PWC: Investment performance tops insurance risks - Banana Skins poll pinpoints key crisis concerns for insurance sector

The ability to of insurance companies to get through the financial downturn crises depends, above all, on their investment performance.

The CSFI’s latest Insurance Banana Skins survey shows that without the stable investment returns they have depended upon, insurance companies are facing an uncertain future in what is proving to be the worst business crisis in decades. This is in sharp contrast to the previous survey in 2007 when the top focus was on operational risks such as too much regulation. That year, market risks barely featured in the top ten – signifying a major shift in risk perceptions due to the crisis.

The major concern ranked in the survey – being investment performance –was the top Banana Skin voiced in North America and Europe. But it was also a big issue in emerging markets, for example in Russia where share prices have collapsed. An SA respondent, said that “market risk has become much more of an issue in the current credit crunch environment. Extreme volatility has to be managed”.

With over 400 responses from 39 countries, including seven South African respondents, the new Insurance Banana Skins survey, conducted by the CSFI in association with PricewaterhouseCoopers, shows how respondents rank the risks facing the industry. High on the list is the macro-economic outlook and its impact on the insurance industry. Lower business volumes are expected to put strains on profitability and capital in many parts of the world.

Concern over capital availability is now ranked as risk No. 3, sharply up from its previously much lower ranking of 26 in 2007, when access to capital by the sector was taken for granted. This risk has now been turned on its head and capital is no longer freely available, or only at a prohibitive price. This capital shortage will put stress on the insurance industry at a time when regulators are pushing through new rules on capital adequacy. It will also constrict capacity and drive up the cost of insurance. One South African broker respondent noted that a shortage of capital “might leave many risks at the upper end uninsurable”.

Also sharply up on the previous survey is the quality of the insurance industry’s risk management (No 6), and its exposure to complex derivative risk instruments (No 8). There is a strong feeling among respondents that the industry is not naturally equipped to enter these markets and will have to “go back to basics”.

The survey also shows that the industry is seen to be less well prepared to handle risk than it was in 2007. Only four per cent of respondents thought that insurance companies were well prepared compared with 21 per cent last time.

Although concern about too much regulation has slipped down the rankings, it remains a big issue in all the major markets, mainly because of concern about a regulatory crackdown in the wake of the credit crunch. Insurance executives are also worried that the industry will be made to share the cost for what is essentially a banking crisis.

Concern about the quality of management in the insurance industry, which featured strongly in 2007, has also slipped down the list, from No. 3 to No. 13. But, again, this has been overtaken by more urgent risks, and has not disappeared.

Very striking is the sharp fall in environmental-type risks. For example, natural catastrophes and climate change which were in the top ten in 2007, are now ranked in the 20s. This is partly because there have been fewer major events, but also because the industry sees risks in this area becoming more manageable.

David Lascelles, the survey’s editor, said: “The underlying message of this survey is all about crisis management. Can the industry sustain its profitability and capital to get through the crisis? The challenges are unprecedented.”

Barry Stott, PricewaterhouseCoopers SA Financial Services Director, said:

‘’Whilst the top risks identified in the survey are not initially surprising it is salutary to see how markedly the perception of key risks have changed since 2007 and how consistent the views of key risks are around the world.”

“The industry is now operating in the worst economic downturn seen in decades which has led not only to a major reappraisal of key risks but also a concern that the industry is not as well placed to deal with them as it once thought. Responding to these challenges and embedding good risk management practice across organisations is critical if the industry is to emerge from this cycle in a better position.’’

Ilse French, PwC Insurance Technical and Knowledge Management Director, added:

“For the life industry, the downturn is likely to hit the savings business, particularly if there is an extended period of low interest rates. On the non-life side, the main concerns are with the outlook for premiums, and a possible surge in claims, including those motivated by fraud. Concerns in the reinsurance industry are mainly with the security of capacity in a difficult market.”

Click here to read the full report (PDF file 2MB)