Keynote Address by Guest-of-Honour, Mr John Palmer, Deputy Managing Director, Monetary Authority of Singapore, at 7th Singapore International Reinsurance Conference (SIRC), 6 Oct 2003, 9.00am, Grand Hyatt Hotel, Singapore
"Coping with Today's Paradox of Price and Affordability of Reinsurance for Asian Companies"
(I) The Global Scene - Reinsurers
The global reinsurance industry is currently going through a rather difficult phase. There is a number of challenges faced by the industry. What are some of these challenges? I will single out three important ones.
2 First, unprecedented claims payouts caused by natural and man-made disasters. Many reinsurers today are still coping with the aftermath of the 911 tragedy, ranked as the largest claim event ever faced by the insurance community.
3 Second, under-reserving for past losses. These have arisen from under-pricing over a number of prior underwriting years, particularly in the casualty business and including claims for asbestosis, medical malpractice, workers' compensation and Directors and Officers' (D&O) related liabilities. As a result, we have seen the need for a number of reinsurers to shore up their reserves. Amounts have totaled in the billions.
4 Third, the recent meltdown of global credit and equity markets, combined with interest rates at historical lows. We have seen a drastic decline in the markets in the last two years. While there has been some recovery in recent months, markets have yet to revert to previous levels. This difficult investment climate has put heavy downward pressure on the value of investments of insurance companies. In comparison with their American counterparts, European reinsurers suffered more, due to their heavier concentration in equity investments. But some American insurers were hit, on the other hand, by major bond defaults. Fixed-income investments have also performed poorly due to the low interest rate environment.
5 What are the results of these global developments? Underwriting performance of reinsurers has been weak. Profit margins have been squeezed. Available equity capital has shrunk and market capacity has been reduced.
6 What have been the consequences? There has been an increasing number of rating downgrades of major reinsurers. In 2002, there were close to 50 downgrades amongst Standard & Poor's Top 150 Reinsurers, including some major names. We also witnessed the exit of one major name from the general reinsurance market. For the remaining reinsurance players, concerns have been expressed about their reduction in capacity, claims payment ability, and adequacy of reserves/ provisions.
7 This series of events has led to some loss of confidence in the reinsurance industry. This loss of confidence is broadly-based. Besides consumers, central banks, supervisory bodies and international financial institutions like the IMF have also become increasingly concerned about the reinsurance industry. These concerns have been communicated publicly through the Financial Stability Forum (FSF). The Forum is a coordinating body of major central banks, finance ministries, supervisory agencies, international financial institutions and standard setting bodies such as the International Association of Insurance Supervisors (IAIS). The Forum has expressed growing anxiety about the reinsurance industry for several reasons, including market concentration, lack of common regulatory standards, inadequate or even non-existent supervision of reinsurers in a number of jurisdictions, opaqueness of reinsurance activities, and deteriorating financial health.
8 This loss of confidence is far from terminal, but it needs to be addressed. Indeed the confidence issue illustrates another paradox parallel to that which forms the theme of today's conference. Though confidence in the reinsurance industry is at a low ebb, at the same time, your services have never been more greatly needed. So there is a strong and powerful incentive for you to get your collective houses in order, and indeed this is already happening.
9 Reinsurers have taken actions on a number of fronts. We have seen some reinsurers raising fresh capital from both the equity and debt markets, while others have resorted to selling minority stakes or suspending dividend payments. There is also a trend towards spin-offs or demergers, with some financial groups divesting themselves out of capital-intensive reinsurance business lines.
10 Reinsurers have started to shift their focus back to their core businesses the things they do best. Underwriting standards, including policy terms and conditions, have been tightened. Reinsurers have also required greater risk retention by the reinsured, imposed higher limits on certain lines of business and added more specific risk definitions and exclusions.
11 In the meantime, there have been other favourable market developments, which to a certain extent, have resulted from the various corrective actions taken by the reinsurance industry. Globally, reinsurance prices are hardening. The hardening is expected to last longer than in previous cycles. There have also been no major catastrophes this year, so far (touch wood!).
12 What is the outlook for the balance of 2003? I think most of you would expect to see a generally improved underwriting year. The recent bounce-back in equity markets has also benefited a number of insurance companies. But, we need to be realistic. Some years of above-average profitability are needed to restore the financial health of many reinsurers.
(II) The Global Scene - Direct Insurers
13 We should now turn our attention to your clients - the direct insurance industry. The global direct insurance industry has been suffering from many of same factors that have caused difficulties for you.
14 Let us consider two key markets by way of example. First, the UK market. The meltdown in the equity markets has adversely affected the financials of both life and non-life UK insurers, in view of their high equity concentrations. Although there have been few casualties to date, many companies are still highly stressed and both policyholders and investors have been unhappy about the poor financial health of their insurers. The situation has not been helped by another eruption of market conduct issues including the alleged mis-selling of mortgage endowment policies.
15 In the US market, which was spared some of the consequences of the equity meltdown, there have been problems with under-reserving for past years, partly in the area of asbestosis-related liabilities. And several major companies on the direct side have had to boost their reserves quite substantially. Just as reinsurers were affected, some direct insurers were impacted by major bond defaults.
16 To sum up the global scene, while the direct insurers are grappling with their own challenges, the reinsurers on whom they rely are still emerging from a period of weakness.
(III) The Regional Scene - Reinsurers and Direct Insurers
17 I have been talking about the reinsurance industry globally. Let us now focus on the regional scene.
18 While the regional reinsurance markets have faced similar challenges to those of the international reinsurance community, they have been impacted to a much lesser extent. Take Singapore for instance. We have seen some market consolidation. The total number of reinsurers operating in Singapore has declined from 42 in 2001 to 33 currently. We have also seen some premium growth. Premiums grew by some 15% in 2002, mainly attributable to rate hardening. As a result, the industry managed to replace losses of more than $300 million in 2001 with a modest profit in 2002. We hope this improvement in profitability will continue.
19 MAS studies have also concluded that the Singapore operations of reinsurers have not been adversely affected by the 911 event or asbestosis and liability claims. They also have not had the high equity exposures of some of he European counterparts.
20 Elsewhere in the region, the picture is reasonably bright. Most markets in the region experienced some premium growth in 2002, with accompanying improvements in profitability and future prospects. Examples include Japan, Australia and Hong Kong.
(IV) Opportunities for Reinsurers
21 So far, we have been talking about problems facing the industry that need to be addressed. But we should not ignore the significant opportunities that may be available to the reinsurance industry. As with other financial industries, the reinsurance industry has up and down cycles. Very often, after a period of weaknesses, significant leaps forward can occur. It is important for reinsurance companies to seek out and seize the business opportunities that are available. Some of the best opportunities are in this region.
22 Reinsurers in this region are ideally positioned to capitalize on the significant growth potential in Asian insurance markets, particularly China and India. Progressive liberalisation and deregulation have improved access to these markets, thereby permitting higher insurance penetration. With increasing consumer sophistication and risk awareness, Asia offers growing business opportunities for insurers and reinsurers alike.
23 All the traditional functions of reinsurance are needed in these developing markets. Through the transfer of risks, reinsurers act as stabilisers to the performance of the direct insurers. They also provide additional underwriting capacity, and create an equity substitute that can be cheaper than borrowing or issuing shares. Reinsurers may also provide guidance and support in the crafting of policy terms and conditions, in setting rates for complex/ unusual coverage, in entering new markets, and even in the dissemination and promulgation of best practices in insurance.
24 As the Asian insurance markets become more developed and complex, reinsurers can and will play a much-expanded role.
(V) Importance of Proper Risk Management
25 If the industry is poised for another leap forward, it is important that this take place on a firm foundation. There is a view within the regulatory community, and MAS shares this, that insurers, both direct insurers and reinsurers, need to adopt a more disciplined approach to underwriting, pricing and investment strategy. Some of the problems that you face have been caused by exogenous factors. But they have often been exacerbated by weak management and control cultures. For instance, some companies have been more concerned about maintaining market share than on achieving underwriting profits. Others have been operating without adequate data to understand their own loss experience in order to make proper pricing and underwriting decisions.
26 Both direct insurers and reinsurers will need to place greater emphasis on risk management. It is the responsibility of the Board and senior management to understand and manage risks in the various business functions.
27 By placing a greater emphasis on the rigorous control of risk, both direct insurers and reinsurers will be better able to weather the difficulties/ challenges facing the industry and take advantage of future business opportunities.
28 As prudent risk management practices become more widespread and deeply rooted, the resilience of the insurance industry as a whole will be strengthened and public confidence will be enhanced.
(VI) Role of Regulators: MAS' Supervisory Responses
29 Insurance regulators are being urged to pay more attention to reinsurance. This is happening through the work of International Association of Insurance Supervisors (IAIS). The IAIS is the key reference source for most insurance supervisors worldwide on best practices of insurance supervision. One good example is the development of the Insurance Core Principles (ICPs) by the IAIS.
30 The ICP framework provides a sound basis for the work of insurance supervisory authorities and sets useful benchmarks for insurance supervisors worldwide on best practices of insurance supervision. The Core Principles cover various aspects of supervisory legislation, supervisory systems and procedures. First adopted in 2000, the ICPs have since been updated and refined. In fact, the revised ICPs were just approved at the largest-ever IAIS Annual General Meeting hosted by Singapore last week.
31 MAS refers to IAIS core principles and standards in making regulations, adapting them where appropriate for local conditions. MAS has been playing an important role in the IAIS. An MAS representative sits on the Executive Committee and chairs the Education sub-committee. We also participate actively in various sub-committees such as the Reinsurance and Solvency & Investment sub-committees.
32 In the area of reinsurance supervision, the IAIS has just completed and adopted a Standard on Supervision of Reinsurers at last week's Annual General Meeting. Supervisory requirements for reinsurers encompass financial strength, supervisory review and disclosure requirements. The Standard also focuses on supervisory review requirements and will be applied to all global reinsurance players. This marks an important milestone towards a harmonized global framework for the supervision of reinsurance activity. At the same time, the IAIS Task Force on Enhanced Disclosure is working towards improving the transparency of the reinsurance industry.
33 What will be the impact of the Standard on Supervision of Reinsurers on reinsurance supervision? As many of you here are aware, reinsurers are currently subject to varying degrees of supervision in different jurisdictions. For those jurisdictions with little or no supervision over their reinsurers (such as some of the European countries), the reinsurers there will experience strengthening of the reinsurance supervisory framework.
34 The impact in Singapore will be minimal. Singapore has always supervised reinsurers operating here. The requirements of the standard have already been largely included in our existing supervisory framework. Reinsurers here will not experience further tightening of our regime.
35 Indeed, we are reasonably comfortable with our existing supervisory regime. We have always sought to strike a middle ground between our prudential and developmental objectives, ie. to protect policyholders' interests, without being unnecessarily intrusive on the insurance operations here.
36 A key element of the IAIS approach to insurance supervision, one that is embedded in the revised Insurance Core Principles and the new Reinsurance Standard is risk management. Increasing emphasis has been placed by the IAIS on monitoring the quality of risk management and control practices factors that will contribute to the financial health of an insurance company, whether direct insurer or reinsurer, over the longer term.
37 How has Singapore responded to the IAIS' emphasis on risk management and control practices?
38 Our on-going risk-based supervisory approach (RBS) is in line with the supervisory philosophy reflected in the IAIS Principles and Standards. Under this approach, we first evaluate the risk profiles of individual companies, before identifying the most important risk areas of each company. We then try to determine whether its internal control processes and systems are adequate for the risks assumed in each key risk area.
39 One of the tools we employ to obtain a better understanding of the risk profiles of individual companies is market surveys. We have completed surveys on several functional areas. The surveys will help us to evaluate the risk profiles of the companies we supervise. We also hope that they will encourage insurance companies to learn about best practices from one another, and upgrade their own standards and practices.
40 As we further refine our supervisory approach, we are committed to seeking views from the industry. We will continue to be open and work in close collaboration with the industry. We want to see not only a vibrant and growing reinsurance industry in Singapore, but also one that is financially sound and well-managed.
(VII) Concluding Remarks
41 These have been difficult times for the reinsurance industry. While issues facing the industry are global in nature, happily, our regional markets have been less affected by some of the global trends.
42 The challenges arising from this difficult period must be addressed, and some progress has clearly been made. At the same time, there are important opportunities for the industry. In particular, Asia's rising profile in global insurance arena, coupled with growing consumer sophistication and risk awareness, offers prospects for significant business growth for both the direct insurers and reinsurers.
43 But, the future will favour the well prepared. To enter new markets and continue to develop new and more sophisticated products, insurers will need to enhance risk management systems.
44 MAS looks forward to working closely with industry and individual companies to help ensure that industry strengthens its prudential base and achieves its full potential in this region.