Is Insurance the Next Victim of The Global Financial Crisis?

Spreading Infection in the DNA of Capitalism

London, UK - 13th December 2008, 17:51 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

Pensions, life, general insurance and reinsurance players may well become the next victim of The Great Unwind as a result of the unprecedented level of disruption in the global financial markets. The scale, speed, severity and synchronisation of the global downturn is turning new chapters in history near the speed of light and comparisons with 1929 are being rendered inadequate in real time. It is said that generals always prepare to fight the last war. Are governments and central banks doing the same with the present Great Unwind global financial crisis by dealing with it as if it was 1929 all over again? As Mark Twain said, "History doesn't repeat itself, it rhymes!"

The focus is entirely on cutting interest rates, rescuing banks and arranging government stimulus. Along the way we have forgotten to connect the dots of how this crisis is likely to affect the entire "Roof Top & Underlay", ie, life, pensions and general insurance, and "The Pillars of Hercules", ie, reinsurance. They together provide the super-structure for globalised capitalism as a system to rest on and operate from. This runaway capitalism includes the massively interconnected "Eight Bubbles" -- sub prime mortgages; emerging market loans; commodities; corporate bonds; commercial and residential property; credit card debt; currencies; and credit default swaps within derivatives -- which we have already highlighted and quantified in previous Socratic dialogue on ATCA.

Pensions, life, general insurance and reinsurance are the DNA of modern capitalism. In order to understand how modern capitalism works and how risk is syndicated, one has to be able to understand the mechanisms of risk transfer that are inherent within insurance and reinsurance. The vital role which the insurance industry plays in our future within a globalised economy, as the underlying fabric of commerce, community and globalisation, is often overlooked. One just has to look closely: the many challenges that humanity faces collectively -- including climate chaos and the environment; geo-politics and energy; organised crime & extremism, advanced technologies such as bio, info, nano, robo & AI; demographics skews; resource shortages; pandemics; financial systems and systemic risk, transhumanism and ethics -- are manifest as embryo or established risk transfer mechanisms within the insurance and reinsurance markets. As an example, Lloyd's of London which was established in 1688 remains one of the premium places in the world for mapping out and covering global risk via its syndicates that provide specialist risk cover.

The different components of the insurance industry stand to fare very differently as a result of the global credit crunch. Pension and life insurers are likely to take a harder hit than health, property and casualty insurers because of their typical asset mix. Their exposure to global equity markets, commercial property and corporate bonds -- asset classes which have suffered heavy falls this year -- has had a severe impact on balance sheets. In addition, the way assets in many complex securities are reported, result in unprecedented collapse in mark-to-market valuations. Even if balance sheets looked solid a year ago they don't do so any more in many cases.

For example, there are large chunks of its US units -- life insurance, business, online car insurance -- that American International Group (AIG) is seeking to sell to repay some of the USD 150 billion government loans that saved it from bankruptcy. In the meantime, Bermuda based XL Capital's market capitalisation, has declined by nearly 60 percent in just one week on a report that it was searching for a buyer after a severe mark down in its underlying capital. XL was formed in 1986 by 68 of the world's largest companies because they were struggling to buy non-life insurance in the US. In the past decade, XL expanded through mergers, acquisitions and launches of new businesses, becoming the largest insurance and reinsurance company in Bermuda, an important offshore centre for the industry. XL was undone by a foray into insuring structured product. In 1999, it formed bond insurer XL Capital Assurance (renamed Security Capital Assurance at IPO and then renamed to Syncora Holdings) which sold guarantees on debt such as municipal bonds. The unit also sold guarantees on mortgage-backed and more complex securities such as Collateralised Debt Obligations (CDOs). As house prices fell and foreclosures soared, mortgage-backed securities and CDOs soured and Security Capital / Syncora's main bond-insurance subsidiaries had to pay out on some of their guarantees, which rendered them insolvent. The fate of XL Capital now hangs in the balance, and given its relationship with other large insurers and reinsurers, there is a semblance of some systemic risk with rising uncertainty. The reason why there is some systemic risk is that XL like similar players of their size, both reinsure their competitors and are reinsured by them in the market. There are many instances where similar players share the same business programme with each other in a collective. It is clear that non-life players are less at risk than life players unless they are following a similar business model and investment template to AIG and XL.

What are the lessons? Pensions, life, general insurance and reinsurance players like other investors often took insufficient care in evaluating the risks of structured credit products, in part because they over-relied on the evaluations provided by the credit rating agencies. Going forwards, the players which constitute the DNA of capitalism have to take more responsibility for developing independent views of the risks of investing in complex securities, as do the banks. Further, their management must only invest in and purvey those products that they truly understand and have core expertise in. Meanwhile, Solvency II, the EU initiative that revises insurance solvency rules, will also have a great effect on the European insurance sector. The Great Unwind coupled with Solvency II is likely to accelerate further consolidation in the insurance industry. The remaining players may need to consider reducing scale, reducing risk, raising capital, employing more risk mitigation, merging with other insurers, selling the business or closing to new business, ie, going into run-off. All this will transform the way in which businesses and individuals operate and make decisions. The transformation and mutation of the DNA of capitalism has begun and it will be accelerated by developments such as those at AIG, XL and other unknown unknowns -- black swans -- that manifest at similar entities. What will emerge? Too early to say, but the world of insurance may have changed unrecognisably in the coming years. Buyers may be much more careful in buying insurance from non-transparent players in the face of default, demand destruction, deflation and depression. Many insurers may not be able to insure as they become severely undercapitalised with inadequate reserve- and solvency- ratios. After the blood-letting with severe pain, and subsequent clean out, a more robust, resilient and reliable industry is likely to emerge. In the past, new capital has always rushed in to form new entities and revive many old ones. Sovereign Wealth Funds?


ATCA Open maintains a presence for Socratic Dialogue and feedback on Facebook, LinkedIn and IntentBlog.

We welcome your thoughts, observations and views. Thank you.

Best wishes

ATCA: The Asymmetric Threats Contingency Alliance is a philanthropic expert initiative founded in 2001 to resolve complex global challenges through collective Socratic dialogue and joint executive action to build a wisdom based global economy. Adhering to the doctrine of non-violence, ATCA addresses asymmetric threats and social opportunities arising from climate chaos and the environment; radical poverty and microfinance; geo-politics and energy; organised crime & extremism; advanced technologies -- bio, info, nano, robo & AI; demographic skews and resource shortages; pandemics; financial systems and systemic risk; as well as transhumanism and ethics. Present membership of ATCA is by invitation only and has over 5,000 distinguished members from over 120 countries: including 1,000 Parliamentarians; 1,500 Chairmen and CEOs of corporations; 1,000 Heads of NGOs; 750 Directors at Academic Centres of Excellence; 500 Inventors and Original thinkers; as well as 250 Editors-in-Chief of major media.

The Philanthropia, founded in 2005, brings together over 1,000 leading individual and private philanthropists, family offices, foundations, private banks, non-governmental organisations and specialist advisors to address complex global challenges such as countering climate chaos, reducing radical poverty and developing global leadership for the younger generation through the appliance of science and technology, leveraging acumen and finance, as well as encouraging collaboration with a strong commitment to ethics. Philanthropia emphasises multi-faith spiritual values: introspection, healthy living and ecology. Philanthropia Targets: Countering climate chaos and carbon neutrality; Eliminating radical poverty -- through micro-credit schemes, empowerment of women and more responsible capitalism; Leadership for the Younger Generation; and Corporate and social responsibility.

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