In today’s environment, managing an insurance company’s risk is increasingly challenging; scrutiny of insurers’ financial health and the inevitable associated market and peer comparisons are greater than ever before.
Currently it is unlikely that investment income can compensate for poor underwriting results. Insurance premium volume is no longer desirable unless it carries with it a significant degree of security and a high expectation of profitability. For insurers trying to grow in saturated European markets, this presents a challenge to differentiate oneself from one’s peers whilst still maintaining a firm hand on the financial rudder and avoiding the risk of seeming opportunistic or impetuous.
There is a perception, rightly or wrongly, that today’s marketplace no longer favours the mavericks. Continuity, stability and predictability are the buzzwords that comfort shareholders and board members alike, whilst senior management remuneration models are increasingly linked to the bottom line and to technical performance. The introduction of the Own Risk and Solvency Act (ORSA) within the Solvency II framework has forced companies to analyse to a far greater degree the potential threats to their balance sheets and to display an approach to risk mitigation that goes beyond the traditional market-accepted norms.
Already, in Eastern Europe, the tenacity of regulators in this brave new world has called time on some companies who were growing at a rate that far outstripped their capital or their claims-reserving acumen. Many of us here are unsurprised by this inevitable development, but somehow the lack of robust risk management was for many years considered a secondary concern to the day-to-day chase for premium.
Profitability vs. Volatility
In recent discussions with two Chief Financial Officers (CFOs) of mid-sized European Property & Casualty (P&C) insurers, when asked about what kept them awake at night, their answers in both cases were remarkably similar; ‘maintaining profitability and avoiding nasty surprises’ was effectively the gist of their responses.
Volatility is one of the biggest threats for financial managers in today’s insurance sector; business plans are set early, Key Performance Indicators (KPIs) are defined on a rolling 3- or 5-year basis and the winners are those who deliver what was promised. Any deviation from the plan is generally viewed with skepticism and alarm.
This presents new challenges for insurers who, on the one hand, are under pressure to grow through developing new products, identifying new market segments and being continuously innovative in their approach to sales and marketing, yet on the other hand are expected to produce stable results and maintain profitability.
This is a conundrum for board rooms across Europe and beyond, who are desperately balancing the desire for expansion with the braking force of regulation and the often conservative expectations of shareholders from outside the industry.
The world of reinsurance has stepped up admirably in recent months to provide innovative and relevant solutions to limit earnings volatility and support stable results. Combined ratio targets are the Holy Grail for CFOs, and it is possible to use reinsurance to provide a buffer in years where the loss ratios threaten to erode earnings.
Loss frequency can be just as damaging to a company’s financial stability as loss severity, yet it is often afforded significantly less weight by risk committees when assessing the threats to profitability.
Taking the example of a typical European P&C insurer with a predominantly non-proportional reinsurance programme, a handful of mid-sized losses in one or more lines of business, hitting the reinsurance retentions each time, can suddenly result in a net position after reinsurance that is distinctly out of line with expectation. Wrap-around protections, multi-year funded net stop losses and multi-line aggregate solutions, to name but a few of the more popular solutions, are some of the ways in which reinsurance can address this issue for companies looking to protect earnings and limit their downside from underwriting losses.
Reinsurers have accordingly adjusted their approach, and those who are most successful in this new environment are those who have recognised that a single-year, single line-of-business approach is no longer sufficiently responding to insurers’ needs.
Whilst catastrophe excess of loss protections or unlimited Motor Third Party Liability (MTPL) layers are certainly not going out of fashion any time yet, there is a significant volume of additional reinsurance being purchased to protect earnings, and we predict that this segment will grow rapidly in the near future.
Whilst unpredictability can be exciting in some areas of life, in our insurance world it’s a word that increasingly leaves senior management with a headache.