It is important for the long-term health of the insurance industry that there is some strengthening of the insurance industry’s capital base

It is important for the long-term health of the insurance industry and its clients that there is some strengthening of the insurance industry’s capital base, according to FSA chairman, Sir Howard Davies. Delivering the annual AIRMIC lecture in January, he said that this was bound to require some increases in premium rates.”However, the industry will clearly need to satisfy customers that it is doing what it can to control its own costs.

Sir Howard identified ‘insurance-based investment banking’ and financial reinsurance as two trends in the insurance industry causing concern. The FSA and the Bank of England had been examining the nature of risk transfers and the motivations behind them, to establish whether or not they created market instability. Sir Howard explained: “More recently, these transfers have taken exotic forms, such as synthetic collateralised debt obligations. One investment banker described these instruments to me as ‘the most toxic element of the financial markets today’.

On financial reinsurance, the regulator has identified instances where it is unclear whether any risk has, in fact, been transferred and where the motivation seems ‘purely presentational’. As a result, the FSA has required a number of companies to renegotiate their reinsurance arrangements. Sir Howard added: “I believe that a number of companies should be asking themselves hard questions about the prudence of their reinsurance practices and indeed - on both sides - about the ethics of arrangements of this kind.

He also noted that, following the terrorist attacks of 11 September, there was a gap between the ‘bottom up’ loss estimates, derived from the provisions made by individual insurers and reinsurers, and the ‘top down’ guesstimates of loss, based on what claimants and potential claimants have said. “There are good reasons to explain part of this gap, to do with double counting and discounting, but nonetheless I find the disparity striking.

Now that the FSA will become the regulator for the insurance broking industry from 2004, Sir Howard outlined the main areas of general insurance where he felt improvement was needed. “With a reputation for sound regulation and for treating customers fairly, there is the prospect of an industry in which we see fewer failures and greater consumer confidence.

Commenting on the content of FSA chairman Sir Howard Davies’ speech when he delivered the AIRMIC lecture - 29 January 2002

David Gamble, AIRMIC executive director, said: “AIRMIC supports the FSA’s focus on the long-term health of the insurance industry and the identification of areas of heightened risk in insurance-based investment banking and financial reinsurance, and welcomes the FSA’s clear intention to monitor these areas very closely. This approach will help bring much-needed stability and clarity to the market.

“Sound regulation will contribute to a stronger and more predictable insurance market.