CROs Gaining Authority, Survey Finds
The forces of change are continuing to reshape the insurance industry and its chief risk officers (CROs) are at the forefront of that change, reports Ernst & Young Global, aka EY.
The professional services multinational just published its fifth annual survey of CROs in the insurance sector. Conducted between December 2014 and February 2015, the survey canvasses views from various senior risk executives at 20 North American insurance companies, with life, P&C and multi-line insurers all represented.
The findings show that “the most profound forces of change” are reflected in an evolution of the CRO role. They have greater authority, are assuming greater responsibilities and gaining an enhanced profile across the organization, with effective risk management increasingly regarded as contributing to market success.
Ways in which this enhanced profile is evidenced include direct participation on key strategic business matters, larger staffs than before and a wider use of stress testing. Nearly three in four CROs told EY that their department had expanded in the past year.
Along with more stress tests, additional staff are needed for operational risk, the own risk and solvency assessment (ORSA) and model risk management. Risk management today is closely “integrated with the business, rather than being an afterthought,” according to one survey respondent.
The report identifies three current key themes cited by CROs:
Capital Standards Still Confuse
The lack of common accounting standards and capital measures makes it difficult to compare performance and solvency across companies. Insurers employ various capital measures, many specific to the company, to analyze their risk exposures over a range of time periods and under different normal and adverse scenarios. The quantitative impact survey (QIS) launched last September by the Federal Reserve Board and field testing by the International Association of Insurance Supervisors (IAIS) persuaded several companies to consider new approaches to regulatory capital treatment.
Expanding risk management capabilities and the hiring of more risk staff confirms that it has become a team activity, played across and at every level of the enterprise.
More Regulations and Intrusive Regulatory Oversight
CROs from insurers not already regulated by the Federal Reserve Board accept, grudgingly, that they will also come under its spotlight. Until recently these CROs were confident that current state-based requirements would remain unchanged, but now accept that the two regulatory regimes, with different risk management standards, will probably converge around more stringent guidelines.
Risk Management Is a Team Sport
The 2015 survey shows CROs spending more time and effort on integrating risk management practices into the business. For some, the risk management function’s value is chiefly measured through its integration with the business. Expanding risk management capabilities and the hiring of more risk staff confirms that it has become a team activity, played across and at every level of the enterprise.
Past and Future Challenges
Asked to identify the main risk challenges currently occupying the insurance industry, 40 percent of CROs surveyed cite the slew of regulation and pending common capital standards. Although a distant second, 14 percent picked cyber risk, showing the CRO’s agenda now extends beyond financial risk. Easing concerns over interest rates and the economy as well as renewal of the Terrorism Risk Insurance Act (TRIA) saw both dip from a year ago to 13 percent and 10 percent respectively. Lingering worries that TRIA might not be extended was subsequently resolved at the end of January. Competition and pricing levels also scored 10 percent.
Looking ahead to the main risk challenges of the next 12 months, 28 percent of CROs surveyed cited capital modeling and stress testing. Three tasks: establishing an enterprise risk management (ERM) framework and governance; integration and transparency; and assessing risk appetite each attracted 15 percent, while both emerging risks and operational risks were cited by 9 percent. Still a high priority a year ago, ORSA has since fallen off the list as many institutions have since participated in one of the three pilots or produced an ORSA draft.
Longer-term, insurance industry CROs expect greater authority and accountability, increased influence and broader interaction over the next few years, with their role becoming more visible and more accountable as it becomes better defined. In the meantime, they are focused on performance and creating value for the business. As one respondent commented, “we are spending less time on defining and debating the role and approach and more time on executing our risk plan.”
The café terraces of Monte Carlo will be bathed in sunshine, literally and figuratively, when reinsurers and brokers meet for Les Rendez-vous de Septembre (RVS), commencing Sept. 9.
Monaco is one of the few European locations to avoid the dark economic clouds that descended on the continent in the wake of the banking sector’s meltdown and ensuing financial crisis. Following five years of austerity, voters used the European Parliament elections in May this year to voice their dissatisfaction.
Yet, despite this sullen atmosphere, the biggest casualties of boom-to-bust such as Spain, Ireland and Greece have been steadily pulling out of recession over the past year.
While Munich Re is averse to speculating on the mood that is likely to prevail at 2014 RVS, its latest Insurance Market Outlook (PDF), published in May, predicted that a broad-based economic recovery across many countries would see global insurance premium growth accelerate to 2.8 percent this year, from 2.1 percent last year, with a further improvement to 3.2 percent in 2015.
Munich Re’s chief economist, Michael Menhart, noted that the pick-up comes after three years of relatively low growth rates.
“In many cases, reinsurance has been used as a means of managing any potential earnings volatility arising from these larger retained portions.” — Charles Whitmore, managing director, head of the property solutions group, Guy Carpenter
Charles Whitmore, managing director, head of the property solutions group at Guy Carpenter, said the “improving economic environment in Europe has enabled insurance carriers to repair balance sheets and press ahead with consolidation and increased retention appetites.”
“In many cases, reinsurance has been used as a means of managing any potential earnings volatility arising from these larger retained portions.”
This generally optimistic outlook was tempered by the fact that Munich Re expects reinsurance premium growth to be more modest than that for primary insurance.
Over the next six years, the German reinsurer expects average growth in global reinsurance markets in real terms of little more than 2 percent per year. RVS attendees will also look back on this year’s January 1 and April 1 renewals, where pricing pressures saw declines of as much as 20 percent for U.S. CAT business.
As Munich Re’s report noted, while the potential of the world’s emerging markets — particularly the so-called BRIC economies of Brazil, Russia, India and China — was a hot topic a few years back, for the time being the major industrialized nations are back in the driving seat.
While the group expects China’s premium volume (which was around $284 billion in 2013) to double by the end of the decade, it will still lag way behind the United States, whose premium volume it predicts will pass the $1,624 billion level by 2020.
Possibly the biggest BRIC disappointment — which attendees may seek to explain — is Brazil. Hopes were high when the country began liberalizing its reinsurance market six years ago, ending the near-70 year monopoly of state-owned IRB.
Within four years, more than 100 reinsurers had established a presence in the country. However, this summer’s World Cup underscored how the economic optimism in 2007, when Brazil won the rights to stage the contest, has steadily dissipated.
Insurer confidence on the country’s economic outlook has fallen to a record low and Standard & Poor’s is among those warning that profitability in the Brazilian reinsurance market remains elusive.
Many reinsurers instead appear to be focusing on gaining a presence in India, once the long-delayed Insurance Laws (Amendment) Bill 2008, which would allow foreign reinsurers to set up offices in the country, is finally cleared by parliament.
France’s biggest reinsurer, Scor, is among those that have signaled their intent to add an Indian operation. Such hopes will have been encouraged by the landslide election victory in May of Narendra Modi. India’s 15th prime minister swept to power on a promise to kick-start an underperforming economy, which reinsurers hope will mean an end to the stalling in opening up its market.
The Top Three
But which trio of issues is most likely to dominate the discussions in Monaco?
“We can be certain that one of the prime themes, as always, will be the prognosis for reinsurance pricing, capacity, [and] terms and conditions at the coming January renewal,” said Christopher Klein, managing director and head of Europe, the Middle East and Africa (EMEA) strategy at Guy Carpenter.
“A second topic will be the continuing influx of new capital into the reinsurance sector from so-called nontraditional sectors, despite the surplus of capacity.
“In the absence of a market-changing loss, continuing pressure on prices and returns can be expected. However, to date, the greatest effect has tended to be in the North American catastrophe market. We will be interested to see if the new capital will start to make significant inroads into the EMEA and Asia Pacific (APAC) regions and non-catastrophe classes.
“Finally,” Klein added, “a favorite topic of discussion at Monte Carlo is speculation about corporate activity and consolidation. This year, we have witnessed some high-profile attempts at consolidation in Bermuda. Expect this topic to continue to make headlines.”
Bryon Ehrhart, chief executive of Aon Benfield Americas, predicted at last year’s RVS that a further $100 billion of alternative capital would enter the reinsurance market by 2018 and said that so far, this prediction is on track.
He cited the decision in early June by the European Central Bank to cut its main interest rate to a record low of 0.15 percent and entering into what the headlines call “uncharted territory” by reducing its interest rate on deposits to a negative figure for the first time, of -0.1 percent.
This could mean that the predicted figure of $100 billion needs revising upwards. As he pointed out, major pension funds are making promises to retirees of returns of 4 percent upwards, against returns on conventional investments that are typically 1.25 percent to 1.5 percent.
Ehrhart cited two relatively recent entrants: Stone Ridge Asset Management — which launched two reinsurance-linked funds as recently as November 2012 and already has $2.5 billion under management — and LGT Capital Partners.
“The impact of the hedge fund reinsurers has been fairly transformative,” he said.
“They have put forward material capacity at very low prices and opened up a whole new set of opportunities for our clients.”
Inevitably, these pricing pressures continue to impact the long-established carriers. As A.M. Best commented earlier this summer, global reinsurance companies in the first quarter of 2014 benefited from below-average catastrophe losses and most continued to report favorable reserve releases, yet those that are publicly traded saw their stock lag the market. From a group of 20, only Bermuda’s Maiden Holdings managed a strong gain (of over 14 percent). The ratings agencies will doubtless dissect this overall sluggish performance at Monte Carlo.
Big Data and El Niño
What else is likely to be on this year’s agenda? The big keynote session or “presentation-debate” will be on Big Data and its potential to significantly change how reinsurers do business. While details of participants were sketchy at the time of writing, the session will be chaired by Michel Liès, chief executive of Swiss Re and the reinsurer said that it “wants to examine with RVS participants and clients how Big Data can enable new business opportunities and how privacy concerns can be addressed.”
Gretchen Hayes, managing director, global strategic advisory at Guy Carpenter, noted the “reinsurance industry is still at the beginning stages when it comes to the potential and competitive advantages of Big Data in combination with predictive analytics.”
“As these technologies continue to advance, insurance companies are reaping the benefits of gathering and analyzing vast amounts of information that come through their own internal networks as well as that of their business partners and even through new external sources.”
Video: The Weather Channel reports on some of the possibilities associated with an El Niño in 2014.
With reports suggesting that there is a 90 percent chance that an El Niño will disrupt global weather patterns this year, the recurring climate phenomenon could also force itself on the discussions.
Beginning as a vast expanse of water in the Pacific that becomes abnormally warm, El Niño has the potential for adverse weather effects ranging from a weaker-than-usual monsoon season in India that starves its paddy fields of vital rain, to scorching heat and bush fires in Australia and sharply reduced fishing catches in South America.
The European Centre for Medium-Range Weather Forecasts predicts that the El Niño phenomenon is highly likely to occur this year; indeed, the organization believes it could potentially be the most damaging since 1997-98, which produced the hottest year on record and a string of natural catastrophes, an estimated 23,000 deaths and total economic losses in the region of $35 billion to $47 billion.
A Taxing Reinsurance Dispute
The U.S. economic recovery is building up a head of steam — a development noted with some envy in Europe where growth is, at best, still anemic. Nonetheless, there is still that pesky deficit to be tackled, which means that tax-raising proposals that never gained much traction before now can still be periodically brought out and dusted off.
Prime examples are bills H.R. 2054 and S. 991, introduced this summer, respectively, by Rep. Richard Neal, D-Mass., who serves on the House Ways and Means select revenue measures subcommittee, and Sen. Bob Menendez, D-N.J., a member of the Senate Finance Committee.
Following President Obama’s budget announcement in April, which raised the possibility of ending some tax breaks commonly enjoyed by international reinsurers doing business in the United States, the duo revived proposals to legislate against U.S.-based companies that claim tax deductions for reinsurance premiums paid to foreign affiliates free from U.S. tax law.
The measure, which has been launched on previous occasions without success, has been promoted this time around as closing an “unintended tax loophole;” one that costs ordinary U.S. taxpayers billions of dollars, as well as handing an unfair advantage to foreign-owned insurers serving the U.S. domestic market over their home-based competitors.
Proponents of the bills cited a $12 billion slice from the deficit over a period of 10 years as the prospective prize if they are pushed through.
Neal has mounted a formidable assembly of facts and figures to back up his argument, such as a steady increase in the amount of reinsurance ceded by insurers to offshore affiliates, from $4 billion in 1996 to $33 billion in 2008; much of the latter figure comprising nearly $21 billion to Bermuda affiliates and over $7 billion to Swiss affiliates.
Meanwhile, Menendez has attacked “the increasing trend of foreign insurance companies moving profits made in America offshore and sticking Americans with the bill,” which he describes as “incredibly troubling.”
CDII Bangs the Drum
The main support for the legislation has, unsurprisingly, come from The Coalition for a Domestic Insurance Industry (CDII) whose slogan is: “Seeking a level playing field for all insurance companies.” The CDII’s 13 U.S.-based members include such big hitters as W. R. Berkley Corp., Chubb, Berkshire Hathaway and Liberty Mutual. Berkley Corp.’s chairman and CEO, William R. Berkley, urged Congress back in May to waste no time in adopting the legislation.
“Congress never intended to give a preference to foreign-controlled insurers over their domestic competitors,” said Berkley. “Closing unintended loopholes to recover lost revenue is one of the best ways to offset the cost of needed tax reform.
“Closing this loophole, staunching the flow of capital overseas, and restoring competitiveness for this important domestic industry is a win for us all.”
Yet the forceful language has not yet attracted mass support for the cause.
As the CDII acknowledged, the legislation has been successfully blocked over several years by what it called “scare tactics” employed by the opposition “claiming that it will adversely affect pricing and capacity in the U.S. market.”
The Federal Insurance Office (FIO) in the U.S. Treasury, set up as a result of the Dodd-Frank Act, has also not been won over by the arguments that lie behind H.R. 2054 and S. 991. This fact was noted by Randi Cigelnik, general counsel at the Property and Casualty Insurers Association of America, when she spoke recently at an insurance conference in Bermuda.
“The domestic industry is split on the [taxation] issue and the FIO is neutral,” said Cigelnik. “Some believe that it will make it more difficult for non-reinsurers to meet the U.S. market’s demand for reinsurance.”
The legislation is also opposed by organizations that stress they are “no friend of the insurance industry” and can, therefore, judge impartially on the taxation issue, such as the Florida Consumer Action Network. Its executive director, Bill Newton, said the proposed legislation would impose “punitive” tax increases on many insurers that Florida residents rely on for hurricane cover.
Newton cited a study by Massachusetts economic consulting firm the Brattle Group on the economic impact of an earlier version of the Neal-Menendez bill. It found that ending the tax concession would result in a 20 percent decrease in the net supply of reinsurance in the United States. According to the study, the impact on Florida consumers would be an overall annual increase of more than $817 million in their insurance bills. The study saw homeowners’ insurance rates rising by 4 percent and a 13 percent hike in commercial insurance rates.
“By shifting the financial burden of rebuilding after a disaster onto already strained domestic insurers and their policyholders, this tariff would disrupt insurance markets while failing to raise revenue in any significant way,” Newton concluded.
The word “protectionism” has also been used, as in a commentary by the think tank R Street Institute. Senior Fellow R. J. Lehmann wrote of the proposal: “This is a protectionist measure that serves the interests of certain large domestic companies by discouraging foreign-based competitors from devoting their capital to U.S. risks.
“It also is simply bad policy, in that it would tend to concentrate U.S. risks within the United States, rather than allowing the global reinsurance system to spread them throughout the globe.”
Back to the Beggining
Brad Kading, president and executive director at the Association of Bermuda Insurers and Reinsurers, said that other consumer groups also oppose the bill, including the European Commission; the governments of the U.K., Germany and Switzerland; former U.S. trade ambassadors; and industry bodies including the Risk Management Society (RIMS).
“The proposal to close the tax loophole has been around for the past seven years and has been part of the president’s budget for the past three,” said Kading. “However, Congress is continually looking at new ways to raise taxes, so the issue hasn’t gone away — even though six insurance regulators and Florida business groups have ‘got the message’ and are opposed to the proposals.
“Indeed the opponents’ coalition has always been much broader based than that of the proponents,” he said.
“Back in 2007, the original proposal was supported by Berkley and Chubb, against which 50 letters of opposition were submitted. So the proponents made their case long before now. However, the Senate has decided that it will go back and begin with a blank sheet of paper in redesigning the tax code and is open to all potential methods of raising revenue.
“Everything is up for grabs,” Kading said, “and this bill might always get through as a part of wider tax-raising proposals. Dave Camp, [R-Mich.], chairman of the House Committee on Ways and Means, wants to have the tax bill ready by the fall. So, theoretically, there could be a floor vote following the Committee vote.”
The external affairs committee at RIMS is also working hard on the issue, as it believes the effects of the bill would be detrimental to members, said Carolyn Snow, the committee’s board liaison member and also director of risk management for health care company Humana.
In April, RIMS wrote to the House Ways and Means Committee’s International Tax Reform Working Group, expressing its disagreement with the administration’s proposed 2014 budget, which includes a proposal to eliminate the tax deduction, as outlined in H.R. 2054 and S. 991.
In the letter, RIMS President John Phelps said the budget proposal to eliminate the tax deduction “would have a chilling effect on the use of foreign reinsurance.”
“As a result,” he wrote, “the availability of coverage would be reduced and costs for consumers would increase significantly, particularly in urban areas subject to terrorism risk and areas prone to natural disasters.”
Snow added that the bill submitted to the Senate by Menendez has, so far, had a notable lack of success in attracting co-sponsors, while that submitted by Neal had gained only one.
“However,” she said, “the U.S. has a big budget deficit and the president has talked of the measure as part of the overall deficit reduction program. So it’s true that there is the potential for it to go through attached to another bill — although quite possibly there’s no more than an outside chance of it happening.
“Nonetheless, it might be regarded as one of the ways of ‘closing the gap’ without creating too much pain, particularly if the general public regards the tax measure as something that affects only corporations. It could, in reality, increase insurance premiums significantly, with household insurance among the classes affected where the insurer cedes reinsurance offshore,” she said.
Snow added that Bermuda-based companies are quietly campaigning against the proposed measure and there is some hope that it might “die a death” naturally, given the strength of the opposition expressed on sites such as www.keepinsurancecompetitive.com.
“One positive sign is that U.S. economic growth shows signs of picking up but there is some question as to how sustainable these signs of recovery are,” she said. “The housing market is showing signs of recovery — but still the deficit remains a major issue.”