Economic capital to become key P&C issue

European regulations are establishing more common insurance industry standards and this is instigating an international push that’s moving insurers towards economic capital even in North American where there is currently no standard economic capital methodology, according to a report recently released by the Insurance and Actuarial Service (IAAS) practice of Ernst & Young LLP.
The study the ‘2006 Industry Outlook,’ which addresses key property/casualty sector issues including economic capital, catastrophe modeling and risk recalibration and M&A activity warns that companies currently not taking economic capital seriously will “pay the price in years to come.”
IAAS says that it is increasing regulatory competition as well as rating agency developments, including S&P’s new enterprise risk management criteria, that in part causing the necessity for economic capital in the insurance industry.
“It is no longer a question of if, but when U.S. companies will be expected to have economic capital measurement capabilities… those who wait for U.S. standards to be set will wake up one day to find themselves behind the competition,” Michael Hughes, principal with Ernst & Young’s IAAS practice, says. “US companies should begin planning and piloting economic capital so they are prepared for the new market reality which is getting closer and closer.”
The report also reports that the 2005 P&C year will be “remembered as the year doubt was cast upon catastrophe models.”
However, IAAS warns in its report that the real fallout will occur in 2006 when the industry must decide what the next steps must be in catastrophe modeling and coverage. The 2006 year represents a crucial period because P&C insurers will be forced to decide if they will continue to retain and manage catastrophe risk or if they will turn to capital markets, the IAAS report states.
In order to determine the next best move, IAAS looks at historical data including the years 1985 and1986 when commercial writers, driven by anemic results, withdrew liability capacity from the market. This move, IAAS explains in its report, trigged an unwanted market response because numerous companies chose to self insure rather than pay rising premiums. Chris McShea, national director for the Property Casualty division of IAAS, says of this incident that; “In an effort to eliminate high-end liability, insurers lost attractive business,”
“If the industry is not thoughtful in its response to recent catastrophe issues, it could set off a series of events leading to premium leaving the market,” McShea warns. “Now is the time to carefully weigh the options and examine the risk/reward of potential next steps.”
The IAAS report also indicates that while the P&C industry has sustained considerable hurricane related losses, there are few insurers and reinsurers that will be forced to sell.
It also reports that expected rate increases have resonated with the capital markets, leaving many companies, particularly start ups, well capitalized.