Address by Ms Luz Foo, Executive Director (Insurance Department), Monetary Authority of Singapore, at the 11th CEO Summit in Asia, 21 March 2011, Marina Mandarin
Ladies and Gentlemen,
1 Good morning and a very warm welcome especially to our foreign guests who have flown in for the event. The theme this year “Repositioning for a New Competitive Era in Asia”, is I am sure of great interest and relevance to all of you. I would like to touch on three areas. These are: the global regulatory environment, the environment in Asia and what insurers should pay attention to, to stay ahead of the game.
The Financial Crisis & Regulatory Reforms
2 In the last three years from 2008, many hard lessons were learnt as the global financial crisis played out. The long growth cycle in many developed countries since the mid 1990s, despite a number of financial shocks, had created an illusion that an economic downturn or recession might be a thing of the past. But over the period, the continued globalization and rapid financial innovation had increased the complexity, inter-linkages and inter-dependency of financial activities. This more complex environment which financial institutions were operating in, was however not fully appreciated. Many had been too pre-occupied with the strong business and economic growth to notice the changing landscape. Risk management was not given sufficient attention or the stature within organizations. And while risk measurement had become more sophisticated especially in its modeling and quantification, it was still largely dependant on historical data inputs. Changes in the external environment and business practices were not properly factored in. Risks which were thought as being sufficiently handled, had multiplied rapidly in the system. All these deficiencies led to a gross underestimation of the risk exposures, and few suspected anything amiss.
3 The financial crisis therefore came as a big shock, and its impact had been extremely brutal and painful. It was not limited to the financial industry. Many economies fell into a deep recession with the sudden collapse in global trade and loss of confidence due to the complete seizure in the credit markets. It is inevitable in the aftermath, that policymakers and regulators would undertake a number of regulatory reforms to increase the resiliency of the financial industry, and with great attention given to large and global financial institutions which are deemed to be systemically important. These reforms touch on a number of areas including capital, liquidity, leverage, corporate governance & risk management. There are also moves to better prepare for cross border resolution of financial institutions, enhance macroprudential surveillance, bring under regulation previously unregulated financial activities, improve cross border supervisory co-operation and ensure greater consistency between cross-sectoral regulations to prevent regulatory arbitrage.
4 The traditional insurance industry was one of the few markets that did not experience any major dislocations. In fact, they held up quite well despite the impact of falling asset prices. But the experience with some insurance groups and monolines had brought attention to certain business models within the insurance industry that had developed a large interconnectedness to other financial institutions and financial markets. They were shown to have played a role in amplifying the crisis.
5 One issue being debated currently is whether insurers pose systemic risks to financial stability. There are some fundamental differences between the insurance and banking business model. Some of these differences help rather to stabilize the system as insurers do not react in the same way as banks would in a given situation, simply because they work differently. In fact, traditional insurers had shown that they did not generate or amplify systemic risk during the crisis. The International Association of Insurance Supervisors (IAIS), of which Singapore is a member of, has shared this view with the Financial Stability Board. But there is recognition that insurers who engage in non-insurance activities interconnected to other financial markets and institutions in a material way, may generate systemic risk. And there is broad agreement that entities carrying out similar activities that have similar risks, should be regulated the same way. As requested by the Financial Stability Board, work is underway by the IAIS on how to identify insurers who might be systemically important.
6 A full review of IAIS’ 2003 Insurance Core Principles (or ICPs) had started since 2007. The ICPs contain principles, standards and guidance for insurance regulators to establish an effective and globally consistent supervisory regime. The updates will take into account the evolving regulatory practices and market developments since 2003. One key area is the incorporation of group supervision into the ICPs. The package of ICPs has been recently released to IAIS members and observers for formal consultation. Regulators around the world, including those in Asia will be reviewing it and accordingly, may enhance their regulatory and supervisory regimes to comply with the ICPs which are being targeted for adoption byOct 2011.
7 Financial institutions including insurers around the world will encounter a myriad of regulatory developments over the next few years. Many of these are necessary to address the shortcomings identified during the crisis. A fine balance must be maintained between achieving the desired regulatory outcomes for financial stability, and not crippling the financial industry. Regulations will also need to be appropriate to local circumstances while preventing regulatory arbitrage.
Environment in Asia
8 Let me now move on to talk about Asia. Asia’s financial institutions escaped the full brunt of the crisis. The collective exposure to the US sub-prime was insignificant, and there were comparatively fewer instances of excessive leveraging. However, the Asian economies were not spared. With many largely dependent on external trade, they were hit hard when global trade collapsed. Singapore with its strong external orientation for example, fell into its deepest recession by 1Q2009. However by 2H09, many Asian economies had recovered and became the engine for global growth.
9 Asia’s growth over the past decade has been impressive. According to the International Monetary Fund, Asia’s gross domestic product (GDP) share of world total grew from 26% in 2000 to 33% in 2010. The four Asian tigers also saw a 78% increase in GDP per capita from 2000 to 2010, while the rest of developing Asia, experienced a 145% corresponding growth.
10 Insurers have long occupied a fundamental role in enabling economic growth and social development around the world. Non-life insurance has helped with natural disaster financing, the economic recovery process after a disaster, protected farmers against adverse weather, supported industrialization, facilitated product development, business expansion and cross border trade to name a few. Life & health insurance have also played a critical role in an individual’s social security and healthcare needs. Insurers as long term investors, have been key to the development of domestic capital markets. So there is a key role for insurers in the Asian growth story.
11 Most of Asia is underinsured in terms of penetration and density. Based on Swiss Re numbers, the insurance density (premium/capita) of Asia in 2009 was only US$247. This is some 6 times lower than that of the US and 7.5 times lower than Europe. Natural catastrophe coverage is also lacking. In Swiss Re’s 2009 report, Asia accounted for 43% of the total number of catastrophes worldwide, and 63% of the total victims. But when you look at its share of insured losses, this was only 9%. More needs to be done to increase the level of penetration and density of insurance in Asia. A strong private-public partnership between industry and governments will be one area to step up on especially in areas of consumer education, introducing affordable protection and in addressing natural catastrophe exposures, some of which might be too large for either party to handle on its own.
12 The strong economic growth, rising affluence, high savings rate, rapid infrastructure development and increasing domestic demand in Asia provide the right mix for insurance growth. There is a mutually reinforcing relationship between economic growth and insurance growth. Based on a Swiss Re report, insurance premiums in Asia grew by 17% in real terms in 2010. And given Asia’s low insurance penetration in both the life and non-life, the potential for continued growth is promising.
13 Nonetheless, there are as many risks in Asia as there are opportunities. Asian economies are at differing stages of development with different needs. Therefore there will be differing priorities, policies and regulatory regimes. How Asian governments and authorities respond to developments on the monetary, marcoeconomic, and regulatory fronts, may increase the level of complexity and uncertainty. These have implications for the business models, strategies, risk and investment appetites of financial service providers in the different countries in Asia.
Maintaining Underwriting Discipline
14 As stalwarts of insurance risks and risk management, insurers should remain disciplined in their underwriting. In fast growing markets, it is tempting to compete for market share and sometimes at the expense of underwriting profitability. But mispricing and under-reserving can lead to serious consequences for the insurer. In a joint study by Grant Reuber in 2000 with OSFI the Canadian regulator, he pointed out that deficient loss reserves & inadequate pricing was a primary cause of insolvency and accounted for about 34% of the insolvencies of general insurers identified. So greater care has to be taken, and it is important that insurers lay the proper groundwork for good underwriting and reserving practices.
15 Placing a heavy dependence on investment returns to compensate for weak underwriting is not a sustainable strategy. The investment environment has become increasingly difficult and will likely remain challenging. Investment managers are also going through a fundamental rethink on their portfolio construction, given the experience with asset correlations and volatilities during the crisis. And although Asia’s capital markets have developed tremendously over the last decade, many may still not be sufficiently deep and liquid, or have enough long term assets to fully meet the needs of insurers who have long term liabilities. In addition, concerns with rising inflation, potential asset bubbles and sudden trend reversal of capital flows out of Asia are creeping in. And while global recovery is on the way, there are still lingering uncertainties. Financial markets remain fragile with the peripheral Euro sovereign debt problem, political instability in the MENA region, and rising oil prices.
16 We have also seen an alarming spate of natural catastrophes occurring in Asia, and we share in the grief of those affected. The floods in China, Pakistan and Australia, the earthquakes in New Zealand, and the most recent devastating Japanese earthquake and tsunami, all of which have taken place within the last nine months. These have a heavy toll on life and the losses have a material impact on the local economy. As noted by Fitch Ratings, some global reinsurers have indicated that they had already exhausted most, if not all, of their 2011 catastrophe budget even prior to the most recent Japanese earthquake. Any further large scale events that hit Asia might challenge the balance sheet of insurers.
17 Insurers must continue to develop their underwriting, pricing and reserving methodologies for risks in Asia. Understanding local market risks and exposures, building better claims data and analysis, establishing or refining Asian catastrophe models, and being able to appreciate the broader economic changes and shifts within the domestic markets and their impact on insurance risks assumed, are important. For example, rising inflation which might not have been anticipated when pricing and reserving, can significantly increase the claims cost. Insurers need to be alert to increased correlation of insurance risks as well during catastrophic events. The Japanese earthquake and tsunami is a good example where large multiple impacts on property, motor, business interruption, marine hull and lives have come together. Insurers must exercise the discipline to stand by adequate pricing levels at all times and to maintain appropriate levels of reserves. This will help minimize the volatility of premiums for clients as well.
Gaining a Long Term Competitive Edge
18 Let me turn to what insurers can focus on to enhance their long term competitive edge in Asia. These are having effective corporate governance and risk management, maintaining fair dealing and high standards of market conduct, developing talent, and finally, enhancing research.
Effective Corporate Governance
19 There has been increased emphasis on effective corporate governance internationally. Many hold the view that a root cause of the global financial crisis was a failure in governance within financial institutions. In particular, this relates to the remuneration and incentive systems, as well as shortcomings in the risk management oversight and board practices. Remuneration systems had incentivised excessive risk taking and short termism that were not in line with the corporate strategy and risk appetite. Risk was not managed properly on an enterprise wide basis. Some Board cultures, whether because of dominant CEOs, Chairmen, or groupthink, stifled challenging and robust discussions critical for good decision making.
20 In 2001, a study was carried out by a group of insurance supervisors known as the London Working Group. This was done in conjunction with the European Commission’s fundamental review of Solvency II. Their remit was to investigate the risks that had threatened the solvency of insurance companies operating in Europe. Based on a review of 21 supervisory cases of failure or near failures, they concluded that weak management or governance was ultimately at the root of every case.
21 In Singapore, MAS recently updated the corporate governance regulations and guidelines. We enhanced the requirements to ensure there is an independent majority in the Board, required a Risk Management Committee to be established for better risk governance, and articulated our expectations of the roles, responsibilities and skills required of a Board in overseeing the relevant risk management and compensation systems.
22 The challenge for financial institutions and insurers is how to implement effective corporate governance. Effective risk management oversight by the Board requires a number of factors to be in place such as good information flows, adequate risk analysis and a good understanding of the impact on potential market events on business models. Having the appropriate IT infrastructure & analytics is needed to facilitate monitoring and obtain timely aggregated risk exposure information. Shortfalls in this area would impede an insurer from accurately measuring its aggregate risk exposures, and therefore make it difficult for management to see the whole picture.
23 An insurer whose board and senior management fully embrace the value and spirit of corporate governance, and work to ensure that there is the right people, systems and processes in place will certainly have a competitive edge in being able to better navigate through difficult environments. In fact in several studies done around the world in different countries, there appears to be empirical evidence which shows a strong correlation between good corporate governance and better financial performance.
Maintaining Fair Dealing and Market Conduct Standards
24 A second area which would give insurers a long term competitive edge is strong fair dealing and market conduct practices. The power of “word of the mouth” is not to be underestimated. Customers who had positive experiences become opinion multipliers. These help to build up the trust and confidence of consumers in insurance products. An insurer that inspires trust and confidence and builds its reputation on this, will be one that is likely to succeed in capturing and growing its market share over the long term.
25 In 2009, the MAS issued fair dealing guidelines to the financial industry in Singapore. These aim to achieve five fair dealing outcomes for the retail customer. Namely, that customers have confidence that fair dealing is central to the corporate culture. Secondly, that financial products and services offered are suitable for the customer. Thirdly, that the financial products are sold by competent representatives who provide quality advice and recommendations. Fourthly, that customers are given clear relevant and timely information to facilitate their decision. And lastly, that complaints if any are handled promptly in an effective and independent manner. We expect the Board to be responsible for charting the corporate policy and strategy to deliver the fair dealing outcomes. This includes setting the culture and incentives, and influencing the attitudes and behavior of its staff to align business practices to achieving fair dealing outcomes.
26 The third important area is talent. Attracting talent is not just a matter of competition amongst insurance companies, but is a bigger issue in relation to the insurance industry’s ability as a whole to attract talent. Many other industry sectors which are growing, compete just as fiercely for talent. In Singapore, the insurers have been working together to attract good talent to the insurance industry. Spearheaded by the General Insurance Association and working with the reinsurers and brokers, they have established an outreach programme to attract and offer the top students from the local universities an internship with the industry. This provides the undergraduates with their first exposure, and aims to create a favourable first impression of the insurance industry before they hit the job market. Another programme run in conjunction with the Singapore College of Insurance, provides a more structured training and career development plan for fresh graduates that have joined the industry.
27 These are useful programmes that MAS is supportive of. We continue to encourage the industry to collaborate more and enhance its training and recruitment efforts at new entrants to grow the “timber” for the whole industry, rather than to just compete recklessly for the same small pool of experienced talent. An increased pool of talent within the industry is mutually beneficial for all in the long run.
28 We encourage insurers to invest in the continuous training and development of its people. The landscape of risks is evolving and getting increasingly complex by the day. Consumers are also becoming more sophisticated. Personnel in the various departments should ideally undergo continuous education to be in the know of the latest developments. Risk managers for example, should be kept up-to-date in terms of the business strategy, market shifts, latest risk monitoring and measurement techniques, and understanding the complex linkages to effectively establish processes and controls to manage, and report risk on a holistic basis. Actuaries would need to have a more thorough understanding of how insurance & mortality risks, investment risks, customer attitudes and medical advances are evolving so as to incorporate these changes into pricing and reserving assumptions.
29 The fourth aspect I will touch on is enhancing research, which can give an insurer a competitive edge. Rapid economic and social changes are taking place in Asia. Climate change is also proving to be another challenge for the industry. Harnessing research will help insurers better understand the risks and areas of vulnerability, whether it is to support product innovation, pricing, increase the sophistication of risk mitigation techniques, or even identify where the next potential area of business might be.
30 The large global insurers, reinsurance brokers, catastrophe modeling companies, and insurance consultancy firms already do plenty of research internally. Entities like the Geneva Association which is supported by the global insurance industry, also does a lot of relevant applied research. However, more research in the Asian context can be done. Academia could be another good source for the industry to leverage on, and there is a lot more room for collaboration between the industry and academia in Asia.
31 A growing number of research institutes have established in Singapore. Those directly related to the insurance industry include NTU’s Institute of Catastrophe Management which does work on natural catastrophe and non-traditional risks, NUS’ Global Asia Institute who looks into aging, climate change, epidemics and urbanization, and SMU’s Centre for Silver Security which looks at a spectrum of issues relating to aging, financial retirement security, health and long term care.
32 In conclusion, it is an exciting time in Asia. There is a strong role for insurers to contribute and share in the growth of Asia. The opportunities are plentiful but the environment has become more challenging from many perspectives. The financial crisis has shown that the unimaginable can happen, and change, when it does take place, occurs all too swiftly. The impact of natural catastrophes on the more globally interconnected Asian countries can also have wider ramifications than originally envisaged. Therefore, insurers must remain vigilant not only against the known risks, but also the unknown risks. Proper underwriting, adequate pricing and prudent reserving are essential for the sustained continuity of insurers. Placing attention on the important areas such as corporate governance, fair dealing and market conduct, talent and research, can further lay a strong foundation for an insurer’s long term competitiveness and viability in Asia. The agenda of the Summit is interesting, and AIR has gathered a lineup of impressive expert speakers. I trust that you will have a fruitful two days. Thank you.