Opening Address by Mr Low Kwok Mun, Executive Director (Insurance), Monetary Authority of Singapore, at the 8th Singapore International Reinsurance Conference, 26 September 2005
Good morning ladies and gentlemen. It is my pleasure to address you this morning. This is the eighth International Reinsurance Conference organised by the Singapore Reinsurers' Association. I understand that this conference has been held once every two years and I am happy to note that each conference continues to draw significant interest from insurance professionals not only in Singapore but also internationally. Perhaps, this is not surprising given the important role of reinsurance in the management of insurance risks.
2 The theme of this conference is on the management of reinsurance cycles, with a particular focus on Asia. This is very apt in the context of developments over the last few years. Reinsurance is really a global business and we cannot ignore the many events that have occurred around the world even as we focus on Asia. After the tragic events of September 11 that led to significant losses for reinsurers, reinsurance premium rates hardened. Over the next couple of years, the operating environment improved and the outlook for reinsurers brightened. But events took a turn in 2004 with the hurricane season inflicting greater losses on the United States than any other storm season in history. Asia was also not spared as Japan was hit by an unprecedented number of typhoons. Worse was to come when Sumatra was hit by a strong earthquake on 26 December, resulting in a massive tsunami that hit twelve coastal states around the Indian Ocean. Many lives were lost and properties badly damaged. Despite 2004 being the costliest year on record in terms of insured losses, the downward pressure on reinsurance rates continued.
3 The new year saw the continued occurrence of other natural disasters, though on relatively smaller scales. A large part of Mumbai was flooded when it was lashed by heavy rains. But the next and much more devastating catastrophe came in August when Hurricane Katrina blew across the Gulf of Mexico into Louisiana. Not long before Katrina hit the headlines, a number of reinsurers told me that they expect reinsurance rates to continue to be flat or softer for the rest of the year. It appears that reinsurers have forgotten the events of 2004, or perhaps they did not expect that 2005 could be worse than 2004. Hurricane Katrina is therefore a timely reminder of the significant challenges facing the reinsurance industry today.
Lessons to be learnt
4 The events of the last few years seem to indicate an increasing frequency of natural catastrophes across the globe, affecting countries with greater severity. Although the number of events in the 2004 hurricane season was indeed unusual, it was not unexpected. 2005 may not be very different. The destruction caused by Hurricane Katrina and the subsequent flooding will make this the largest insured loss in the history of the United States, surpassing the losses incurred during September 11 and Hurricane Andrew in 1992. The actual losses are still unclear, with some estimates as high as US$60b.
5 The US National Oceanographic and Atmospheric Administration (NOAA) forecasts a whopping 21 tropical storms - double the norm - before the end of the hurricane season this year. That means the United States, Mexico and the Caribbean could still be pounded by many more storms before the year is over, including a major hurricane on a similar scale as Katrina. Fortunately, not all of these will make landfall. A study done by a group of US climatologists noted that the number of tropical cyclones had grown in both duration and intensity by about 50 per cent since the 1970s. As I was preparing this speech, Hurricane Rita was picking up speed in the Gulf of Mexico and threatening to be more devastating that Katrina. But fortunately, it turned out to be less severe. Asia is also not spared such calamities as a number of typhoons have already swept across North Asia, the latest being typhoon Damrey.
6 With stronger balance sheets, the global reinsurance industry managed to weather the difficult times in 2004 and is expected to withstand the losses arising from Hurricane Katrina, notwithstanding that the ratings of some companies have been put on negative credit watch. But this should not give us cause to be complacent.
7 A key lesson from the events in the last few years is the importance of risk analysis and management of accumulation risk arising from natural catastrophes. For simplicity, traditional statistical methods have assumed that the severity and frequency of future losses will be comparable to those in the past, with appropriate adjustments made for rising concentration in insured values. However, we have seen from the Asian tsunami and Hurricane Katrina that the scope of what mother nature could conceivably do is simply too wide. At the same time, the speed of economic changes have picked up considerably. This raises the question of whether historical experience can be relied upon in analysing and projecting future risks. At a more specific level, there is also no reliable model to estimate damage caused by flooding, which partly contributed to the difficulty and delay in arriving at firm estimates of insurance losses from Hurricane Katrina.
8 Going forward, reinsurers will need to adopt more sophisticated risk management techniques to identify, model and monitor risks. There has been some debate on whether reinsurers rely on some moral obligation from their cedants to compensate them for losses on past contracts when negotiating future contracts. But whether or not this is true, it would not matter if the reinsurer is not able to withstand the losses in the first place. As such, in order to ensure their long-term viability, reinsurers will need to invest in appropriate risk management systems that will allow them to assess and accept only those risks that they are able to bear.
9 I am told that in the aftermath of Hurricane Katrina, reinsurance rates have already begun to harden. In addition, there are already some encouraging signs with the increased use of more sophisticated pricing tools amongst reinsurers. Hopefully, with improvements in risk management and greater underwriting discipline, the boom-bust cycles in the reinsurance industry will be a thing of the past.
10 We recognize that we cannot control the forces of nature. Natural catastrophes will continue to occur. We can only be better prepared to face the consequences. Much can be done to mitigate the financial consequences. This is where the roles of insurers and reinsurers are so important, but often not recognised. On the contrary, insurers and reinsurers often get the brunt of the blame if payouts are not made on time or when insurance coverage in the policy contracts is not clear. In a natural catastrophe with substantial loss of lives and property, insurers are often pressured on compassionate grounds into making compensation even if they are not contractually obliged to do so.
Clarity and Certainty of Reinsurance Contracts
11 It is therefore important that there is greater clarity and certainty in insurance and reinsurance contracts. It has been reported that victims of Hurricane Katrina are concerned whether they can claim for damage caused by flooding and looting. Their concerns are understandable. While most standard homeowners' policies exclude coverage of flood damage, it is uncertain whether insurers would agree to recognise claims arising from flood damage to avoid unwanted legal suits and the ensuing bad publicity. If so, reinsurers may likewise be pressured to follow suit.
12 Other complications that may cause problems include whether the losses were the result of "one event" as usually defined in reinsurance contracts. Would the flooding that followed the hurricane constitute a separate event? Even if the flood damage is deemed directly attributable to the hurricane, will all the losses fall within the usual 72 hour limit on an event? Can the insurance and reinsurance community reasonably ascertain how much damage falls within the hour clause?
13 These complications are not unique to the losses arising from Hurricane Katrina and they highlight deficiencies in reinsurance contracts. I am relatively new to the reinsurance industry and I find the reinsurance business quite intriguing indeed. There are many complex and intricate issues. It is quite impossible to craft a reinsurance contract that is so tight that it will not give rise to any legal disputes, especially when it covers natural catastrophes. However, I believe the reinsurance industry could come together to work out solutions to those problems that have already been identified. This will go some way in improving the clarity and certainty of reinsurance contracts, and reinsurers will be better able to identify and manage their risks.
Need for Regulation and Supervision of Reinsurers
14 Natural catastrophes can cause much suffering and distress to those affected. However, they also serve as useful reminders of the important economic benefits provided by insurance products. With adequate insurance coverage, those affected can be compensated for their financial loss so that they can rebuild their homes and companies can restart their businesses.
15 Insurance companies therefore play a significant role in the social and economic well-being of a country. Given their importance in the financial system, insurance companies are subject to regulation and supervision around the world. Insurance companies in turn cede part of the risks they have assumed to reinsurers, which play an important role to spread out the risks that may be too significant for any one insurer to bear. Without strong reinsurers, insurers may have difficulties meeting their claims obligations arising from a large loss event.
16 This is why in Singapore, we devote particular supervisory attention to the reinsurance industry. This is especially so since we allow direct insurers in Singapore to recognise reinsurance obtained from reinsurers in Singapore in the calculation of the insurers' capital and fund solvency requirements. However, almost all of the reinsurers operating here are branches of foreign-incorporated reinsurers, whose operations are beyond our control or influence in Singapore. We have to rely on the strength of the supervision of the parent supervisor.
17 However, the extent of supervision of reinsurers varies across different jurisdictions. In some jurisdictions, there is only basic regulation with minimal supervision. At the same time, there is still much more to be done to strengthen the exchange of supervisory information amongst insurance supervisors around the world.
18 At the 2003 Annual General Meeting of the International Association of Insurance Supervisors (IAIS), a Standard on Supervision of Reinsurers was adopted. This encompasses areas like financial strength, supervisory review and disclosure requirements. While there is still a long way to go before we could achieve greater consistency globally in the supervision of reinsurers, the Standard is an important first step towards that goal.
19 Another significant development is the passing of a new European Union (EU) reinsurance directive in June this year. The essence of the EU reinsurance directive is the introduction of a standard level of supervision which would enable European reinsurers to operate across the EU. The other features of the directive include a mandatory licensing system and quantitative solvency requirements which reflect the increased recognition of the need to regulate reinsurers and the reinsurance industry. This is a positive development indeed.
20 Given that reinsurers operate globally, there is concern that increased regulatory requirements across different jurisdictions could impose unnecessary burden on the industry. Like any other regulated industry, regulation does come with a cost. However, supervisors are mindful not to raise the regulatory costs on the reinsurance industry unnecessarily.
21 At the Monetary Authority of Singapore, we recognise that there is a need to balance between having sound regulations and providing adequate business flexibility. This will be the guiding principle for our review of Risk Based Capital (RBC) requirements for reinsurers. As mentioned earlier, we have a real supervisory concern to ensure that reinsurers operating in Singapore remain financially sound and well managed. But it would not be in our interest to impose too heavy a regulatory burden on reinsurers such that it becomes no longer viable for them to operate here.
22 Events over the last few years have posed significant challenges for reinsurers. While it appears that most global reinsurers will be able to weather the losses, it is perhaps an opportune time for reinsurers to reconsider their pricing models and risk management approaches. There may be a need for a fundamental review of their pricing strategies to ensure that they are able to meet their obligations, especially with the increasing frequency and severity of natural catastrophes. Perhaps, it should not be taken for granted that there would be a repeat of the boom and bust cycles of the past. To minimise this from happening, insurance supervisors around the world have an important role to play in promoting better risk management and underwriting discipline amongst reinsurers. We will do our part in Singapore.
23 I am sure there will be many opportunities for you to consider these issues with the many renowned reinsurance experts that will be speaking to you at this conference. On this note, I wish you a fruitful conference.