INSURANCE AND REINSURANCE; A HISTORICAL CHRONOLOGY: More Money Matters; A Poor Start for 21st Century; Natural Catastrophes and a Positive Outlook
More money matters
During the 1960s, countries increasingly held more US dollars than the US could back with its gold reserves.
In 1971, Richard Nixon took the US currency off the gold standard and initiated the demise of the Bretton Woods system, which had supported the stability of global currencies.
Capital markets were quick to adapt to the new risks posed by fluctuating exchange rates and inflation.
Over-the-counter derivatives were used to hedge against such risks and even reinsurance futures were suggested as early as 1973.
The oil crises of 1973 and 1979 upset the international markets further and gave rise to neo-liberal politics.
The ensuing deregulation of the markets was to change the insurance landscape once again.
Markets and companies not prepared to change were slowly overwhelmed by foreign investment and eventually taken over.
Even the London market was forced to wake up when US management styles were introduced and large German insurers started buying British companies.
Mergers and acquisitions of long-standing insurance companies became the norm in the later 1980s and continued into the 1990s.
While most takeovers occurred within the industry, some banks and insurers began joining forces and prepared for a comprehensive financial services model, which would include banking and pensions and sometimes also property insurance.
Large conglomerates appeared on the US market, where the gradual separation of commercial and investment banking opened new market opportunities.
Investment bankers, insurers, pension fund managers, and securities traders were in some cases now all working under one roof.
The question remained whether they were really working together. The most successful part of this all-finance trend was to use banks as distribution channels for insurance products.Most other business lines were kept separate.
One more area, however, led to successful cross-fertilization. Large hurricanes such as Andrew in 1992 highlighted the need for more capacity to handle natural catastrophes.
For investors ILS presented a welcome opportunity to invest in products that were not linked to conventional economic cycles and helped them diversify their investment portfolios.
All in all, during the 20th century, the pace of globalization quickened and rising Asian and Eastern European economies joined the competition.
Insurance was in greater supply than ever to meet growing demand in existing and new markets.
But risks, too, were becoming more and more global.
Towards the end of the 20th century the threat of a global collapse of computer systems caused by the so-called Y2K or millennium bug alarmed every single computer owner across the planet and businesses and government organizations even more.
In the end it turned out to be a non-event. The risk had been overestimated, as had been the performance of many new-technology companies before the so-called dot-com bubble burst, causing a severe stock market crash.
Yet the largest man-made insured catastrophe of all times was to happen somewhere else and in a way that no-one had foreseen.
A poor start for the 21st century
In many ways the new millennium began amid widespread optimism. The benefits of globalization and technological progress were having a dramatic effect on the lives of millions around the globe, and brisk international trade signaled that the world’s economy was growing.
However, this optimism was soon overshadowed by fear and uncertainty and the first decade of the 21st century was to epitomize the major challenges the industry is dealing with today:
Terrorism, financial crises, natural disasters, pandemics, longevity, and changes in the regulatory environment.
The terrorist attack of 11 September 2001 claimed the lives of almost 3,000 people, many of whom worked or insurance and other financial services firms.
In addition to the tragic loss of life, 9/11 ushered in a period of persistent political volatility and global security concerns.
The insurance industry shouldered much of the economic burden. Insurers paid an estimated USD 23.8 billion, making 9/11 the most costly insured man-made disaster ever – and, at the time, the second most expensive insured loss after Hurricane Andrew.
Assessing
the insured loss was a highly complex undertaking; large claims were filed for
a number of seemingly unrelated risks including aviation, property, liability
lines, business interruption and life insurance. Losses and potential exposures
were not confined to New York, either – airlines were grounded, restrictive
security measures were implemented and events were cancelled around the world.
Insurers realized they could no longer offer terrorism insurance on the same terms as in the past.
Once offered as a blanket cover with property insurance – and with little consideration for price and accumulation of exposure – terrorism cover was immediately withdrawn by all but a handful of specialist insurers. The aviation and property insurance markets, however, were quick to respond with alternative solutions, and the standalone terrorism insurance market was born.
The size and complexity of losses would force companies but also society at large to think differently about risk. Although the stock markets remained reasonably robust in the aftermath of 9/11, the attack brought the global economy to a grinding halt, due to uncertainty of the effect on stocks worldwide.
Insurers had to contend with unstable financial markets during this volatile period. The dot-com bubble preceding 9/11 and the ensuing political uncertainty of wars affected the investments of insurers and reinsurers, causing many to write down the value of their assets and reduce their exposure to equities.
Some insurers, and European reinsurers in particular, embarked on an accelerated programme to strengthen their risk management, governance, and asset management.
They fortified their systems to manage accumulations of risk and liabilities in their asset portfolios and developed the first economic models.
All of this occurred at the end of a soft market. Low rates and increasing liability claims had started to erode the profits of US insurers, and prices began growing firmer in some commercial lines.
The losses of 9/11 accelerated this trend, and almost overnight the cost of insurance went up.
The hardening market for insurance helped restore profitability, but within four years the market was to face a second major catastrophe.
Natural catastrophes
Katrina first made landfall as a Category 1 hurricane in Florida on 25 August 2005; four days later it came ashore again as a Category 4 storm. Katrina caused massive damage to New Orleans before moving inland to wreak havoc across the southern US.
At the time, Hurricane Katrina was the most expensive catastrophe ever recorded, with total losses of USD 135 billion.
It has since been surpassed by the 2011 Tõhoku earthquake and tsunami which caused USD 210 billion in losses, although Katrina remains the most expensive insured loss at USD 75 billion.
Yet despite the magnitude of the losses inflicted by Katrina, the hurricane failed to bankrupt a single company.
This was largely due to reinsurers who over the previous decades had specialized in providing cover for natural catastrophe risks and had done so to a much greater degree than had other organizations.
Besides prompting a greater focus on analyzing accumulated exposures, the hurricane was a boon to the growing catastrophe bond market, which enjoyed its best year ever in 2007, issuing some USD 8.5 billion of protection.
A series of large catastrophes in the past few years dramatically reminded the world of the need for reinsurance cover.
The Chile earthquake in 2011, European windstorm Xynthia, floods in Australia both in 2011 and in 2012, the Canterbury earthquake in New Zealand, Hurricane Sandy and the largest insured loss in Japanese history, the Tõhoku earthquake and tsunami, were exceptionally severe tests of strength for the insurance and reinsurance industry.
Financial catastrophes, regulation, and a positive outlook
For the global banking sector, the financial crisis of 2008 was a catastrophe; for the real economy it brought on the most severe and dramatic decline since the Great Depression. Insurers, however, were better prepared.
With a business model and regulation that is different from banks, insurers weathered the financial storm unleashed by the subprime mortgage crisis and failure of Lehman Brothers in 2008. Overall, the insurance industry has proved remarkably resilient to the problems of other sectors.
The crisis demonstrated how insurers are not exposed to the same liquidity issues as banks. Confidence in the insurance business model was reinforced.
All the same, there were lessons for the sector – namely in regulation, risk management, and investment. Government bonds, for example, for decades a preferred low risk investment, could turn toxic very quickly, as the finances of sovereign states have come under increasing scrutiny.
Insurers caught in the financial storm of 2008 fell into two camps: financial guarantee insurers and those that had participated in banking-like activities such as credit default swaps and derivatives.
However, the vast majority of insurers around the world experienced few issues besides the impact of volatile investment markets.And even at that level, previous financial crises had taught them the importance of re-balancing their portfolios, which to a degree mitigated underwriting losses.
To be sure, the crisis did have other implications for insurers. It alerted policymakers and regulators around the world to the need for consistent regulatory standards and increased cooperation between supervisors.
It also reinforced the need for more robust risk management and governance, reflected in insurance regulatory reform mainly in Europe and the United States, which was to spread to other markets.
In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act brought sweeping reform of banking and established a Federal Insurance Office to collect data on insurers and recommend changes to state regulation of insurance.
European legislation lagged the US to some degree. In the mid-1990s the US had already adopted an overall risk-based model for capital requirements (RBC) in insurance companies. Europe at that time was still using the Solvency I system, largely based on the solvency regime which the EEC had put in place for insurers in 1973 and which mainly relied on defining capital requirements for insured risk.
But
more sophisticated risk measuring models and methods had been made available
over the thirty years prior, and so the Solvency II Directive was drafted with
a much wider scope but also with a broader impact on insurers. This is because the
costs of tighter capital requirements for insurance ultimately feed through to
products but in some cases cannot be passed on to consumers.
Although many countries around the world adopted the US-type risk-based capital regulatory system, the Solvency II directive has had a huge impact on insurers worldwide, even before its pending implementation.
Not only in Europe, many states outside the EU are evaluating the Solvency II model with a view to adapting it for their use.
In fact, the directive provides useful guidelines to setting up comprehensive enterprise risk management for insurers, but it may also prove very costly to implement.
Certainly, the Great Recession also reaffirmed some of the fundamentals of insurance and reinsurance: to understand the underlying risks, to challenge models that suggest the future will follow the past, and to think the unthinkable.
Today’s issues and challenges for insurers are plentiful: ageing populations, natural catastrophes, pandemics, terrorism, energy solutions, financial stability, food security, or climate change are only the top of a long list that requires attention from insurers and reinsurers.
Solutions can be found in both traditional products and in financing such risks on the capital market by means of securities.
In essence, the art of risk management has remained the same over the last 150 years; what has changed is the complexity of those risks, their global distribution and their inter-dependency.
But the many lessons that have been learnt over the long history of insurance and reinsurance have prepared the industry to cope with more challenges in the future.
The value of reinsurance
Today, insurance is an integral part of our lives. Building a house, marketing a product, driving a vehicle, all would be unthinkable without taking appropriate insurance cover.
By contrast, reinsurance remains virtually unknown by the general public, even though it plays a key role in taking on risk and enabling economic growth and progress.
Reinsurance is “insurance for insurers”.
It carries out one of the fundamental principles of insurance, namely that risks need to be spread as widely as possible.
The
more broadly they are shared, the more cost effective it becomes to cover them.
From the very beginning the reinsurance business was international, helping its clients offset their risks across the globe.
Similarly, its breadth of activity across lines of life and non-life business, let specialized insurers diversify their risks over a wider range.
And through its longstanding client relationships, some dating back to the 19th century, a third dimension has opened up of distributing risk over extended periods of time.
Reinsurers accept risks of virtually every kind, from natural catastrophes to higher mortality and motor insurance to aviation liability.
These risks are transferred to them by the primary insurers, who then need to keep less risk capital tied up and can write more business as a result.
As the premiums paid for reinsurance are invested via the financial markets, both primary insurers and reinsurers contribute significantly to the economy, which helps drive growth and benefits society in general.
Reinsurance naturally researches risks and the nature of risk more than any other part of the financial services industry.
Knowledge accumulated over centuries today is harnessed in statistics and state-of-the art models to better understand the risks of the 21st century. This effort directly benefits clients and society as a whole.
And reinsurers are also an active voice in the public discussion on risk.
For addressing the big issues of our time and coping with natural perils or epidemics, insuring large-scale projects and consumer products, and, ultimately, insuring our everyday lives, reinsurance has become indispensable.
Yours
truly
Emmanuel
Sanyu Safali
The
founder and host of
+256752187255
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