Wave of new regulation tops insurance sector risks

‘Banana Skins’ poll pinpoints key concerns for insurers

“The greatest risk facing the insurance industry is the raft of new regulations being introduced simultaneously at international and local levels, according to a 2011 global survey which ranks insurance sector risks” says Victor Muguto, PwC Southern Africa Insurance Leader. He adds that “In South Africa the combined effect of the Solvency Assessment and Management, Twin Peak Prudential and Market Conduct proposals are significant examples”.

The 2011 global Insurance Banana Skins survey conducted by the Centre for the Study of Financial Innovation (CSFI), in association with PwC, says that new rules governing issues such as solvency and market conduct could swamp the industry with costs and compliance problems. It could also distract management from the more urgent task of running profitable businesses at a time when the industry is already under stress.

The survey polled 490 insurance practitioners and industry observers in 40 countries – including 4 South African respondents - to find out where they saw the greatest risks over the next 2 to 3 years. Regulatory risk emerged a clear leader in all major markets, including North America, Europe, Middle East/Asia and the Far East/Pacific.

The EU’s Solvency II Directive, due for implementation in the EU by the end of this year, was the focus of strongest concern. South Africa’s Solvency II equivalent, Solvency Assessment and Management (SAM), is due for implementation in 2014. The survey also identified new international financial reporting standards, the UK’s review of retail distribution practices and other tax and regulatory initiatives as swelling a heavy agenda.

Other high-ranking concerns revealed by the survey include the availability of capital to meet tougher regulatory requirements – particularly in the EU. Respondents from the US, Bermuda, the Far East and South Africa also expressed similar concerns. Other concerns include the uncertain state of the world economy and financial markets. Sluggish world economic growth has a significant impact on the demand for insurance, while resurgent inflation negatively impacts insurance portfolios. A combination of economic recession, low interest rates and sovereign debt fears in the euro zone has also cut investment returns at a time when the industry badly needs them. These are adding to the pressures on an industry which is already being squeezed by slow growth and intense competition.

A strong riser in this year’s ranking of 26 risks was the incidence of natural catastrophes, a reaction to recent disasters in New Zealand and Japan. Also rising strongly is political risk, a consequence of events in North Africa and the Middle East, plus growing concerns about the solvency of some euro zone countries such as Greece and Spain.

A new entrant is the shortage of talent, which emerged as a major issue in all regions, including specialist areas of underwriting. South Africa was one of the respondent countries highlighting the difficulty of finding and retaining good staff. The demands of Solvency II, and SAM, are also seen as drawing the industry’s best people away from managing the commercial side of business, and adding to the shortage of talent.

As normality returns to financial markets and to the banking sector, deep-seated reputational issues for the insurance industry are beginning to appear. Issues include consumer mistrust of insurers, accusations of lack of desire to pay out claims due to floods/water damage, exclusionary language, poor policy wordings and insufficient transparency. In South Africa, one respondent said that “churning of life policies due to upfront commission is leading to reputational damage and further regulation.”

On the other hand, a number of risks have fallen in urgency, among them the use of complex instruments which created difficulties for insurance companies during the financial crisis. The industry’s capacity to manage risk is also seen to have improved.

Despite a high incidence of floods, bombings and oil spills over the last couple of years, concern about climate change, terrorism and pollution risks remains low. These are seen to be manageable underwriting risks, and less threatening to insurers than regulatory change.

Muguto adds that “Insurers’ attention has clearly changed, with much more focus on how to deal with the increasing regulation they face. This could potentially distract key resources and talent away from opportunities to grow their business. However, to gain a competitive advantage, insurers need to move the regulatory burden away from a box-ticking exercise, to something that is embedded in the businesses and used to manage the changing risk profile. All this is set against a challenging backdrop of increased natural catastrophes, low interest rates and uncertain world economy.”

A breakdown of the insurance industry responses by sector shows that the life side is specifically concerned about the impact of low interest rates on investment performance, and the task of managing complex and competitive retail distribution networks. On the non-life side, the main concerns are with excess capacity and competitive pricing, along with the impact of surging catastrophe claims. Concerns in the reinsurance sector are mainly with the security of capacity in a highly competitive market.