Reinsurers and cedants may have to retain lower levels of capital to cover potential claims in the future. But will that lead to lower prices and increased product development? David Sawers is not so sure
Many IFAs might believe that the trainspotterish mechanics of reinsurance is a world away from their day-to-day task of advising clients about the need for financial protection.
But proposals unveiled by the Financial Services Authority (FSA) last month could have a very real impact on their world – by as early as next year.
Some market observers are even suggesting that – in spite of the current price war in the sector – a consultation paper released by the financial watchdog could give insurers room to slash prices still further.
In the past, insurers that sell protection products have had to prove they hold enough capital to cover any unexpected avalanche of claims. They have even needed to hold enough capital to cover policies that would in any case lapse. But new regulations under consultation from the FSA suggest those limits could be eased. Some long-term contracts could also in the future be valued as assets. That means primary protection insurers’ dependence on the reinsurance market could be diminished. Quite simply, protection products could become cheaper.
In a recently-published consultation paper (CP06/16), the regulator said it plans to extend “realistic” capital requirements currently applied to with-profits insurance to non-profits and unit-linked business.
The proposals for so-called Pillar 1 requirements will affect approximately 160 non-profits and with-profits insurance firms.
In essence, that means that the FSA believes insurers in the past have been expected to hold too much in reserve to cover potential payouts. The proposal moves the industry closer to Solvency 2, the European Union’s initiative that has been designed to reform insurance regulation and bring in a coherent, risk-based system.
In other words, that could mean a) insurers need to rely less on reinsurers b) insurers could reduce the cost of their products c) insurers could develop more sophisticated products d) insurers could siphon off the freed-up capital as profit.
It is a multi-choice scenario that has attracted the attention of some of the most influential figures in the world of protection.
Nick Kirwan, protection market director at Scottish Widows and head of the Protection Committee at the Association of British Insurers, says: “Writing protection business is very capital hungry. But this ruling could have one immediate effect – protection business could become more profitable.” Price cuts could be “almost instant”, he adds, although he warns that there are other factors that influence the cost of protection.
Likewise, Peter Hamilton, protection management director at protection provider Zurich Assurance, suggests: “Any moves by regulators to allow insurers to price products according to a basis that better reflects actual capital requirements and risk rather than a more stringent regulatory level ought to be good for the marketplace. It should offer a greater degree of flexibility, although it doesn’t follow that prices will automatically fall. Pricing will be influenced by a range of other factors.”
Primary insurers have long campaigned for the rules to be changed – not least because that could ease the grip that reinsurers have on them. Currently, many primary insurers only hold around 10% of the risk on protection products, with as much as 90% being taken on by reinsurers.