The credit crisis has changed the financial world forever and, says Andy Baldwin, there must be a frank dialogue between insurers and regulators on any new fiscal rules
When Bob Dylan sang that The Times They Are a-Changin’ back in the 1960s, he clearly didn’t have the global financial system in mind. But if ever there is a song or particular lyric that has resonance with the situation that we find ourselves in today, it has to be the line: ‘‘Your old road is rapidly ageing, please get out of the new one if you can’t lend a hand.”
In the past 12 months we have witnessed corporate failures, a spate of “shotgun” mergers, government intervention and corporate fraud, the likes of which regulators, the public, policymakers, politicians and indeed the industry do not ever want to see again. The existing regulatory “rule book” has been found wanting and is in the process of being rewritten.
In comparison to the banking and asset management sectors, the insurance industry has weathered the storm relatively well, but it must now be actively involved in the debate. Principally, it must fulfil two roles: firstly, as a major institutional shareholder of UK Plc, and secondly representing the UK and global interests of the UK-based insurance industry. Failure to do so risks allowing a politically motivated regulatory agenda being imposed on the market.
The industry is already deep into the planning phase for Solvency II and International Financial Reporting Standards (IFRS), while life assurers are still working through the implications of the FSA’s recent retail distribution review (RDR) changes. There has never been a greater need for co-ordination between the tripartite regulators in the UK, the EU and across the globe.
The need for “smart” legislation change is particularly important as a recent Ernst & Young global financial services survey suggests it is unlikely that financial services will return to growth before spring 2010. But it is expected that we will see some areas returning to significant profitability this year; ironically led by the trading and investment banking arms of the global banks, which suffered such massive losses in the preceding 18 months. However, in the mainstream UK (and global) retail banking and insurance sector, the majority of players are being driven towards cost reduction, restructuring and selling non-core businesses to navigate back to the required levels of profitability. Those with cash and capital to spare are exploring opportunities to strengthen their primary product, market and distribution strategies.
While managing profitability, the financial services industry has already responded to the underwriting, credit and operational risks presented by the crisis. Our survey showed that the majority of financial institutions have made permanent changes to their risk management strategy; 68% have implemented permanent differences to their regulatory framework and over half (54%) have changed their operating or business model. In difficult trading conditions, insurers must be able to show how they are ensuring the management of underwriting risk in line with target portfolios. The design, placement and management of treaty and facultative reinsurance have received particular attention.
However, it is likely that the final shape of the new risk and regulatory regime will require further investment in risk-management processes. In the current climate, financial institutions may well need to fund these changes by making further cuts or maintaining downward pressure on discretionary spending. This change is likely to be accompanied by a renewed focus on capital-intensive products and activities. Insurers are already seeing the early recognition of the forthcoming Solvency II regime with management attention focusing on certain capital-intensive life products (for example, variable annuities). The underlying investment strategies to support the returns of such products have exposed life insurers in particular to the volatility of the markets drawing greater regulator attention to their own solvency thresholds. It will be interesting to see whether the industry suffers any regulatory “spill-over” effect from the desire to impose counter-cyclicality (that is putting capital away in the good times to ensure it is available in the bad) that appears destined for the UK banking industry.
As the new regulatory framework begins to emerge, it is clear that the landscape for financial services in the broadest sense will never be the same again. While not deemed to be responsible for the original misdemeanours, insurers need to be both vocal stakeholders in shaping the agenda as well as acting as good corporate citizens in the interpretation and operational of any new regime. This is a significant task given the industry is already wrestling with Solvency II, IFRS and a raft of national-specific and EU legislation.
Regulators need to balance two demands: firstly, to make more certain that individual institutions have a fundamentally sound risk profile to protect the consumer; and secondly, to ensure that the amalgamation of individual financial institutions at a country, regional and global level does not again represent a systemic risk to the overall financial system.
The politically charged debate around national versus international regulation will continue for sometime yet. However, it is clear that as regulatory initiatives converge globally, there has never been a greater need for improved dialogue between regulators and insurers, with the latter taking the lead where possible.
If Dylan’s song could be updated, then I am sure hitching a lift would not feature. It is up to the industry to make sure its voice is heard and that it takes a driving seat in the changes ahead.