Address by Ms Teo Swee Lian, Deputy Managing Director, Monetary Authority of Singapore, at the Life Insurance Association of Singapore, Annual General Meeting Luncheon on 5 March 2009, Shangri-La Hotel, Singapore
1 Good afternoon ladies and gentlemen.
2 Thank you for inviting me to your Annual General Meeting Luncheon, and thank you for the very warm welcome. May I congratulate Mr Darren Thomson on his election as the President of LIA and Mr Tan Hak Leh as Deputy President. I would also like to thank them personally for agreeing to take up the challenge to lead the LIA under such difficult times.
Lessons from the current financial crisis
3 The steepness and to some extent the suddenness of the recent financial meltdown came as a surprise to many. The word “sub-prime” was not unknown. Indeed there had been some warnings that this would be a vulnerable pool of loans but unfortunately, most market watchers and even international bodies tasked to spot early signs of threats to financial stability had mistakenly thought it would be a containable risk.
4 Of course, the events of September 2008 will now forever be etched into memories. In MAS, we now date matters according to pre-Lehman and post-Lehman. The crushing collapse of Lehman Brothers and the bail out of a string of financial institutions which had previously been regarded as indestructible will now be the material of countless business school case studies, books and perhaps even movies. What began as a “containable” US problem has quickly spread to every corner of the globe.
5 Singapore was not spared. In the fourth quarter last year, our economy contracted by 4.2 percent on a YoY basis, bringing total GDP growth for the full year of 2008 to 1.1 percent, this was down substantially from the 7.8 percent in 2007. Though a slowdown in the economy was expected, the size of the drop in growth was well beyond what had been anticipated. Like many other countries, we were hit by the financial tsunami that followed the US sub-prime earthquake. However, our Government was quick to respond. The unprecedented Resilience Package announced by the Minister for Finance is aimed at protecting jobs, kick-starting the economy through stimulating cash-flow, and preparing ourselves with the skills and strength to catch the upswing when the global economy recovers.
6 For the financial sector, we also had to take some precautionary moves. After similar steps were taken by other countries, the Government moved to guarantee all Singapore Dollar and foreign currency deposits of individual and non-bank customers in the middle of October 2008. This was done as a precautionary measure to avoid any potential erosion of our banks’ deposit base and ensure a level international playing field for banks in Singapore. In late October, MAS also established a US $30 billion swap facility with the US Federal Reserve as a purely pre-emptive measure to ensure dollar liquidity for our banking system.
7 The financial crisis has placed a strain on our broad economy and will pose significant challenges for insurance companies as well. Nonetheless, I am comforted that our insurers have thus far been prudent in the management of their businesses. Insurers in Singapore have so far remained well-capitalised, with capital adequacy ratios safely above the minimum regulatory requirement. However, it is essential that insurers continue to remain vigilant in monitoring both their solvency margins and operations because the markets are still fraught with uncertainty.
8 It is clear to all that we have learnt many lessons from the recent crisis and there will be many more to be learnt. For the insurance industry, allow me to touch on three important areas: the importance of sound risk management, keeping to core business, and building long-term customer relationships.
Importance of sound risk management
9 The sudden and sharp falls in global asset markets have emphasised the importance of sound risk management in financial institutions. Financial institutions should proactively manage their business and market risks to enable them to take pre-emptive measures when confronted with stresses in the markets. For example, they should take measures to strengthen their solvency positions early before the financial markets become even less forgiving, thus making it more difficult to raise funding. In the case of insurers, particularly life insurers, managing asset-liability mis-matches is particularly important in making them less vulnerable to adverse market movements. We recognise that in Singapore, the lack of a suitably liquid long-term bond market may pose a challenge to life insurers in matching their long-term liabilities with long-term assets. We acknowledge the feedback and are talking to relevant parties to address the problem. However, there are also opportunities for life insurers to seek innovative but safe solutions to hedge their long-term liabilities in other ways.
10 Stress testing is another important tool that has come under the spotlight in the current crisis. Regulatory bodies have been busy coming out with new enhanced stress testing methods. A common current practice is to stress test according to the worst financial conditions that has historically occurred. However, as demonstrated both historically and by current events, each financial crisis is often unique and could be unprecedented. Stress testing should therefore not be based solely upon historical scenarios but be cognisant of so-called “black swan’ events. A financial institution should also think of what events, however unlikely, could cause it to crash. These are so called “stress to failure” scenarios. By reverse-engineering and understanding the nature and causes of such scenarios, the financial institution could think through measures that can be taken to mitigate or protect itself from these risks.
11 For life insurers, the management of market risks is particularly important given their large investment portfolios. Currently, MAS requires life insurers to undertake an annual stress test that includes prescribed scenarios to assess their resilience to market falls. However, insurers should not just rely on these scenarios but also ponder scenarios that could be specific to but potentially devastating for their own business profiles. Insurers should consider doing “stress to failure” tests so that they are aware of the combination of stress conditions that could lead to insolvency. The more quantitatively-inclined among you, and I suppose this would include the actuaries, will be mortified to hear me say this but we must learn not to get too obsessed over the numbers that are generated from stress testing. The stress testing exercise is as much an art as it is a science. Understanding the dynamic relationships between the different scenarios and the financial health of the institution is what is important. This understanding should help the Board and senior management focus on where the largest vulnerabilities of the firm lie and how to take steps to protect these areas.
12 Besides managing market risks, life insurers should also pay close attention to their investment strategies. Markets all over the world are seeing massive deleveraging and a flight to safe instruments. However, never assume that things do not change. What was once regarded as safe may not be so in future. For example, the burden of corporate debt is now shifting rapidly to public debt. For some countries this may mean large supply shocks to hitherto stable government securities markets.
13 Another area that must not be neglected is the possibility of fraud. It is during times such as now, when there is tightening of available credit and a renewed focus on corporate governance, that previously undetected fraud are brought to light.
14 Moreover, the difficult economic and financial conditions increase the risk of new fraud being committed as people and even firms become increasingly desperate. As noted in the latest Global Fraud Report by Kroll Inc, a risk consulting company based in United States, it is believed that the financial crisis will lead to more fraud claims, legal disputes and regulatory action. These may include cases of “non-malicious” corporate fraud in order to inflate profits to save the company and protect jobs, or the deliberate attempt to “squeeze the cow dry” as in the case of fictitious companies set up to avail themselves of funds of failed companies.
15 For insurers, the issue of fraud would usually involve an exaggeration of an otherwise legitimate claim, premeditated fabrication of a claim or intentional misrepresentation of material information. In life insurance, fraudulent activity would be centralised around health care and longevity products, and we even have instances of people faking death to allow their beneficiaries to claim on their insurance policies.
16 Needless to say, financial institutions must have the necessary measures in place to deter or prevent fraud, and it is not just about buying the latest anti-fraud software or installing the most up-to-date technologies. Fraud is one of the hardest risks to detect and prevent. It is about pitting the intelligence of unscrupulous individuals against the robustness of systems. Financial institutions should constantly be reviewing its controls and measures and have in place a fraud management function to prevent loopholes that fraudsters can exploit.
17 To round off this section on risk management, I would also like to reiterate the important role of the Board and senior management in ensuring that their institutions have sound risk management policies and procedures. The tone from the top is very important in what risk culture permeates a company. Just like the Captain of a ship, the Board should always try to keep the institution on an even keel. It is precisely when times are good that the Board and senior management should not throw caution to the wind but exercise restraint in ensuring that risks are adequately assessed and managed. This will ensure that during stormy times, the institution is in good shape to weather the uncertainties and be well-placed to ride the next wave.
Keeping to the core business
18 In case any of you need reminding, the core business of life insurers is in the underwriting of mortality, morbidity and longevity risks. The primary aim should be to invest the premiums received from selling life policies in assets that generate returns to match the expected payouts for the policies sold. Insurers should not charge into investing in complex products which they have no expert knowledge of, with the slender hope of generating higher returns. They should only be underwriting risks that are within their core expertise. The industry is now littered with examples of those who got into credit derivatives and structured products with disastrous consequences. Ultimately, it is the responsibility of the Board of insurers to ensure that the interests of policyholders are not compromised in the blind pursuit of higher returns for shareholders.
19 That being said, insurers should continue to innovate and develop new products to fill gaps that may exist in the current product market but not in a reckless or haphazard way. In any adversity is an opportunity, companies which are able to differentiate themselves sensibly and prudently in these difficult times will be future winners.
Building long-term relationships with policyholders
20 Again, in case anyone here needs reminding, life insurance is a long term product and hence it is important to adopt business strategies that build lasting relationships with your customers. According to LIA’s statistics, new single and regular premium business in 4Q08 dropped by 69% and 16%, respectively, compared with the same period last year. The sharp fall in single premium business reflects a combination of consumers’ lack of confidence in the financial markets as well as a reduction in disposable income resulting from the significant economic slowdown. Hence the fall is not surprising but it is unfortunate given that many Singaporeans already do not have adequate insurance protection. Life insurers should therefore educate the public on the importance of insurance even in a period of economic uncertainty.
21 First, effort must be taken to ensure that the consumer fully understands the product that is being purchased. It is important that there is always proper disclosure of risks, benefits, fees and charges at the point of sale. However, it goes beyond this to well after the sale has been made. Life insurers can provide more regular updates to policyholders on the impact of the financial turbulence on their policies. This would help allay some of the concerns that policyholders may have and avoid unwarranted, ill-informed policyholder reactions. For instance, insurers can provide information to assure their policyholders of their financial strength and measures they have taken to mitigate the risks in the current market environment. This would calm the fears of policyholders with regard to the security of their policies. It would be unfortunate if policyholders decide to surrender their insurance policies based on rumours and hearsay rather than on facts.
22 Life insurers should also ensure that their agents and financial advisers are adequately briefed and updated with the necessary information. Being often the only point of contact for policyholders, agents and financial advisers play a critical role in ensuring that clear, comprehensive and timely information is communicated to policyholders.
23 Insurers should develop and maintain a good relationship with their policyholders throughout the tenure of their policies and not just in times of uncertainty. The purchase of insurance should not be a once-off transaction but should serve the long-term needs of policyholders as they go through the different stages of their lives.
24 With the current weak investment markets, we note that some insurers have shifted their business strategy from promoting investment-based insurance products towards protection products, in particular, term-life insurance. As I have mentioned earlier, insurance protection amongst Singaporeans is inadequate and this move by insurers is welcomed. However, I hope that this is not only an interim strategy and that when markets recover, the focus will shift back to marketing investment related products where the protection needs of customers again take a back seat. Products should not be recommended based on commissions or prevailing trends, but on the suitability and needs of the customer.
25 Along with increasing customer sophistication and the greater complexity of financial instruments, it is essential that an insurer has a pool of well-trained talent to support its business going forward and to effectively serve its customers’ needs. Building up on such capabilities should not be done only when the business is doing well and ignored when times are difficult. For instance, insurance companies should build up their actuarial and analytical knowledge so that they are able to assess and price risks adequately, even during volatile markets. During the economic boom, insurers have often found themselves stretched in sending staff for up skilling courses. The current financial downturn and slack in new business might serve as an opportune time to invest in talent development. This would position them well to capture future growth opportunities when the economy recovers. Life insurers must invest in training and build their own timber instead of opting for the quick and easy route of just poaching lumber from competitors. This merry-go-round ultimately does not help the industry.
26 This is why MAS has enhanced the training incentives funded by the Financial Sector Development Fund (FSDF). This aims to encourage continued investment in training by the financial industry during the current economic downturn. The enhancements include increases in co-funding from 50% to 70% under the Financial Training Scheme (FTS), and from 70% to 90% for training programmes which are accredited under the Financial Industry Competency Standards (FICS) framework. In addition, the range of Masters programmes that qualify for support under the Finance Scholarship Programme (FSP) has also been broadened beyond the current areas of financial engineering, risk management and actuarial science. They now include programmes in the areas of finance, applied finance and financial economics.
27 I would like to strongly encourage insurers to take advantage of the enhanced funding to further develop their human capital.
28 To conclude, the financial crisis has had a devastating global impact. It has exposed shortcomings in the financial markets and put many financial institutions as well as regulators to a severe test. Those who can survive the challenge and learn from this crisis will emerge stronger and fitter. Even though Singapore’s financial system has not been as badly hurt as others, the environment is still highly uncertain. We must remain vigilant and work together to continue to safeguard the resilience of our financial system as well as individual financial institutions. We look forward to continuing to work closely with individual institutions and with the LIA to achieve this.
29 Thank you.