What are the implications of the financial crisis for your business?
For most of this year insurers and insurance commentators have proclaimed that insurance companies will not be much affected by the world financial and banking crisis.
Opinions are now divided. The crisis is causing the underlying asset bases of insurance companies to be seriously eroded and this undermines both the amount of risk they can accept and their overall security.
Whilst insurance companies are regulated, so too are the banks; enough said.
The rating agencies have been criticised along with the regulators for not having predicted and forewarned.
What did they know, what should they have foreseen? That question will not be answered just yet.
An inconceivable event
The American insurance giant, AIG, has recently been bailed out with an $85bn loan from the Federal Reserve Bank of New York. This was as unpredicted by the industry as the events of 9/11. It would
have been thought inconceivable, if it had been considered. AIG is regarded by some as an exceptional case because it was not solely engaged in insurance affairs but also investment banking.
The fact is that there has been intense competition for market share amongst insurers for so long without a correction that the underlying risk-baring insurance rates have been cut to ribbons. Combined with pressure on underlying solvency and assets, the erosion of reinsurance and other financial hedges, the outlook cannot be good.
At this time of year two major reinsurance conferences take place; Monte Carlo in September and Baden Baden in October. At the Baden Baden conference, in particular, the world's leading reinsurers meet to decide the price of reinsurance treaties for the following 12 months starting in January.
The availability and volume of reinsurance capital ultimately determine the ability of insurance companies to trade and the price they charge. The mood at the outset of the conference was reported
to be one of stoicism. Some industry leaders are saying that the soft market has still not bottomed out but it could also be argued that they would say that in front of their competitors. They will keep their powder dry until they get home.
Some market commentators are expressing surprise that the recent damage caused by hurricanes (most recently, Ike), always a topic at conferences, failed to turn the market despite the damage caused by Ike being a category 4 storm. The mood at the close of the conference has been one of confusion. No-one really knows what will happen.
Laying off - complexity
Insurance companies lay off their risk for much the same reasons as betting shops and banks. Insurers buy reinsurance, reinsurers protect themselves with retrocession insurance and those insurers lay off their risk and so on, up the spiral. Eventually the top slice of risk can be offered to, and accepted, by the originating underwriters at the bottom of the pile and its starts all over again. Combined with the remarkable array of derivative and swaps products
that have been born of recent years and the failing bond insurers who were guaranteeing creditworthiness,
the financial complexity underpinning insurance companies is unprecedented and when the bubble is pricked it is
inconceivable that insurers, worldwide, will remain unaffected. It will affect them differently of course, according to their reserves, investments and protections but there is a real possibility of a collapse.
The underlying capitalisation of the leading reinsurers is still said to be robust. It is said that equity
capital has fallen by only 2% in the last twelve months whereas it had fallen by nearly 20% between 2001 and 2002, at the start of the last hard market; when it was not very hard or for very long.
Time will tell.
A testing time
As insurance companies come to their financial year end, and auditors do their annual rounds, insurance companies can expect exceptionally robust treatment. Accountants and actuaries cannot afford to take any risk with
the opinions they give this year.
Prices up? Or worse?
On the other hand some reinsurers are now announcing price rises in 2009 and it is likely that other will follow because it is difficult to foresee a business reason for not doing so. Claims always follow recession and there are predictions both in Europe and USA of a "claims tsunami" on the way. This is, of course, the nub of the issue.
Claims start at the primary insured level and may take several years to reach the reinsurers and show in their results.
This has a levelling effect on insurance rates when investment returns are good and the financial markets are operating at their optimum capacity but when they are not - there is no precedent to determine what will be
the effect. It could be the beginning of the worst crisis the insurance industry has ever experienced. The possibility of insurance companies having to be supported by Government cannot be eliminated. In March of this year predictions were cautiously made that the credit crunch and the underlying sub-prime crisis would not affect Europe and certainly not the insurance industry. That was wrong.
The bottom line
So what are the implications for ordinary policyholders trying to keep insurance in place?
Premium escalation of substantial percentages is the usual impact. In the mid 1980s increases of up to 300% were seen. Market capacity shrank and insurers put their policyholders through extra hoops to sift out the preferred risks and decline the others. Declinature by insurers is a problem in itself because it carries with it a stigma that puts other insurers on notice that there must be something wrong. Even when there is nothing specifically wrong the time and effort needed to persuade insurers otherwise is a further expense and some brokers will just give up. Inevitably, people will put off addressing the issue of what they will do if they cannot afford or cannot get insurance until it haphappens.
It has been so long since anything of this proportion has occurred that most people will not be able to perceive the damaging impact it can have. If insurance is compulsory the implication is one of not being able to trade. Otherwise, it is a matter of exposure to risk and most businesses have not properly assessed that exposure because there has been no need to do so in a prolonged soft mar-
The outlook and options
This presents a fairly bleak outlook for all of us. No-one wants to believe it will happen to them but these are extraordinary times. There are, however, options available and it is worth considering them well in advance of your next renewal.
This document is intended for general guidance. It is not intended to apply to any particular case and does not constitute either legal or insurance advice.