Industry told it holds key to economic recovery

One of the UK’s most senior insurance regulators has said the insurance industry has a significant role to play in helping the global recovery but warned too much state intervention would impact the industry’s ability to meet the challenges of emerging risks.

Anna Sweeney, (pic) Executive Director, Insurance Supervision Division, Bank of England, speaking at the Bank of America 25th European Financials CEO Conference, urged insurers to play their part in driving the economic recovery.

On the pandemic she said she believed that it presented an opportunity for the industry to show its worth despite the negative publicity around business interruption coverage.

“Covid-19, a human tragedy for millions, the worst economic crisis in the UK for several centuries and an unparalleled global challenge,” she said. “Our economy and the actors within it are continuing to face numerous challenges and a great deal of uncertainty. The aim of the Bank of England – along with colleagues from other public sector institutions – has been to build a bridge across the economic disruption caused by the pandemic. And insurers – as providers of protection, as guarantors of retirement income and as institutional investors – have an important role to play in the recovery from that crisis.”

However, Ms Sweeney added the industry had three key areas where its support was vital to the economy. She said it had the ability to provide protection for significant financial losses; Channel investment into a wide range of assets; and provide security of retirement income in the form of savings and annuities, facilitating stable demand for goods and services.

“Efficient transfer and pooling of risk reduces aggregate risk and by freeing individuals from risk allows them to avoid reducing consumption in favour of excess saving,” she explained. “And it allows businesses to put capital to work in their areas of expertise and opportunity, without having to worry about – or reserve for – risks that they are not equipped to manage or diversify, and so will not be adequately rewarded for. It has particularly high value in current circumstances.”

“Failure of risk transfer markets in things like directors’ and officers’ indemnity and – yes – business interruption would have a cooling effect on this necessary investment,” warned Ms Sweeney. “So, if a protection gap were to emerge through the reactions of insurers and insured to what they have learned about contract uncertainty, we should worry about the wider impact that that might have on economic recovery.

“I do see a risk of a protection gap. The pandemic has highlighted risks around unintended exposures in insurance contracts and unexpected links across risk areas under extreme circumstances. Most acutely on business interruption insurance – where we have seen vastly different interpretations of how policies should respond to the restrictions placed on businesses as a result of Covid-19, and the sums involved have perhaps militated against either insurer or insured settling for a compromise outcome to claims.”

She recognised there is a risk that supply will be curtailed.

“As a result of potentially large and unintended accumulations, insurers will naturally take actions to limit their future exposure. This could be in the form of tighter policy wordings, exclusions, withdrawal of capacity or significant price rises, reducing the availability and affordability of non-specific peril cover and creating an increasingly concentrated market.

“For example, we know that on average, D&O (Directors’ and Officers’ protection) premiums have doubled this year. To some extent this is of course individually sensible risk management, and it is right that insurers consider the broader lessons from recent events about the potential contract uncertainty within their portfolios and take steps to reduce this. But there is a risk of excessive risk aversion and an overshoot leading to an aggregate reduction in supply that damages recovery.”

Ms Sweeney added the insurance industry has proven it can react to demands for cover for emerging risks.

“It is not impossible to transform a seemingly uninsurable peril into a diversifiable, insurable one,” she added. “Cyber risk is a helpful example. A severe, global cyber event causing systemic losses is considered uninsurable – the risk does not diversify, and the industry’s capital could never be sufficient. There are a number of industry initiatives across the world to explore further public-private partnerships to provide ultimate backstop for systemic losses.

“Clearly there is a limit to the size of losses that private insurance capital can cover, and it is worth exploring whether an explicit public-private backstop along similar lines to Pool and Flood Re in the UK is one way of mitigating the risk of a shock to supply of insurance.

“But we should be mindful of the risk of moral hazard and of crowding out private capital. To return to the example of cyber risk, the industry is now able to provide explicit cyber cover for those aspects of the risk that are insurable such as recoverability, physical damage and the cost of notification of lost records. And we know there is appetite in the market to keep the insurance business model relevant and seek out alternative sources of profit by underwriting new risks.”

She added: “A financially resilient, competitive and productive insurance sector not only ensures that individual policyholders are protected but signals an industry that is able to support the recovery of the wider economy whilst maintaining high prudential standards.”