Conference: Risk, Returns, Regulation and More Regulation

Coming off a rough few years of recession, then a disaster prone 2011 — and then more global uncertainty in 2012 — the world and the insurance industry have a few things to look forward to in the next year.

They also have some things to fear. And then there’s Europe.

Those were the central themes echoed in late July by speakers at the Western States Surplus Lines Conference 2012 at the St. Regis Monarch Beach in Dana Point, Calif., where several hundred insurance executives gathered for the four-day event.

“It was not a fun five years, but we’re much further along than Europe,” said Thomas Holzheu, Swiss Re’s chief economist for North America, who compared the message being delivered by economists and industry experts at the conference to a Greek tragedy.

Holzheu outlined the key risks as he sees them that the global economy faces in the coming year, namely: Policy error in the U.S. or Europe; oil price shock; a hard landing in China.

The former is among largest looming risks, he noted, adding that “governments have to step in” to keep economies balanced, but that in stepping in we “sometimes end up on the wrong side of the cliff.”

Holzheu said he believes that governments will keep interest rates low, and inflation in check — in other words don’t expect a great year for investment returns.

“We will be in a low yield environment,” he said.

This follows a year in 2011 that saw $370 billion in economic losses worldwide, which Holzheu noted is “the biggest ever,” and $116 billion in insured losses, the second highest on record.

“This is the highest privately insurance year of cat losses ever,” he said of that year, adding that insured losses were dominated by weather-related losses.

The most notable catastrophe in 2011 was the Tohoku earthquake in Japan, costing an estimated $210 billion in economic losses, and $35 billion in insured losses, making it the second most expensive event in history for the insurance industry.

The earthquake produced major supply chain problems around the world, which Holzheu noted has changed the way the industry looks at underwriting business interruption insurance.

Another change in the way the industry looks at risk is exactly where that risk is placed. The floods in 2011 in Thailand, which yielded the largest in insured losses from a fresh water flood in history with losses of $12 billion, as well as the massive earthquake in Chile a year earlier, both occurred in emerging markets, he noted.

“The globalization of production has shifted,” he said, adding that much of that production has gone to places the industry doesn’t have as much information about.

“The underwriting becomes much more difficult,” he added.

And then there’s the Eurozone crisis.

“The system must always be on the brink of the abyss to keep the reforms going,” he said, outlining a string of issues in that region of the world. “That’s why we will be dealing with the Euro crisis for many years.”

Technology

Graeme Newman, marketing director of CFC Underwriting, discussed technology, offering several predictions about how that will change the industry and the world.

“I believe within the next five years we will witness our first-ever war carried out online,” he said.

Newman, who spent his early career working for Deloitte on Internet security projects with the UK Ministry of Defence, was talking about the growing number of battles being carried out by entities too sophisticated to be other than large organized governments, such as Stuxnet. That virus, or worm, was developed by the U.S. and Israel to attack centrifuges in Iran that are believed to be enriching uranium for use in nuclear weapons.

Other than that dire prediction and a talk about the proliferation of cybercrime, Newman, who said he believes we are in the “second dotcom boom,” gave a mostly upbeat outlook about the impact of technology on insurance.

Unlike the boom then bust at the turn of the millennium, he said, “this time it feels very, very different.”

He noted that 2 billion people have Internet access, and that if Facebook were a country its reported 1 billion users would be considered the third largest country in the world.

Some of the top trends for the future he spoke about included crowdsourcing, which uses human processing power to accomplish tasks and solve problems, and cloud computing, or outsourcing technology, and 3D printing.

“Knowledge is no longer power,” he said. “The power is in being able to understand the data.”

Lloyd’s of London

Hank Watkins, president of Lloyd’s America Inc., talked about the insurance giant’s goals and outlook for the rest of 2012 and into 2013.

“The U.S. and Canada I believe will shrink as a percentage of the overall market,” he said, adding that “the emerging markets are a unique opportunity for us and the entire insurance world.”

One of the big issues for Lloyd’s and the rest of the market is the Solvency II directive that codifies European Union insurance regulation, for which Lloyd’s is responsible for 88 syndicates that must meet those standards.

Such regulation, which Watkins described as making Lloyd’s operating environment more difficult, but not impossible, is the new world that insurance will be likely be operating in from now on, he added.

“None of us anticipated 10, even five years, ago that the government would get so deep into our pockets,” Watkins said.

That regulation, along with changes in technology, is prompting a Darwinian evolution of the industry, as well as at Lloyd’s, he said, adding that the world’s oldest insurer must keep up with market modernization. “We can’t be the same old Lloyd’s,” he added.

Regulation

Speaking extensively of regulation was Benjamin McKay, the newly appointed executive director of the Surplus Line Association of California.

McKay, who started at the post only days before the conference, spent the last eight years as the senior vice president of federal government relations for the Property Casualty Insurers Association of America.

He noted that Congress’ attitude toward the insurance industry is evolving.

Much of that attitude change is due to the financial collapse, and misplaced blame on the insurance industry, he added.

“They think the “I” in AIG stands for insurance,” he said.

And as the government is currently operating, he added, “They believe in socializing risk.” These changes are putting the insurance industry in a position in which it will be subject to more and more “bank-centric rules,” he said.

McKay said the upcoming elections are key to how these things, including healthcare reform, are implemented.

“If we fall off the fiscal cliff it’s going to be because of election-year politics,” he said.

He noted that upcoming issues include letting lapse Bush-era tax cuts, massive budget cuts, fuel prices and natural disasters.

For 2013 he predicted “more federal involvement.” He added, “I think it’s just inevitable.”

Afterward McKay sat down with the Insurance Journal to discuss his new role and how California and its surplus lines sector will weather these changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, part of which is the Nonadmitted and Reinsurance Reform Act.

One big change is how taxes are collected under NRRA. To provide a sharing mechanism two entities were formed: the Non-Admitted Insurance Multi-State Agreement (NIMA) and the Surplus Lines Insurance Multi-State Compliance Compact, or SLIMPACT.

While NIMA is supported by the National Association of Insurance Commissioners, a competing agreement, the Surplus Lines Insurance Multi-State Compliance Compact, or SLIMPACT, has been embraced by other states. Several states have recently left NIMA.

However, it’s McKay’s belief that neither surplus lines tax clearinghouse, as things are currently shaping up, will be the solution chosen by most states.

Considering so little is collected and then divided on premium taxes, increasingly more states may decide to keep 100 percent of the premium taxes in their state, McKay said.

“It ends up being so little money for so much effort,” he said of the two entities.

While state legislature is on break and few bills have been introduced to bring California into compliance with NRRA, McKay said he believes there are several pieces of previously introduced legislation with vague wording, or bills that have little chance of passing, also called “shell bills,” which can be stripped and replaced with language.

It’s the shell bills in which California legislators will slip the language that will bring California into compliance with NRRA, he said, adding, “I think the cleanup of the NRRA language is probably going go into one of these shell bills.”

He called this new era of regulation a “time of transition,” and a “test” for California.

“California, I do believe, is up to the test,” he said.