Wave of new regulation tops insurance sector risks

‘Banana Skins” survey pinpoints key concerns for insurers

The greatest risk currently facing the insurance industry comes from the wave of new regulations which are being introduced at international and local levels, according to a new survey which ranks insurance sector risk.

The CSFI’s (Centre for the Study of Financial Innovation) latest ‘Insurance Banana Skins’ survey, conducted in association with PwC, says that new regulations governing issues such as solvency and market conduct could swamp the industry with costs and compliance problems. It could also distract management from the more urgent task of running profitable businesses at a time when the industry is under stress.

The survey polled over 600 insurance practitioners and industry observers in 54 countries to find out where they saw the greatest risks over the next two to three years. Regulatory risk emerged a clear leader in many major markets, including North America, Europe, Africa, and the Far East/Pacific. There were 12 responses from South Africa and 7  from Africa, respectively.

Tom Winterboer, Leader of Financial Services for PwC Africa, says: “This is the second successive Banana Skins survey which has identified regulation as the top risk concern for insurers, underlining the continuing uncertainty surrounding major regulatory initiatives.

“The fear is that these initiatives will load the industry with heavy costs, and distract management from the task of running profitable businesses.”

The European Union’s (EU) Solvency II Directive, now in its seventh year of planning, is the focus of strongest concern, particularly since many non-EU countries are awaiting the outcome before they finalise plans of their own. South Africa’s Solvency II equivalent, Solvency Assessment and Management (SAM), is due for implementation in 2016.
South African respondents cited the risk of failing to attract and recruit the right talent highly as a big concern (No. 3) - well above the global average (No. 19). Victor Muguto, Long-term Insurance Leader for PwC Africa, says: “The shake-out in the financial services sector has made it easier for the developed economies to recruit and retain talent. However, the situation is harder in the emerging markets, such as South Africa, where qualified talent remains in short supply.”

Crime was also seen as another big concern by South African respondents, ranking at No. 7, in comparison to the global average (No. 22). Cybercrime and data theft in particular are seen as an increasing risk for businesses.
A related set of risks lay in the area of business practices (No. 4), another area of regulatory scrutiny. Despite the amount that has been done by companies and regulators to clean up practices such as mis-selling, this is still seen as an area of high risk particularly at a time of economic stress when pressure to generate sales is strong.

Other high-ranking concerns disclosed by the survey include the uncertain state of financial markets (No. 2) and the world economy (No. 3). For the South African insurance industry, these risks also featured prominently at No. 8 and No. 2 respectively. These are adding to the pressures on an industry which has been squeezed by years of low interest rates and intense competition.
A particular focus of concern was the legacy of products which offer guaranteed returns but cannot be profitably funded at today’s low yields (No. 6). Savings products that offer guaranteed returns were the rage a few years ago, but now they have returned to haunt the insurance industry – at least those parts that offered them – with the slump in yields. This is the first time the study has tested the ranking of these products, and the fact that they came in at No. 6 (South Africa: No. 12), suggests they are an important concern.

The continuation of difficult market conditions has also put the spotlight on the quality of management (No. 8) and in particular risk management (No. 7). The specific issues listed by respondents included short-termism, bonus fixation, and the quality of talent available. Many respondents felt that the growth of regulation was putting good people off from joining the industry. However, the quality of management (No. 15) and the quality of risk management (No. 17), featured less prominently in the South African insurance industry, where respondents felt that management was performing well.

This year’s survey shows continuing concern about underwriting risks in natural catastrophes (No. 5) given the greater frequency of events, and the rising cost of claims. For many insurers, the main concern was that increased frequency of extreme events in recent years will become the new normal, especially in heavily populated and insured areas – a fear aggravated by climate change and the anticipation of ‘overdue’ disasters, such as on the fault line of San Andreas in the US.

On the other hand, a number of risks have fallen in urgency, notably concerns about the availability of capital to sustain the industry (down from No. 2 to No. 16). This risk was also seen as less of a concern by insurers in South Africa (No. 23). The situation is now reversed: there is excess capital in the industry, particularly on the non-life and reinsurance sides, which is keeping prices soft and hurting profitability.

Actuarial assumptions (No. 21) were seen as less of a concern in South Africa than elsewhere. A new risk was introduced into the study this year, social media, to measure the level of concern about the influence of Facebook and the like on customers and their choices. The fact that it came at No. 21 suggests that it is still low on the horizon, though some respondents felt the industry should take greater notice because of its fast-growing potential to affect markets.
A breakdown of the insurance industry by sector shows the life sector specifically concerned about the effect of low interest rates on investment performance, and the task of managing complex and competitive retail distribution networks. On the non-life side, the main concerns are with excess capacity and competitive pricing, along with the impact of surging catastrophe claims. Concerns in the reinsurance sector are mainly with the security of capacity in a highly competitive market.

Muguto says: “It is ironic that the industry’s greatest risks are seen to come from regulation, which is intended to reduce risk, at a time when operating and underwriting conditions are also very hard. It is no surprise that these pressures are reflected in rising concerns about the ability of management to handle them.”

Winterboer concludes: “There is a risk that by solely focusing on these recurring issues insurers could miss other threats and opportunities coming up over the horizon. The industry faces transformational shifts in technology and customer expectations, which are reshaping how insurance is sold, how risk is priced and even what we mean by insurance. These developments could open the way for nimble new entrants or other financial services players to move in and pick off profitable business.”