Getting the balance right

The second part of KPMG International's research program on how the crisis has affected attitudes in the insurance industry explores the potential impact of regulatory intervention, and how approaches to risk and capital management are changing in response to broader market trends. Huub Arendse summarizes the findings.

Earlier in 2009, the first part of KPMG International's program of research into how the insurance industry was responding to the financial crisis¹, revealed that insurers were cautiously optimistic about growth, but that capital market weaknesses were resulting in significantly greater concern about risk management and capital performance (see: 'A glimmer of hope', frontiers in finance, June 2009). The second part of the research² explores these issues further, in the context of the big regulatory challenges which lie ahead.

In Europe, many insurers face the implementation of Solvency II, new rules governing capital adequacy, and also Market Consistent Embedded Value reporting, where all assets and liabilities are measured in the same way that financial markets would measure assets and liabilities with similar cash flows³. The International Accounting Standards Board has also published draft proposals for IFRS Phase II, which will move the valuation of insurance contracts to a more market-based assessment. All these regulations will impose costs on the business, and will most likely affect levels of capital and earnings volatility.

Many insurers in North America are also bracing themselves for regulatory intervention, possibly spilling over from banks in some cases, but there remains considerable uncertainty over what form this will take. Meanwhile, rating agencies will continue to apply pressure on the industry, including developing their own requirements for solvency and risk management to maintain ratings.

Many insurers have come through the financial crisis with reasonably strong reserves, but this does not prevent capital from being foremost in their minds when they consider possible constraints on growth. Regulatory intervention that could force them to hold more capital is the number one concern, but they are also worried about the cost and availability of capital should they need to increase their buffers. Respondents from both life and non-life insurers share broadly similar concerns about this issue.

Although regulatory change is undoubtedly an issue that keeps senior insurance executives awake at night, it is not the main driver behind strengthening risk and capital management. Important other drivers include the need to improve risk-based decision-making and the allocation of capital. Complying with regulatory change comes a long way down the priority list. This suggests that the primary reason to strengthen risk and capital management is to improve business performance, not simply to react to regulatory change.

A key constraint, however, as the survey suggests, is that many companies lack risk expertise, especially at the most senior level of the organization. Doubts about the level of risk expertise at board level suggest that, while information about risk may be appropriate and reaching the right people, the recipients lack the knowledge to respond to it, or provide the leadership that is necessary to instill a broader risk culture.

There is a clear need for better coordination between risk functions and other areas of the business. The twin drivers of regulatory change and internal pressure to improve business performance are encouraging companies to build stronger bridges between risk functions and other parts of the business. Among the steps that some insurers are taking to improve risk and capital management, the top three relate to improved coordination and collaboration. They want to build stronger links between the risk and finance function, increase the involvement of the risk function in strategic aspects of the business, and facilitate better conversations between risk and lines of business. These findings suggest a real appetite to embed risk management more deeply in their business.

Despite the fact that comprehensive and reliable data is essential to effective risk and capital management, it does not yet appear to be an investment priority. Although insurers have long complained about the quality and availability of data, forthcoming regulatory requirements will expose even greater shortcomings if nothing is done to address the problem. They seem reluctant to invest in improving their data. It comes low down on the priority list for investment, behind process, technology, recruitment and training.

Nevertheless, many insurers recognize that Solvency II, and similar legislation, will have a positive impact on financial stability and risk management: respondents questioned for the research broadly welcome the new capital regime. The majority of respondents believe that the legislation will have a positive impact on their risk management, and on their capital management. Insurers that overcome the barriers to improvement, and invest in the necessary infrastructure to get their risk and capital management right, as well as anticipate and manage forthcoming regulatory initiatives well, will be in a stronger position than their peers. They will also be able to take advantage of emerging product and market opportunities.

Article author

Huub Arendse
Partner
KPMG in the Netherlands +31 20 656 7462 Huub Arendse View all articles by this author

1. A glimmer of hope: Growth prospects in the global insurance industry and the escalation of risk and capital management, KPMG International, June 2009.
2. Getting the balance right: Long-term capital, risk and regulatory challenges for insurers, KPMG International, November 2009.
3. See: 'Fine tuning, Why future regulatory compliance can deliver clarity and performance', frontiers in finance, December 2008.