Has insurance industry finally learned from its mistakes?

10 April 2011

By Kathleen Barrington

About 20 per cent of Irish based insurance companies cannot meet new EU capital requirements from their existing financial resources, according to a report from the Financial Regulator.

The regulator examined the impact the proposed rules, known as Solvency II, would have on insurance and reinsurance companies. It found that while the majority would meet the solvency capital requirement from existing resources, about one in five firms fell short.

About five per cent would fail to meet even the lower minimum capital requirement. Forty-three companies did not have sufficient own funds to meet the higher requirement.

Of these, 12 would have to raise more capital to meet the lower requirement.
The report found general insurers needed more capital compared with life insurers when the new test was applied.

Overall, 220 companies - representing 81 per cent of the companies impacted by the proposed new rules - participated in the survey.

The Financial Regulator acted after the European Commission asked the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) to run a study on the impact of the so-called Solvency II rules.

The test was conducted between July and November 2010 and based on data at December 31, 2009. It was designed to show how the new rules would have affected companies if they had been in force at that date.

At European level, the test found the financial position of the European insurance sector remains comfortable.

The insurance industry’s funds exceeded the regulatory requirement by around €360 billion, a decrease of €120 billion compared with the current regime.

At European level also, 15 per cent of the participants did not fully meet the solvency capital requirement which would trigger regulatory action.

Just under 5 per cent of the participants did not fully cover the lower minimum capital requirement which would trigger the most serious intervention from the supervisor - the withdrawal of the license.

The European insurance lobby was out in force last week warning of dire outcomes if the proposed new rules are introduced.

Writing in the Financial Times, the Comité Européen des Assurances, Pan European Insurance Forum, Chief Risk Officer Forum and Chief Financial Officer Forum were not behind the door in reminding readers that the European insurance industry employs one million people and invests more than €6,800 billion in the European economy. The industry argues that the new rules could make the industry more vulnerable to economic downturns and force companies to charge higher prices.

The rules are being designed to protect consumers by requiring insurers to hold reserves in proportion to the risks they underwrite. But the industry is arguing that the new rules are too conservative and will have the opposite effect.

The firms argue, for instance, that the rules result in excessively high capital requirements for non-life and catastrophe risks.

Peter Vipond, director of financial regulation and taxation at the Association of British Insurers was quoted in the Daily Telegraph saying that ‘‘the current draft of the rules are poorly thought through in places, leading to them holding unnecessarily high levels of capital, ultimately penalising consumers.’’

The industry may be right that higher levels of capital will penalise consumers in the form of higher insurance prices. But it is also true that lower levels of capital can ultimately penalise taxpayers if struggling insurance companies end up being propped up at enormous public expense when things go wrong - as has happened with the banking industry.

The cost of bailing out insurance companies can be truly enormous, as the example of American Insurance Group (AIG) has shown.

AIG had to be bailed out at a cost of $182 billion at its peak, after it emerged that it had written so much credit default and mortgage protection insurance that it would break the company - and possibly the entire US financial system - if it were not rescued. Too-big-to-fail AIG had several Irish subsidiaries based in the International Financial Services Centre in Dublin.

Among them was AIG United Guaranty. Its main business in Ireland is providing reinsurance coverage for mortgage indemnity guarantees written throughout the EU, including Spain. Many of those guarantees are being called on as Spain and other countries have suffered a major property crash.

AIG United Guaranty began to report significant losses in 2008 when the credit crunch hit.

So it decided to stop writing new business and to lay off some of its risk with a related party in the US known as MG Reinsurance.

The notes to the Irish company’s 2009 accounts reveal that the move had the ‘‘intention of protecting the company’s surplus in relation to all business written and in force at December 31, 2008.’’

When a reinsurer lays off some of its risk with another reinsurance company, it is known as retrocession.

The notes to the Irish company accounts reveal this retrocession manoeuvre improved the Irish company’s 2009 year end performance considerably.

‘‘The 2009 retained profit of the company of €9.587 million in comparison with a retained loss of €114.784 million for 2008, reflects the impact of the retrocession coverage purchased during the year,” the notes to the accounts reveal.

Closer to home, there are fears that Quinn Insurance, which has been in administration for more than a year, may yet have to rely on the taxpayer to prop it up if no buyers are found willing to assume all the risks that the company has insured.

Insurance is a complex business which is difficult for the lay person to understand. But it is hard to escape the conclusion that many insurance companies have learned little from the financial turmoil of the last few years.

It seems they dislike the proposed new solvency rules because they will require companies to allocate more capital for the risks they are writing, a move that would dent the profitability of the insurance industry.

Instead, they would prefer to report big profits on small capital bases when times are good, and hand taxpayers the bill when times are bad.