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Hard Times Are Still Ahead

James Portelli explores the effects of the financial crisis on technical performance.

At a macro level, much is being said about the impact on the insurance industry of the global financial crisis and the subsequent spill-over effect on Dubai.

Industry media is often seemingly oblivious of differentiating factors between insurance and “big brother” banking. As a consequence, predictions are sometimes dished out on a wholesale basis. Prior to listing some potential negative technical consequences for the insurance industry, it is worth delineating insurance from banking, since general market woes may not necessarily be directly applicable to insurance.

Insurers are not banks
R Jones, managing director and chief criteria officer for S&P Middle East drew up the following differentiating factors during the 2009 CRO assembly:
. Insurance companies generally have naturally liquid balance sheets and cash flows except in post insurable risk catastrophe and/or as a result of significant surrender (life assurance) activity
. Insurance companies have typically lower leverage than banks and are less capital market dependent
. Insurance companies pose a much lower systemic threat (in fact virtually negligible in the view of other market experts, such as Jo Oeschlin, Munich Re CRO)
. The insurance sector and its rating have been resilient over the past two years
. There were no rated failures or rescues by the state in insurance within the region
. The S&P insurance downgrades (14 per cent) and negative outlooks (19 per cent) over the period corresponding with the crisis were mostly to do with the economic consequences of the turmoil. Of these, there were also 8 per cent rating upgrades in 2009 and four per cent of outlooks turning positive.

Echoing Lord Levine, chairman of Lloyds, insurance companies may suffer more indirectly as a result of a regulatory whiplash than through their own doing (such as in the case of the introduction of regulation on performance bonuses).

In addition to the above, the financial crisis in the region has been accentuated by other factors that further illustrate that this is more of a banking than insurance crisis namely:
. 70 or so local and international banks are exposed on highly leveraged real estate and/or development companies linked to the Dubai government. This is more of a direct asset risk for banks than it is for insurance companies (who may only be indirectly affected as institutional investors)
. Inadequate loan to value ratios by lending institutions competing for business over a sustained period subject to relatively high inflation. This problem is solely associated with lending institutions and not with insurance companies
. Financial (as opposed to physical) value of wealth given undue importance. Although in line with IFRS convention, one has to counter-weigh this with the fact that the region’s financial markets have yet to reach maturity and this was taking place in a period of prolonged inflation in a region undergoing unprecedented growth. As a consequence, and in hindsight, several transactions from equity to property to their subsequent financing may more often than not have been over-priced. Since pricing in insurance is based purely on physical (and not financial) value insurers were not exposed to this risk
. Ahmad Hamad Al Gosaibi & Co and Al Saad potential exposures. Again this is a purely lending/credit risk to which banks and not insurance companies were primarily exposed
. A deficient demand/supply spiral resulting in a slowdown and/or termination of projects with a consequent reduction in asset (lending) portfolio development for banks in the region. This has a knock-on effect on insurance in terms of lower top line growth, but is also paradoxically a positive factor for insurance companies from a risk management perspective.

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