Risk Management Setting a New Course

Transcription

1 Risk Management Setting a New Course Raj Singh, Chief Risk Officer, Swiss Re European Commission, DG MARKT, 12 November 2010 Raj Singh MultaQa Qatar March 2010

2 Agenda (Re)insurance fulfils important economic functions (Re)insurers weathered the crisis well (Re)insurers are faced with challenging regulatory reforms Crisis reinforces the call for strong ERM Swiss Re's approach Closing remarks 2

3 (Re)insurance fulfils important economic functions 3

4 (Re)insurance enables entrepreneurial risk-taking Henry Ford, referring to New York City in the early 20th century: «This has only been made possible by the insurers. They are the ones who really built this city. With no insurance, there would be no sky-scrapers. No investor would finance buildings that one cigarette butt could burn to the ground.» Source: Swiss Re, Introduction to Reinsurance ed. 1995/2000 4

5 (Re)insurance is a catalyst for economic growth What (re)insurers do Benefit to society Pre-requisites Risk transfer function Diversify risks on a national or global basis Make insurance more broadly available and less expensive Mobility of premiums and capital Capital market function Invest premium income according to expected pay-out Provide long-term capital to the economy on a continuous basis Ability to invest in real economy (equity, corporate bonds, etc) Information function Put a price tag on risks Set incentives for risk adequate behaviour Market and risk-based pricing (Re)insurers absorb shocks, provide capital for the real economy and support risk prevention 5

6 (Re)insurers manage the coverage of large and complex events Insured catastrophe losses Ocean Drive, FL, 1926 USD bn, at 2009 prices 120 increased insurance penetration more values more values in high-risk areas higher vulnerability climate change (storm,flood) Ocean Drive, FL, : Hurricanes Ivan, Charley, Frances 1999: Winter storm Lothar 2001: Attack 1992: Hurricane on WTC Andrew 1994: Northridge EQ 2005: Hurricanes Katrina, Rita, Wilma 2008: Hurricanes Ike, Gustav Earthquake/tsunami Weather-related Nat Cats 2005 Man-made disasters Source: Swiss Re, sigma No 1/2010, Figure 3 6

7 Diversification is necessary to cover large losses such as terrorism World Trade Center Losses By Company headquarters USD million U.S. Reinsurers U.S. Primary Insurers Europe Reinsurers Europe Primary Insurers Bermuda Companies Lloyd's Japan Companies Total announced International (re)insurers paid 64% of 9/11 related claims of USD 26.8 bn Source: Dowling & Partners 7

8 Same benefits of global diversification apply to coverage of hurricanes Regional distribution of 2005 hurricane payments: Wilma, Rita and Katrina 100% Other US Reinsurance US Insurance Lloyd s Europe Bermuda 80% 60% Foreign (re)insurers made more than 60% of Wilma, Rita and Katrina total loss payments of USD 59 bn 40% 20% 0% Wilma Rita Katrina Open markets for (re)insurance are a pre-requisite to efficiently absorb large risks Source: J. David Cummins, The Bermuda Insurance Market: An Economic Analysis, 6 May

9 Demographics indicate life and health insurance growth will continue 100% % 60% % Asia Age: 0-14 (in %) % % 8 Europe (in %) North America 65 or over (in %) Ageing population in the developed world Continuous improvement of average global standard of living Responding to increasing demand for insurance and wealth protection solutions Source: Swiss Re, Economic Research and Consulting 9

10 In managing risks, insurers become the world s largest institutional investors Assets under management, USD trillion Pension funds Mutual funds Insurance companies Petrodollar foreign assets Asian sovereign investors Hedge funds Private equity Insurers world-wide investments totalled USD 16.2 trillion (= 22.5% of institutional investors assets at end of 2008) Insurers and pension funds together account for 57% of institutional investors assets under management 0.9 The real economy needs the financing from (re)insurers and pension funds Source: McKinsey Global Institute, The new power brokers,

11 Insurers provide long-term capital to the economy Asset allocations of nonlife and life insurers Based on five largest insurance markets* 100% Example European life insurers** Cash Other Real estate Loans Equities Bonds 80% 60% Investments in affil. Shares undertakings 5% 4% Cash and Land and deposits buildings 1% Mortgages 2% 1% Participation in investment pools 12% 40% 20% Bonds 61% Investments for linked life insurance 15% 0% Non-life Life Overly conservative investment rules would mean lower returns for policyholders and less capital for the real economy Source: Swiss Re Economic Research & Consulting *US, Japan, UK, France, Germany ** Germany and France 11

12 (Re)insurers weathered the crisis well 12

13 Crisis hit insurers less than banks, resulting in lower recapitalisation need Cumulative credit losses since 2007 Total capital raised globally Cumulative since USD 1715bn USD 1468bn x x USD 271bn USD 170bn 0 0 Insurers Banks Insurers Banks Lower credit losses for insurers meant stable prices and capacity for customers Source: Geneva Association Systemic Risk Report 2010 based on Marsh EMEA Insurance Reports 2007, 2008 and 2009, Bloomberg (as at 10 February 2010), DataStream, Oliver Wyman analysis 13

14 Overall, (re)insurance weathered the crisis relatively well Reinsurers losses were mainly related to investments due to the asset meltdown in financial markets Reinsurers remained solvent and no diversified reinsurer failed during the crisis Cover was always provided both in insurance and reinsurance, and claims were paid as usual throughout the crisis. Prices remained stable Problems arose from monoline insurers involved in financial guarantee business and insurers with important quasi-banking businesses Crisis revealed critical accounting issues and flaws in supervisory systems Core (re)insurance was conducted in a business as usual manner 14

15 Capital situation of large (re)insurers recovered after a dip Shareholders equity Shareholders equity by country Index Jun 2007=100, USD* Index Q4 2007=100, USD % % 90 80% % 60 40% % 30 0% 2007Q Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Sep 09E 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 Sample average (21 companies) 3 Canadian companies 7 US companies 6 European globals 5 UK companies* *UK companies are reporing semiannually Source: Company reports, Bloomberg Top 30 companies* = approx. 25% market share *) Sample: ACE, AEGON, AIG, Allianz, Aviva, AXA, AXIS, Fortis, Generali, Hartford, HSBC, IAG, ING, Liberty Mutual, Lincoln Financial Group, Manulife Financial, Mass Mutual, MetLife, MSIG, Prudential, PLC, QBE, RSA, Talanx, Travelers, Vienna, XL Capital, Tokyo Marine, Zurich, Chubb, Prudential Financial Sources: Company reports, Bloomberg, Swiss Re Economic Research & Consulting 15

16 Different business models of banks and (re)insurers demand different regulatory treatment Issue Insurers Banks Contract Insurance only pays when there is a real insured event (financial loss as conditionality). Capital market contracts pay whether or not the counterparty has a loss (sight / term contracts). Liquidity risk Insurance business is pre-funded through premium payments. There is no liquidity risk in property & casualty, however, life savings products can be redeemed, but usually only at a high cost. Many of the liabilities of banks deposits, savings accounts and commercial paper are short term. Therefore, significant liquidity risks exist. Contagion There is little risk of contagion between insurers. And gradual cash flows allow to take corrective actions. The inter-bank markets and other short term funding make banks vulnerable to contagion (bank run). Unwinding of global groups Due to the long duration of liabilities, insurance books of business can be wound-up by regulatory authorities in an orderly manner. Due to the risk of a bank run, regulatory authorities must act very quickly to avoid further disruptions. And the crisis revealed that there was a need for bankruptcy laws for large investment banks. 16

17 (Re)insurers balance sheet: built-in resilience to shocks Reinsurance industry*, 9 months 2009 Assets Assets Assets matched to liabilities, often held to maturity Liabilities Liabilities Technical Reserves, gross 56% Total investments; 73% Payment is triggered by real event Other liabilities; 18% * Based on a sample of 27 leading reinsurance companies, excl. Berkshire Hathaway Insurance is pre-funded by premiums Reinsurance recoverables; 11% Debt; 4% Hybrid debt; 3% Other assets; 11% Shareholders' equity ; 20% Intangibles; 3% Deferred acq. costs; 2% Low level of shortterm debt Source: Swiss Re, Economic Research & Consulting No systematic liquidity risk in (re)insurers balance sheet Accounting mismatch between assets and liabilities as key issue 17

18 Risk profile of insurers is more diversified than that of banks Breakdown of economic capital for European banks and insurers 100% 10% 7% 4% 80% 11% 9% 8% 60% 18% 32% 6% 17% 36% 40% 2% 8% 7% 1% 37% 45% 28% 19% 41% 79% 72% 20% 10% 0% Commercial Banking Retail Banking Sales & Trading Market Life Insurance Financial risks 43% 30% 40% Credit 3% 11% 5% Asset Management P&C Insurance Insurance risks 25% 23% 13% 7% Life Insurance P&C Insurance Business Reinsurance Operational Other Other risks Source: Geneva Association Systemic Risk Report 2010 based on 2006 ECAP Survey, IFRI CRO Summary, prepared by Oliver Wyman Companies Annual Reports 18

19 (Re)insurers are faced with challenging regulatory reforms 19

20 The crisis accelerated existing regulatory initiatives and triggered new ones United States Federal Insurance Office Systemic regulator NAIC solvency modernization Financial tax initiatives CDS regulation Compensation regulation Rating agencies reform Europe Solvency II implementation New supervisory architecture Crisis management Compensation regulation Insurance guarantee schemes Rating agencies regulation Pension reform Revisiting securitisation International IAIS ComFrame Financial Stability Board IMF levies IASB & FASB project Basel III G 20 agenda 20

21 Insurance industry faces significant regulatory challenges Regulatory developments New macro-supervisory regimes Conservative regulatory reactions Spill-over risks from banking requirements Influence of central banks Protectionism and fragmentation of regimes Market distortions and competition issues Supervisors and governments under political pressure to implement changes without full assessment and appreciation of economic impact 21

22 Crisis reinforces the case for Solvency II Principle-based, economic and risk sensitive approach Promote sound risk and capital management Principles of approved Framework Directive are economic and risk-based Implementation to properly reflect these principles Introduce effective group supervision Regulation must keep pace with globalisation of business Large institutions to be supervised in their entirety Revisit group support regime after 2015 Increase regulatory convergence through equivalence Opportunity to accelerate cooperation and recognition among regulators Switzerland well positioned for equivalence: Swiss Solvency Test (SST) complemented by Swiss Quality Assurance (SQA) 22

23 Industry raises concerns on Solvency II implementing measures Industry welcomes Solvency II as new risk sensitive solvency regime However, on-going regulatory concerns due to conservative proposals from the supervisors through CEIOPS QIS5 is a critical test; first finding demonstrates that the standard formula is not appropriate for large (re)insurance groups Industry general concerns Reinsurance specific issues Treatment of own funds Recognition of (non-prop.) reinsurance Calibration of capital requirements Calibration of cat risks (primary non-life) Internal model approval process Segmentation for technical provisions Reporting and public disclosure Diversification effects at group level Key objective for (re)insurers is to avoid detrimental effects of the new EU solvency regime on the European insurance industry 23

24 Systemic risk debate is shifting to (re)insurers, while they were not the source of the crisis Both supervisors and the insurance industry have concluded that core insurance activities do not pose systemic risk Geneva Association report (March 2010) and IAIS position paper (June 2010) However insurance supervisors remain under pressure and insurance is part of macro-prudential regulation Financial Stability Board (FSB) has focused on systemically important banks, as they are at the centre of the financial crisis FSB paper on moral hazard associated with SIFIs Focus is shifting to other financial institutions, including (re)insurers Critical to strike the right balance between (re)insurance and systemic risk regulation 24

25 Regulatory focus needs to be on risk activities and not on institutions The insurance industry provided policymakers and the public with its view on systemic risk in insurance through the special report of the Geneva Association (March 2010) The report indentifies potential systemic risk drivers and puts forward some recommendations on how to deal with them Review of FSB/IMF systemic risk definition and criteria Size: a typical large insurer is much more diversified than a bank; the size of specific activities should be assessed rather than the whole institutions Interconnectedness: insurers and reinsurers far less inter-connected than banks in their risk transfer and funding activities Substitutability: insurance capacity is highly substituable as demonstrated after natural catastrophes Timing (IAIS criteria): insurers are not exposed to sudden liquidity crunches and timing of insurance claims settlements reduced the risk of contagion The impact of the definition and criteria of systemic risk varies depending on the range of activities carried out by financial institutions 25 Source: FSB, IAIS

26 The industry put forward five recommendations to strengthen its resilience Mitigating measures to reinforce regulatory regimes and strengthen industry practice 1 Implement comprehensive, integrated and principles-based supervision of insurance groups 2 Strengthen liquidity risk management 3 Enhanced regulation of Financial Guarantee Insurance 4 Establish macro-prudential monitoring with appropriate insurance representation 5 Strengthen risk management practices and build on lessons learned To tackle the issue of systemic risk, supervisors and policymakers need to identify systemically risky activities Potentially systemically relevant activities should be dealt with through a responsive regulatory framework 26

27 Cross-sectorial implications of regulatory reforms need to be better understood Banking and capital markets reforms Basel III and liquidity reforms Contingent capital and new forms of "loss absorbency for banks" Resolution and "living wills" Derivatives regulation and securitisations Insurance industry concerns Regulatory reforms must take into account the linkages/repercussions between regulatory changes in different sectors Regulatory changes threaten to move insurers away from optimum pattern of asset and liability holdings Limitations of insurers' willingness/appetite to supply (CoCos) finance to banks Insurers cannot not be the solution to problems that regulators are trying to fix in the banking sector 27

28 Insurers and bank wind-ups are not comparable as they are driven by different business models Insurance company wind-ups traditionally conducted in an orderly manner Insurers are required to hold reserves against claims as well as incurred but not yet reported claims Supervisors early intervention allow appropriate work out (reinforced under Solvency II) Low lapse rates in life insurance during run-off (as compared to banks) Insurance failures extend over many years, as liabilities mature over an extended period Insurers lack two-way trading portfolios as they have one set of liability holders and one set of assets Regulatory frameworks provide further stability to insurers wind-ups Strict regulation on reserves covering liabilities Policy-holders claims generally receive privileged treatment in insurers insolvencies Supervisors have far reaching powers ahead of actual insolvency Supervisors can act as liquidators or order deconsolidation during insolvency proceedings International legal challenges remain in the case of cross-border resolutions (Re)insurer failures should not be prevented at any cost (re)insurers are not "too big to fail"

29 Global (re)insurers actively participate in the global regulatory debate Key objectives for the industry Underline (re)insurance specificities Acknowledge differences in business models of (re)insurance and banks - and therefore a differentiated regulatory approach Promote sound risk and capital management Implement economic and risk-based regulatory framework under comprehensive group supervision Maintain market access and level playing field Secure commitments to open markets and avoid market distortions Promote global regulatory Support IAIS effort to establish global standards and achieve greater standards transparency and recognition among supervisory regimes Respond to remaining resolvability concerns Address international legal challenges and engage into open dialogue with (group) supervisors and colleges Achieve accounting convergence Enforce market-consistent valuation and avoid pro-cyclicality under harmonised accounting standards 29

30 Swiss Re takes an active part in industry discussions on the new regulatory regimes Swiss Re s activities Active contribution to consultation papers Discussions Active with regulators and supervisors' experts groups participation in various industry bodies Comité Européen des Assurances Geneva Association CRO Forum Pan European Insurance Forum American Council of Life Insurance Reinsurance American Association Pan European Insurance Forum CFO Forum European Financial Services Roundtable Institute of International Finance

31 Crisis reinforces the call for strong ERM Swiss Re's approach 31

32 Swiss Re has been driving key developments in the evolution of risk management in the industry 1960s 1970/80s Enterprise Risk Management (ERM) Industry Mitigation of insurance hazards Financial market risks and their management Operational risks and their management Swiss Re Technical focus on life risk management Nat Cat accumulation control Financial market risk modelling Today 1990s Integrated modelling Independent CRO function at Executive Board level Integrated perspective, i.e. comprehensive analysis and quantification Capital allocation and risk adjusted returns 32

33 Independent and centralized risk function remained critical during the crisis The economic crisis highlighted the importance of a centralized risk function Realizing the full benefit of an independent function requires that Risk function is well embedded in the strategic steering of the company CRO has an equal seat at the decision table Risk has the courage to raise its voice Risk provides an independent and transparent view of obstacles ahead 33

34 Capital and liquidity risk management were key focus during the crisis Four key control requirements of insurers Insurer balance sheet give rise to two key questions Control diversification Ensure asset liquidity Hold enough liquid assets to meet expected and unexpected liquidity requirements Liabilities Assets Economic equity Pool large number of sufficiently independent risks, to make aggregate claims more predictable Ensure capital adequacy Use risk capital to absorb unexpected losses Capital Sufficient capital to absorb unexpected losses? Capital adequacy framework Liquidity Sufficient spot liquidity and liquidity generation capabilities under stressed conditions? Liquidity stress testing framework consistent with capital view ALM Control ALM risk Investing premiums and capital to match market risk of liabilities 34

35 Risk management further embedded across the full performance cycle Group risk policy and tolerance Capital cost allocation (factual) Reporting of impact on capital adequacy Limit monitoring Accumulation control Part of all decision taking bodies concerned with risk taking Capital cost allocation (projected) Large transaction approval Strategy Portfolioand performance measurement Decisionmaking Capital allocation Target setting Risk model input into optimisation Testing of risk tolerance criteria Derivation of limit framework 35

36 Strategy Definition of risk tolerance reinforced as the basis for risk steering and limit setting Swiss Re risk tolerance: To be able to continue to operate following an extreme loss event. Extreme loss event : 100 year annual aggregate Group loss Can we meet all our obligations as they fall due (operation)? Do we hold enough capital (survival)? Regulatory capital Rating capital Capital adequacy requirements Internal capital Liquidity stress test Related liquidity risk 36

37 Target setting Leading-edge internal model continuously enhanced and challenged to reflect changing risk environment Time-tested expertise P&C risks L&H risks Credit risks Financial risks Over 15 years experience in integrated risk modelling Over 10 years experience in economic value management (EVM) Basis for reporting to Swiss supervisor (SST on Tail Var risk measurement) Consideration of entity relationships and intra-group transactions 37

38 TC NA WS EU EQ California EQ Japan Actual situation from all capital perspectives Group risk tolerance Risk tolerance criteria of the Board Annual Group Plan Risk appetite derived by optimisation procedures Group Tail VaR of Plan Group Risk Model as basis for limit setting Mortality Longevity Financial risk Equity Hedge Funds Interest Rate Real Estate Credit (spread & default) 38 Business capacity measure Nat Cat L&H risk Business capacity measure P&C risk Available capital Business capacity measure Target setting Quantitative limit framework translates risk tolerance into defined risk appetite

39 Importance of group-wide liquidity risk management Capital allocation increased during the crisis Liquidity is fundamentally different from capital and requires separate measurement but fully integrated into Swiss Re s ERM Swiss Re s core policy is to hold sufficient unencumbered highly liquid assets in the individual regulated entities to meet potential liquidity stress event Swiss Re has proactively responded to the market crisis by reviewing and strengthening our liquidity stress tests assumptions suspending our share buyback programme selectively raising additional liquidity increasing the amount of readily available liquidity held centrally Swiss Re s exposure to liquidity risk (mainly through its legacy activities and regulatory constraints) is managed and monitored centrally 39

40 Decision making Chief Risk Officer (CRO) participates in all Group committees concerned with risk taking Board of Directors Audit Committee Compensation Committee Investment Committee Finance and Risk Committee Executive Committee Risk and Capital Committee Asset-Liability Committee Products and Limits Committee Regulatory Committee 40

41 Measurement Independent risk reporting to provides transparent and timely risk information for internal and external stakeholders External Internal Executive Committee / Finance and Risk Committee Risk Updates Annual reports Capital Adequacy Dashboard Investor presentations Client discussions Reports to Regulators (eg SST Report) and Rating Agencies Liquidity Risk Report P&C, L&H and ORM dashboards Financial Risk Report 41

42 Closing remarks 42

43 Key findings (Re)insurance enables the risk taking that is essential to economic growth and entrepreneurship Risk diversification is an essential value proposition of (re)insurers (Re)insurers are long-term investors; assets are managed against liability-driven benchmark (Re)insurers and banks are driven by different business models, which explains why (re)insurers weathered the crisis well The insurance industry faces significant regulatory challenges due to the crisis as insurance gets bundled into the banking debate (Re)insurers are not "too big to fail" and core insurance activities are not sources of systemic risk Solvency II is the appropriate response to the crisis for the insurance industry, but principle-based and economic-based approaches need to be preserved Crisis reinforced the need for an independent, integrated and empowered risk management function 43

44 Thank you Questions? Raj Singh MultaQa Qatar March 2010

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