The industry “needs leaders that will actually lead,” said outgoing president Andy Homer as he closed the 102nd Insurance and Financial Services Conference of the U.K.’s Chartered Insurance Institute (CII) on Sept. 19. He also admonished the assembled leaders of Britain’s insurance community that facing the market’s new challenges and profiting from new opportunities are ultimately their responsibility.
The conference began with the induction of new CII members, and an impressive lineup of speakers addressed the delegates during the two-day event over a broad range of local and global concerns. The state of the capital markets, equity values and interest rates, the U.S. tort system, asbestos, applying technology, cutting costs, underwriting discipline and how to avoid the market cycle, all figured in discussions.
Closer to home, the delegates examined the effect of the Financial Service Authority’s (FSA) proposed regulations and how to improve the industry’s tarnished image with consumers.
Lloyd’s sets the tone
In his keynote speech Lloyd’s CEO Nick Prettejohn echoed remarks by its chairman, Lord Peter Levene. He called for the industry to reform itself, to overcome the cycle of “peaks and troughs” that dominate the history of insurance, and stressed the vital need to use technology to modernize the way the industry operates in order to reduce costs.
After citing Lloyd’s past initiatives, including establishing Equitas in 1996 to handle asbestos claims, the move to a franchise system and the introduction of annual accounting, he reviewed the market cycle from several viewpoints. “Whichever way you look at it,” Prettejohn concluded, “general insurance has been a cyclical business.” The result “for some classes of business” has been “extremely volatile pricing, which cannot be in the long term best interests of the shareholders of underwriters or brokers—or most importantly, policyholders.”
He echoed the industry’s new mantra—the absolute necessity of making profits on underwriting, rather than relying on investment returns to make up the difference, although this has rarely, if ever, been the case. He stressed that “in the end, generating sustainable positive cash flow and earning a return on capital that exceeds the cost of capital is what matters.”
Company failures are historically caused by management failures, Prettejohn noted, as he urged the industry to improve how it operates. “Time and time again, in history’s two by two matrix, it is only the combination of strong management and strong underwriting, that produces excellent results over the long term.”
A major target is “the legions of people” he observes everyday “around the environs of Lime Street … carrying piles of documents.” The industry still maintains too many inefficient and expensive practices that keep costs high—not only from unnecessary form processing, but also as a result of errors and misunderstandings, many of them traceable to the multiple re-keying of data. “The Lloyd’s market currently spends in excess of £500 million [$825 million] per year on lawyers (and other experts) as part of the claims process,” he said. By using Xchanging for back office processing and through its project Kinnect, Lloyd’s is trying to solve the problems, as are London brokers and the Insurance Underwriting Association, through the “Market Reform Group.”
At a press conference Prettejohn voiced the heretical notion that in order to control the cycle it might be necessary to simply maintain Lloyd’s present capacity (around £20 billion – $31.8 billion) at current levels or even reduce it. “I wouldn’t be disappointed [if capacity stays the same], and we avoid losses.” Lloyd’s may be in a position to do so as its unique structure makes implementing such a business plan more feasible. It will be interesting to see if the rest of the industry can follow its lead.
Impending FSA regulations
While many priorities are shared on a global basis, the U.K. insurance industry is specifically worried about the FSA regulations that will come into force in Oct. 2004 with full enforcement in 2005. According to a CII straw poll 23 percent of the delegates said it was their greatest concern. The new rules, designed to regulate the financial services industry, will require increased reporting and transparency, especially regarding investment products.
During the course of the conference delegates heard from Sarah Wilson, director of the FSA’s “High Street,” or local division and from its new head John Tiner—the microcosm and the macrocosm. Neither of them sought a confrontation, as the FSA needs the cooperation of the insurance community, as both Tiner and Wilson stated, and the insurance community needs the FSA if it’s to restore public confidence. The goals of the FSA and organizations like the CII are in fact quite similar: raise standards of qualification for those who work in insurance; get rid of the bad apples; prepare to face future developments; and above all, treat the public/policyholders, fairly.
That doesn’t mean there’s agreement on all fronts. Insurers are concerned not just about the costs involved, but also the adverse effects the new rules may have on the industry. “The rules on capital requirements are very complex and potentially very burdensome,” said Pierre Lefèvre, CEO of France’s Groupama. “They could undermine the competitiveness of the industry.” He warned that they could drive companies out of the U.K., to places like Gibraltar in a quest to avoid their impact.
Perhaps the best summation came from Robert Hiscox, who heads the company that bears his name. “We need good regulation; in fact I welcome it,” he said. “The needs of society need to be addressed, and that requires good leadership,” which he admitted hadn’t always been evident. He wryly noted the recent influx of brainy people into the industry, but admonished the panel and the audience that you also need “gut instincts,” i.e., experience.
The role of capital
Swiss Re CEO John Coomber, the first Englishman to head the world’s second largest reinsurer, also addressed the needs of society, but from the view of its capital providers. In his luncheon address he pointed out that while loss events such as 9/11 and the U.S. financial scandals had cost the industry around $40 billion, the meltdown in the equity markets had been far worse, effectively withdrawing over $180 billion in capital. He reminded the delegates that “insurance is a pooling mechanism,” and the loss of such a large amount curtails the industry’s ability to perform its role in society.
He also inveighed against the notion of “unlimited liability,” pointing out that it was inherently “a promise that can never be fulfilled.” Coomber stressed that capital should be used to establish companies and attract the skilled people to run them, not to pay claims. Echoing Prettejohn, he expressed disapproval at setting prices by premium level, rather than by the level of risk, and indicated that in some areas, such as terrorism coverage, the industry was simply “not equipped to cope,” making government backup a necessity.
On the following day Martin J. Sullivan, AIG’s vice chairman and co-chief operating officer, was quite pleased to discuss capital positions, especially AIG’s—around $58 billion, $56 billion of which represents retained earnings, with $622 billion in assets. He pointed out, however, that generally the industry’s capital is stretched thin, and stressed the need to consider capital strength when placing policies.
Echoing his boss, Maurice “Hank” Greenberg, Sullivan attacked the high costs of the American legal system, and its inherent unfairness. To British delegates, concerned about “the compensation culture,” as it’s called in the U.K., Sullivan’s statistics were the stuff of nightmares: 15 million lawsuits in 1997; class actions up 1,000 percent since then; $300 billion in awards by 2005; 200,000 asbestos cases in the courts; $13,000 per bed to insure nursing homes in Florida; and all the other horrors of an out of control legal system. Sullivan warned that unless there are some serious reforms, U.S. consumers would be paying an additional $1,000 annually by 2005 to compensate for insurers’ increased costs. The delegates got his unspoken message: You’re next, if you ignore the problem.
Concerns over public image
The U.K. insurance industry is indeed worried about consumers, but less about their lawsuits than about the low esteem consumers have for the industry. According to the straw poll only 11.9 percent of the delegates considered “consumer trust and industry reputation” their chief concern, but, judging from the multiple discussions the topic engendered, it is uppermost in the minds of practically everyone involved in the U.K. insurance market. It was a principal factor that led to the formation of the FSA, and to giving it responsibility to regulate the industry.
The problem may be an old one, but the insurance industry’s entry into financial services has exacerbated it. Beginning in the late 80s and early 90s life and pension insurers’ began marketing a large number of fairly complex financial products; notably “endowment mortgages” (home purchase loans with insurance guarantees) and “with profits” life and pension vehicles, whereby buyers participated in investments. Unfortunately the market downturn and a lot of bad investments resulted in a number of people losing a lot of money when the companies couldn’t meet their promised financial goals. As a result courts and regulators have levied fines and ordered billions of pounds in reimbursements against companies found guilty of “miss-selling” these types of policies. Even though most of the blame falls on the financial services sector, the reputation of the general insurance industry has suffered through contagion.
This has given the industry a big image problem, and several discussions focused on ways to improve it. The CII invited Dame Sheila McKechnie, the outspoken head of the U.K.’s Consumers’ Association and Mick McAteer, the organization’s senior policy advisor, to address the delegates. Unfortunately, Dame McKechnie, whose oft quoted remark that the financial service industry consists of “wide boys [slang for gangsters or hoodlums] in white collars and suits being no better than common thieves,” was ill and could not attend.
McAteer, a deceptively soft-spoken Irishman, more than held his own in the panel discussion he participated in and the lunchtime debate on the final day with CII General Director Dr. Sandy Scott. No one openly disagreed with his observation that restoring consumer confidence should be a top priority. He observed, however, citing remarks by former British Prime Minister William Gladstone in 1864 on his low esteem for the insurance industry, that the problem was not a new one. It’s taken on increased importance, however, because the public’s need for insurance services has grown dramatically, as government pension schemes are being curtailed and risks covered by general insurers multiply.
His concerns on behalf of consumers went well beyond the miss-selling problems. McAteer pointed out that changing demographics—higher numbers of retirees, a fragmented labor market, an increase in the number of single households, trends toward social exclusion, the growing debt burden—signal “a seismic shift in society,” in which the “industry has a vital role to play in contributing to the well-being of the country as a whole.”
The CA has repeatedly criticized the U.K.’s insurers for failing to play that role, and McAteer offered no apology for his organization’s stance. Instead he urged the industry to work with consumers in trying to fulfill their real needs, not just sell them products. “The world has changed and the industry has no choice but to adapt,” he told delegates. He did offer somewhat of an olive branch—with thorns. “If you want to talk to me about it, my door is open. If not, then there will be no compromise and no mercy.”
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