Category Archives: Financial Crisis

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WEF Spotlights Insurers, Risk Response Network

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The annual World Economic Forum (WEF) kicked off yesterday in Davos, Switzerland, welcoming more than 2,500 business leaders, politicians and social activists.

A laundry list of issues awaited those in attendance, from the global economy to Eurozone debt to responsible capitalism to preventing the next financial crisis.

These issues, along with several others, are what prompted the WEF to form the Risk Response Network (RRN), “to better understand, manage and respond to complex, interdependent risk.”  In response to the new RRN, Kevin Steinberg, chief operating officer for the WEF in the United States commented:

“Over the past several years, the world has been very reactive. If you look at the number of crises that have hit from financial to social to economic ones, almost everybody has felt they’ve been trying to avoid falling off the cliff.

One of the moods we’re starting to see here in Davos is the sense we need to be more proactive. We need to think about risk not only in terms of responding to events after the fact but structuring our thinking before, being prepared.”

The RNN will be comprised of risk officers from top corporations, governments and global risk regulating bodies who will draw from the WEF’s own knowledge and insight with the aim of helping decision-makers better understand risks and respond to them proactively. The project also involves WEF-led partnerships that mobilize rapid response teams after disasters.

In other news from Davos, insurers became the topic of conversation when the question was raised as to whether large insurers should be included in a shortlist by regulators “for big players in need of more safeguards to avoid posing a threat to the whole financial system” These “big players” are known as Systemically Important Financial Institutions (SIFIs), and even though it has been said time and time again that insurance companies are not inherently systemic, the questions arises yet again. Needless to say, insurance execs at the WEF resisted being grouped as a SIFI.

“I don’t see any reason to elevate the status of insurers in a way that they are systemic,” said Dieter Wemmer, Chief Financial Officer at Swiss insurer Zurich Financial Services. Sometimes the word systemic is being used very loosely and we should understand what it means.”

‘Round and ’round we go…

Betting on Catastrophes

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Investors are looking to recoup money lost in the recession by betting on the likelihood that a catastrophe will soon strike.

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They are investing in catastrophe bonds at an unprecedented level in expectation that a massive hurricane, large earthquake or torrential floods will take place at some point, somewhere. It is a hedging technique used to bet against the movements of the traditional equities and fixed income markets.

2010 marked the third strongest year in the cat bond market’s 20-year history with $5 billion invested, according to Swiss Re.

“Last year marked a strong rebound after the financial crisis – we have seen healthy year-on-year growth since then, mainly due to the conservative collateral structures that came to market after Lehman Brothers collapsed as well as further price convergence with the reinsurance market,” Martin Bisping, Swiss Re’s Head of Non-Life Risk Transformation, said in a telephone interview.

Considering that the cost of natural disasters to insurers increased by more than two-thirds to $37 billion last year from 2009, investing in cat bonds may be the safest, and probably most depressing, bet around.

Economic Recovery: The Good, the Bad and the Ugly

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We got some very good news as far as the overall economic recovery goes: businesses, especially small businesses, are hiring. As this CNN Money article notes, small businesses, in part due to their operational agility, are often the first to start hiring as the economy improves. Most importantly, the 297,000 jobs added significantly outpaced the expectations of most economists.

Small businesses saw a sharp jump in hiring in December, according to an ADP report released Wednesday.

The private sector added 297,000 jobs overall last month, with almost all of the gains coming from companies with less than 500 workers. Those firms added a net 261,000 new positions during the month, ADP estimates.

This doesn’t mean unemployment rates will markedly fall in the near future, and the country surely still isn’t out of the woods yet, but it is at least some good news — something that has been hard to find for the past two years.

Unfortunately, there is an increasingly prevalent threat looming that may hamper economic recovery on a global level: energy costs. The BBC explains.

The current high price of oil will threaten economic recovery in 2011, according to the International Energy Agency (IEA).

It said oil import costs for countries in the Organisation for Economic Co-operation and Development had risen 30% in the past year to $790bn (£508bn). The agency says this is equal to a loss of income of 0.5% of OECD gross domestic product (GDP). The IEA’s chief economist said oil was a key import of any developed country.

There are also concerns about the rising costs of other commodities. The UN’s Food and Agricultural Organisation (FAO) said the high oil price had pushed the price of food to a new record.

The article goes on to mention that higher oil and coal prices don’t just affect food, of course, but trade balances and household spending as well. Taken together, these two bits of information feel like one step forward, two steps back.

And this brings us to the Federal Reserve’s latest plan to buoy the economy.

A video that was made toward the end of last year was recently brought to my attention by by Forbes’ Amity Shales, who calls the viral cartoon Quantitive Easing Explained the “the best commentary on Fed policy currently out there.” I’ll let her explain in her own words why the blunt, cut-to-the-chase message about the Fed’s controversial decision to buy $600 billion worth of Treasury bonds has resonated so well with an American public tired of hearing government officials tout economical theory that few laymen understand — particularly when all most laymen want is more work.

What the national leap to these new media tells us is that many Americans are desperate. They want to know what must be changed—or kept the same—in the U.S. economy. Professional economists may be on the trail of the answer, but to find it they have to dedicate more time to inquiry and less to self-important obfuscation.

This so-called Quantitative Easing 2 (or QE2 as much of the financial media likes to term it so endearingly) will remain controversial for some time, and neither side will be proved correct until they are. And really, as with most interventionalist economic policy, unraveling all the threads to even determine what actually caused what will always be difficult — if not impossible — to know. There are so many externalities and all that.

So the mud-slinging debates surrounding the Fed’s latest move will remain ugly as many workers (or wannabe workers) ask similar questions to those in the video below — and companies continue to ponder when it will actually be safe to once again start spending and hiring.

Q&A: The Impact of Basel III

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Banks have feared the impending Basel III reforms for some time now. We have covered the topic in the past, both on the Monitor (the most recent Basel III-related post here) and in Risk Management (our April 2010 issue).

Starting tomorrow, regulators will come together for a two-day meeting of the Basel Committee on Banking Supervision. The purpose of the meeting is to come to an agreement on liquidity and the quality of capital to fill gaps in an overhaul of rules known as Basel III. Earlier this month, the G-20 endorsed the Basel reforms.

To get a bit of insight on the matter and how the reforms will affect insurers, I contacted Adam Girling, principal at the Financial Services Office of Ernst & Young, with a few questions on the topic.

How will the largest global investment banks deal with the impact of Basel reforms?

Adam Girling: One of the most significant impacts of the new Basel reforms is the substantial increase in capital requirements for trading book exposures, which are those positions held on a short-term basis with the intent to trade. The Basel Committee Quantitative Impact Study (QIS) and industry estimates suggest that risk-weighted assets for many trading portfolios will rise under the new requirements by three to four times on average, and potentially more for some portfolios. Particularly hard hit are securitization exposures. The global banking organizations with sizeable trading portfolios are looking at where their capital requirements are increasing most and whether they need to bring capital requirements down by hedging or unwinding positions — although liquidity of positions remains an issue. Coupled with the analysis of changing capital requirements are new Basel III leverage and liquidity coverage standards, as well as industry reforms around over-the-counter (OTC) derivatives and proprietary trading. So institutions are reviewing their business strategies and considering which businesses to exit stay the course or grow given the combined impact of changing market dynamics and new regulatory constraints.

Do you think economic growth will be hampered by Basel III bank capital standards?

AG: This is a profound question and there is certainly a divergence of views. For example, the Institute of International Finance (IIF) analysis suggests a potentially large impact, while the Basel Committee itself projects a quite limited impact. Theoretically, the extended implementation period should provide an opportunity to identify potential unintended consequences and an opportunity to make adjustments as, and if, necessary. The biggest risks are likely in the transition phase. The Basel committee has calculated that with the long transition periods retained earnings can boost capital ratios sufficiently, but the industry may set expectations for banks to meet the new standards sooner. If this is the case, banks will either need to raise extra capital or will need to reduce the risk in their balance sheets — potentially via changing their lending profiles to maintain an acceptable rate of return on equity.

How will the Basel reforms affect insurers?

AG: Basel II applies to banking organizations and Basel III does not propose to change those subject to the risk-based capital standards.  In the US, Basel II has, to date, only applied to the largest and most internationally active banking companies on a consolidated basis. And to my knowledge, none of these institutions have a top-tier parent that is an insurance company. If any insurance companies were deemed systemically significant under the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is quite possible that the enhanced capital and liquidity requirements to which they would be subject would incorporate Basel III. In Europe, however, Solvency II is enhancing risk-based capital for insurers using a three pillar framework similar to Basel II.