Ladies and Gentlemen.
It’s a pleasure to be here.
This is not the first time that I have attended your annual dinner. It’s always an enjoyable night and I am sure tonight will be no exception.
This year, I have a slightly expanded role than in previous years. The range of issues which I am currently taking the running on is testament to the pervasiveness of insurance through every aspect of our daily lives. Until recently, the community was largely unaware of the critical role that insurance plays in enabling ordinary activity to continue.
The availability and affordability of insurance after September 11 and the HIH collapse is a topic which greatly impacts on the Australian community. Concerns range from the exposure of major buildings to terrorism exclusions, to the "death of fun" for community groups, so graphically described in the tabloids.
Since the collapse of HIH last year, there has been and will continue to be intense interest in and scrutiny of the insurance industry.
The industry is currently undergoing significant and much needed structural changes.
As this audience is one where there is a real appreciation of the need for change and maintaining the business and social fabric held together by the ability to transfer risk, tonight I intend to make a few comments about the new prudential regime due to come into effect on 1 July 2002.
As I have sat in on many meetings over the past weeks, there has been a troubling undercurrent which questions the necessity of capital adequacy requirements that some companies may have difficulty in meeting.
Commentators who question whether a lighter approach to regulation might assist under capitalised groups over the hump must not have been paying attention!
In the past year we have seen the far-reaching and serious impacts that the failure of an insurance company can have on our community.
The current crisis in medical indemnity is a salient example of what can happen when capital adequacy requirements are insufficient or non-existent.
While high insurance premiums are difficult for many, much greater hardship arises if an insurer fails and confidence in the industry is eroded. Cheap insurance is not insurance at all if a company can’t pay out claims when they arise.
The interests of consumers are not served by enabling poorly capitalised entities to operate in the market.
Prudential regulation is essential to ensuring the ongoing financial viability of insurance companies.
In recognition of the vital role that insurance plays in society, the Government has put in place a new prudential framework for general insurers. These fundamental reforms commence on 1 July this year.
The most important aspect of these reforms is that they significantly increase the level of regulatory capital which must be held by insurers in order to do business. The complexity and risk involved in pricing insurance premiums today, to meet claims that occur in the future means that capital is absolutely crucial in the insurance context.
The pricing of insurance products relies on assumptions about claims and investment returns. If these assumptions turn out to be incorrect, this can have an enormous impact on a company’s balance sheet. Without capital reserves, policyholders would immediately be exposed to underwriting losses arising from mistaken assumptions made at the time of pricing the product. Capital provides a buffer which can absorb losses before they impact on policyholders.
The longer the time frame between the pricing of a product and the likely payment of claims – that is, the longer the tail - the bigger is the risk that an insurance company will get some of the assumptions wrong. Hence, longer tail products such as public liability and professional indemnity require more capital.
The new, risk based capital adequacy standard takes this into account by requiring insurers operating in long tail classes to hold more capital. It also takes into account the potential asset risks in insurance companies and the accumulation of risks which can arise through a single event having an impact on a wide range of policies in an insurer’s portfolio.
Another important component of the new prudential requirements for general insurers is that insurers will be required to value their liabilities in accordance with a Liability Valuation Standard.
Accounting standards which rely on probable outcomes as an appropriate value for liabilities are not sufficient in the insurance context. The variability in insurance liability estimates requires a higher level of probability of sufficiency to be in place. This is especially the case in long tail classes.
The new liability valuation standard ensures that provisions are set at a 75 per cent probability of sufficiency, substantially improving the minimum 50 per cent allowed by the current accounting standard.
The new requirements should also see an improvement in the risk management processes of insurers. Risk management is not a concept that should be foreign to insurers. After all insurers’ core business is the pooling and management of risks.
However, the new Risk Management Standard has focused the minds of insurance executives on the risks involved in running their businesses. This can only lead to improvements in practice across the industry as a whole.
Another major component of the reforms is a Standard designed to improve the basis on which insurers consider whether or not to purchase reinsurance. While buying reinsurance cover when it is cheap and retaining more risk when reinsurance is expensive may be a rational response to a market cycle, these decisions need to be undertaken within the context of a company’s overall appetite for risk and other internal policies.
Directors of insurance companies have an obligation to their policyholders and shareholders to ensure that these settings are at an appropriate level to safeguard their business.
I am advised by APRA that they are currently assessing applications for reauthorisation under the reformed Insurance Act.
The good news is that most insurers are already operating their businesses on a sound basis sufficient to enable compliance with the new requirements from 1 July this year.
For those companies that will not comply at 1 July, APRA’s highest priority has been to encourage the formation of recapitalisation, merger or exit plans to enable full compliance across the industry by the end of the transition period at 30 June 2004.
The move to the new regime has certainly meant a lot of hard work for both the regulator and insurers. However, these reforms are necessary to ensure the ongoing integrity of the insurance sector.
For my part, I am confident that these reforms will provide policyholders with a renewed level of confidence in this essential industry.
Finally, I would like to acknowledge the responsible attitude that the ICA as the representative of its member companies has taken in supporting the move to the new prudential requirements.
I am very much aware of the challenges facing the industry, and also the impact on the broader community if risk cannot be transferred in the way of traditional insurance cover.
Ultimately the interests of consumers can only be served by safe, stable and sustainable insurance companies.
Insurers have an unparalleled chance to demonstrate their capacity to be responsive to the needs of the Australian community.
Francis Bacon, the 17th century English philosopher and statesman
could have been speaking to the insurance industry in 2002 when he wrote “A
wise man will make more opportunity than he finds”.