, prudent diversification is paramount to effective risk and capital management in this business, and preparing for material unexpected losses must be a part of the risk and capital management framework.
Weather volatility is always a topic for property-casualty companies — it is the gift that seemingly keeps on giving and keeps CROs busy. But the nature of these events is not necessarily consistent. In 2011 the big issue wasn’t hurricanes (or post-tropical cyclones in Sandy’s case) it was tornadoes — inland convective storms. We have seen a wide-range of weather events with little discernible trend other than heightened volatility. CROs are being asked by their boards, “is this activity the new normal?” We spend considerable time with our Board on weather risk management issues, including discussions of climate change and weather volatility, and I expect that will continue. Incidentally, following the exceedingly active tornado cycle of 2011, 2012 turned out to be among the lowest years of tornado activity on record. Then came Sandy, adding another extreme event of a different nature. So, again, patterns and year-on-year trends are challenging to pinpoint, but volatility continues to be heightened.
The classification of Sandy as a storm rather than a hurricane, and the implications for deductibles, took many in the industry by surprise. What are the implications for CROs?
Much of the industry has used the hurricane designation as a trigger around higher hurricane deductibles as a risk-sharing mechanism. But with Sandy, we experienced a “post tropical cyclone” event with hurricane force winds! The intent of the deductible is clearly to keep the cost of the insurance reasonable, and commensurate with the risk. But the industry may now have to go back and look at the effectiveness of this risk sharing mechanism and ask ourselves if the design, which theoretically lowered the risk and price, really just lowered the price. If we are modelling reduced risk which isn’t there when the event hits, we must reconsider the risk and associated cost to ensure we are prudently managing our overall risk profile for the long-term benefit of our policyholders.
We have the ability to quantify the impact with and without those deductibles. But whether that is fully reflected in price but not in loss costs, that’s a different issue. And it gives rise to other issues, of course, for example around reputation risk.
What’s the outlook for insurance market conditions, from a CRO perspective?
There’s so much uncertainty impacting insurance market conditions, from the weather to investment markets, from taxes to regulatory reform, from disruptive technology to information security. These uncertainties impact the insurers (how they plan, how they invest, how they price, and what and where they choose to write), but they also impact our policyholders. Risk (in this case, uncertainty) is opportunity and this level of uncertainty creates an environment that makes people think carefully about transferring risk. It also underlines the role of CROs in companies that want to be prudent about how much risk they accept, the types of risk they accept, and at what price they accept it in order to protect the long-term solvency of the firm.
Insurance pricing drivers having to do with supply and demand are still there. But if I broaden the aperture I see so much more that affects insureds’ decisions as well as the insurers’. As a mutual insurance company, our role is about pooling and diversifying the risks that individuals can’t bear themselves — and insureds (both commercial and consumer) are constantly adding to that list of risks in these times of heightened uncertainty. Our challenge is to effectively diversify these risks, price them prudently, and back them with a strong capital position to provide stability and protection when it is needed.
What are the likely big topics in 2013 for North American CROs? Any emerging risk issues on your radar right now?
On the true risk management agenda, the low interest rate environment will continue to be an area of concern for the industry. How long will it persist and what are the risks three years out? Ten years out?
We will continue, and enhance, our focus on emerging risks in 2013. Some so-called emerging risks are already here, but may become amplified over the horizon. Information security and privacy, for example, are not new but they’re becoming more pressing as the threat environment continues to change.
There are some interesting liability risks that emerge out of technological advances, as we see with fracking, for example, or the use of nanotechnology. Further into the future, there will likely be disruption in standard lines such as in auto with the development of the driverless car. How will changing consumer behaviours influence customer needs and product design? That’s a big question for the future.
And of course there continues to be significant regulatory change, particularly around convergence or alignment of frameworks at the international level. There is likely to continue to be significant CRO engagement (including via the North American CRO Council and European CRO Forum) in providing input as regulatory risk and capital frameworks evolve.