Thank you Professor Gruendl. It is a great pleasure to speak at the House of Finance and I would like to congratulate you on the recent establishment of the International Centre for Insurance Regulation at this university.
This is the first academic institution to specialise in the regulation of the insurance industry. And it is not the only new institution in Frankfurt looking at insurance regulation. On the first of January this year a new European Supervisory authority for insurance companies – EIOPA –started work in this very city.
The increased activity in regulation is, of course, a response to the financial crisis of 2008.
The world has changed a great deal since the collapse of Lehman Brothers. First, there is China’s return as a great economic power. And second, the crisis has introduced a new phrase into every business lexicon: systemic risk.
Both of these are positive. Both will make the European economy stronger. And, crucially, both must guide the work of regulators.
Europe needs an economy dynamic enough to face competition from the new economies and stable enough to withstand systemic risk.
Stable dynamism or dynamic stability is a big ask. At first glance, it sounds like a paradox. How can we be stable and dynamic at the same time?
I believe that we can. But it will require both businesses and regulators to understand that the need to protect the consumer and the need to grow an enterprise are of equal weight and measure.
My primary concern at present is that new regulations will prevent European businesses from competing, in particular with the new economies.
The new world no longer refers to North America. The new world is China and its Asian neighbours. I think we are all used to being told that China is a coming economy, but not everyone has grasped that they have already arrived.
China is now the second largest economy in the world. It produces more cars than the United States. It imports more fine wines from Bordeaux than Germany.
I sit on the board of the second largest bank in the world. It isn’t in London, or even in New York. It is in Beijing.
In light of this, we have to ask whether we have the regulatory framework which allows us to compete with China, or Brazil or Russia.
Chinese growth represents an opportunity for European businesses. The one EU country which has proved that, indisputably, is Germany. One of the reasons that I am here this week, is because I wanted to talk to representatives of Mittelstand companies. I have been incredibly impressed by their achievements in selling to Chinese industry. To put these into perspective, German exports to China are more than double those of the UK and France combined.
Europe probably has a window now to exploit our advantages.
But that window won’t last for long, because the Chinese are learning new skills quickly. And this isn’t simply the case in manufacturing. Their financial sector is growing at a pace. Shanghai wants to become a global financial centre. Indeed, Lloyd’s is advising the Shanghai authorities on this.
So it is critical that regulators in Europe keep a very close eye on what is happening elsewhere, so that we do not achieve stability at the expense of growth.
It also remains critical that we learn the lessons of the 2008 crisis and take positive steps to manage systemic risk. However, this term applies to more than simply the new financial risks arising from a globalised economy. At the moment, everyone – regulators, media and public – sees this term as practically synonymous with bad debt travelling across borders.
But systemic risks exist outside of finance. I have been asked today to speak about the risks which the CEOs of the future will face. Some are financial. But some, crucially, are not. Boards need to consider their exposure to a whole variety of risks, including climate change, commodity scarcity or technological risk.
But before I touch on these points, I would like to say a few words about regulation of the financial services industry, and Solvency II. The best observation on regulation was undoubtedly made by the Goethe, who this university is named for. He said: welche Regierung die beste sei? Diejenige, die uns lehrt, uns selbst zu regieren!
The relationship between a business and a regulator is not always easy. Indeed some might even call it something of a Faustian pact. Although I shall leave you to decide who is Faust and who is Mephistopheles.
But I think, at heart, we in fact share the same objective – to make the European economy – a safer and a stronger place. The last few years have been difficult for regulators across the globe and I know that everyone at Lloyd’s is grateful for the continuing efforts made by the Commission to work with us to get the right result.
Of course, Lloyd’s, like every other European insurer, has one clear priority for 2011 – to prepare for the introduction of Solvency II.
The new rules are the biggest change to insurance regulation for a generation. The purpose of the regulation is to ensure greater capital stability and risk management. In short, this will require European insurers to put aside more capital to pay claims and will also introduce more reporting requirements to allow regulators to be certain that an insurer is able to meet the risks which they have promised to cover.
This focus on the insurance industry recognises the central role which insurance plays in any society. We provide stability to a thriving economy. We allow other industries to manage their risks and thus their own development, freeing up capital to further develop their businesses. Insurance was prevalent two centuries before Christ, when Babylonian traders wanted to manage the risk of their caravans travelling across the Arabian peninsula. The Romans took out insurance to enable them to pay for elaborate funerals. The first formal contracts of insurance took place in renaissance Italy, another thriving merchant’s economy.
But the place where insurance began to be conducted in regular premises was at Lloyd’s, in Enlightenment London. It is no surprise that the birth of the insurance industry took place during this era. Because insurance is not about gambling with fate – that is a common misunderstanding - it is about understanding probabilities. So when Europeans turned away from the superstition of the medieval era and developed an interest in mathematical probability, then it became possible to set premiums based on the likelihood of a disaster occurring.
These principles govern risk management culture today. Insurance is not banking. We do not speculate with capital to acquire more wealth, we preserve it to allow us to meet claims. The mark of a great insurer is not how many premiums they can take in, but how many claims they can pay out. Getting this balance right is not always easy, particularly in a soft market. Our main message to the market at the moment is to write sensibly, we don’t want them to chase downward rates, but to focus very closely on sustainable business.
The challenge for regulation generally, and for Solvency II in particular, is to enhance the structures which we use to understand and prepare for the risk which we take on. Our aim at Lloyd’s is to implement the new regime in such a way that it makes us better. We are hopeful that we will be able to do this, but we need to keep up a close and frank exchange with the regulators about what is working and, of course, what isn’t.
But the important thing to remember is that we are working to the same aim: a sustainable business model, which includes the need to ensure that European insurance companies can compete with foreign competitors.
If European insurers need to take in significantly more capital, or file more reports to regulators, will it drive clients away from us?
Any insurer can offer a lower premium rate. But he might not be around to pay the claim. Which is pretty useless for the client.
Equally, any insurer can offer the highest rate, but he may well find that the client either finds an alternative, or decides to self insure.
Getting the balance right is the skill of the underwriter. The challenge for insurers, and their regulators, is the same: to find the balance between security and a decent price.
That has always been a challenge, but globalisation is making it harder. Partly because of those other, non financial, systemic risks which all of the future CEOs in today’s audience need to understand. I will touch on three today. climate change, resource scarcity and technological risk, but there are many more.
The change in the earth’s climate is not something which we have just discovered. Lyndon Johnson’s cabinet was aware of the risk of temperatures rising. Over the last few decades, German industry has carved out a niche as the leading producer of wind turbines and solar power systems and Lloyd’s is insuring these products.
But, despite a high level of awareness of the risks associated with climate change – notably sea level rise and more extreme weather events - not much is actually happening to solve this problem.
This leaves the insurance industry in a difficult position. Because as the seas rise and the winds blow, we will need to pay out more and more claims. Something which isn’t helped by governments allowing, even facilitating, construction of properties in flood planes or vulnerable coastal areas.
Climate change has, I am afraid to say, already arrived. Last year saw the second highest number of natural catastrophes since 1980 .
The squeeze on commodities, particularly energy sources, is the other side of the climate coin. Rapid economic growth, by both West and East, over the past 100 years means that we are approaching a tipping point where cheap, easily available energy is a thing of the past.
This will create a number of major risks. The prospect of new conflicts over fuel or water. Volatility in markets due to spikes in the cost of fuel and business interruptions caused by the failure to secure a steady supply of the commodities which they need for processing goods.
Europe – which has very few natural commodities – will be heavily effected. Germany’s economic miracle since the second world war has been to become the world’s second largest exporter of goods with very few natural resources of its own – it imports two thirds of its energy.
These are difficult issues. People are nervous about nuclear power, as was shown by the heated debate over whether Germany should keep to a 2022 deadline to phase out nuclear power. In the UK, the Government have called for eight new nuclear power stations. These were difficult and unpopular decisions, which were taken because of the uncertainty in Europe around how we can meet our future energy needs. If Europe cannot source raw materials at the right price, it will face an economic collapse beyond the financial crisis of 2008. So we need to see a concerted effort to maintain a steady supply of energy. The effects of the uprising in Libya on oil prices have shown the volatility of this market.
The final systemic risk I want to touch on today is the prospect of harm or disruption to the technological network upon which we have all come to rely over the past twenty years. The phrase cyber risks conjurs up images of hackers looking to steal credit card details or intelligence operatives stealing state secrets.
These are individual events. But the big picture is even more worrying. A world which is dependent on its technology. Ships running on GPS signals, which a generation ago would have been navigated by manual skill. Railway signals powered by digital technology rather than people.
These innovations save us time and money. And I am not suggesting that we should move backwards to a more mechanical age. But the pace of change has outstripped our ability to manage it. And we need to understand this dependency on technology, and the new risks which it brings. I was in an office earlier this week, when the IT system went down. In a matter of moments, a busy hive of activity took on the atmosphere of an undiscovered tomb, as people went to get a coffee or chat at the water cooler and wait for their email and internet connections to be restored.
One of our more alarming reports last year was one which we published on space weather. At first glance, it seems quite a narrow subject, targeted at our space underwriters and their clients who launch and manage satellite technology, but on closer reading it reveals that many technologies could be affected by weather in space. Solar flares and the like have already destroyed generators, grounded airplanes and created new risks for aircrew, whose radiation levels are now monitored during their regular medical tests.
These risks cannot be completely mitigated by insurance. The traditional role of insurance is not to make a risk go away. It is to manage the financial consequences of an event happening.
But insurance has another advantage. We can work with our policyholders to help them to manage their risks. I can see why big conglomerates choose to self insure if premiums are high and they have capital at their disposal to manage their own risks. However, what they lose, is not just the financial cover, but a second pair of eyes examining the vulnerabilities of their business.
And of course, with these sorts of risks, we need to work with governments and wider society to understand them and plan and prepare for the worse. Showing once again, how insurance has social value.
Ladies and gentlemen,
I was asked to speak today about the risks which the CEOs of the future should fear. My answer?
CEOs should not fear risk. But they do need to be aware of the risks which they are running, and plan how to deal with them. Insurance is part of the solution.
And however tempting it is to suggest that we should fear regulators, we need to work with them, because we share one aim. To make Europe safe. To make Europe strong and, above all, to make Europe sustainable.
That means working together to manage some of the biggest risks faced by society – whether they are financial or not. And it means facing that other legacy of the 2008 crisis, the rise of China, so that we can compete, so that we can continue to find employment for millions of Europeans.
The question of whether the insurance industry represents a threat to the global financial system was studied by the Geneva Association. They concluded that it was not. I agree. We do the opposite. We help businesses to manage risk, systemic or otherwise. We play a central and positive role in the stability of the economy.
