Cyril Roux: Insurance pricing and supervision
Opening remarks by Mr Cyril Roux, Deputy Governor (Financial Regulation) of the Central
Bank of Ireland, at the Committee on Finance, Public Expenditure and Reform, and
Taoiseach, Dublin, 6 October 2016.
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I would like to thank the Oireachtas Finance Committee for the invitation to meet with you
today. General insurance protects people from financial losses that would disrupt their lives
or businesses. Having the appropriate insurance in place, which pays out when needed,
enables consumers and businesses to conduct their business on a day-to-day basis.
Before I delve into insurance pricing and supervision, let us remember that behind the cold
numbers of motor insurance premiums and claim costs that show up in insurance accounts
and in the bills we receive, lie the losses suffered in road accidents. On the one hand, rising
insurance premiums affect consumers and businesses. On the other, we know how
devastating road traffic accidents can be on the lives of victims and their families. Reducing
the number, severity and cost of road accidents is a worthwhile policy goal in itself. As a
secondary benefit, it would provide ground for sustainable insurance premiums. Low
premiums with high payouts cannot last and ultimately result in failure and further consumer
detriment. It is against this backdrop that I would like to set out the role of the Central Bank in
the area of insurance and then to give an overview of the motor insurance market in Ireland. I
will also briefly cover areas of focus for the Central Bank, together with some thought on how
to address the challenge of increasing costs.
Role of the central bank
The Central Bank of Ireland has two specific mandates as regards insurance. It is
responsible for the prudential supervision of insurance companies authorised in Ireland. It is
also responsible for the supervision of conduct of business in Ireland, also referred to as
consumer protection. We describe this dual role and how we discharge it in our Annual
Performance Statement, which has been provided to the Committee.
Prudential supervision seeks to ensure that insurance firms remain solvent. That is to say,
that insurers are able to pay claims in full, as they fall due. Because claims are paid long
after the premiums are set, this requires a forward looking assessment, with respect to the
entire business of the insurance and reinsurance company, of its state of solvency, of the
establishment of technical provisions, of its assets and capital. The Central Bank is
responsible for looking after the solvency of insurance companies incorporated in Ireland,
whether or not they belong to international groups.
However, when they do, supervision takes place in an international college of supervisors
chaired by the supervisory authority of the head of the group. Such is the case for all major
domestic insurers such as AXA, Allianz and RSA, with FBD being the exception.
Insurance Directives have prescribed for decades that prudential supervision of (re)insurance
undertakings, including that of business they pursue through branches or under the freedom
to provide services, shall be the sole responsibility of the home member state. As such,
foreign insurance firms such as Aviva and AIG, Zenith and Enterprise, Qudos, and Setanta,
are incorporated, authorised and subject to prudential supervision by foreign authorities, and
not by the Central Bank.
In the area of business conduct, the Central Bank has put in place a consumer protection
framework to protect the interests of consumers in dealing with insurers. The consumer
protection framework also applies to European insurers selling in Ireland on a freedom of
establishment basis or a freedom of services basis. The consumer protection framework
includes codes and regulations which set out standards for firms when dealing with
consumers, including when selling insurance policies, handling claims and renewing policies
as well as the provision of information and dealing with complaints.
The Central Bank does not have a role in the setting of premiums, and like all supervisory
authorities in the European Union, is explicitly prohibited by European law from doing so by
Article 181 of the Solvency II Directive. This is a long-standing prohibition carrying over from
Solvency I. In carrying out its dual mandates of prudential and conduct of business
supervision, insurance regulators throughout Europe, including the Central Bank, cannot
intervene on premium rates, but must rely on other instruments.
This is because the European single market for insurance has been set up by EU legislators
on the basis of free market principles. This is in keeping with the guiding spirit of the Treaty
of Rome. The contention underpinning this institutional choice is that over the medium term,
the free play of market forces brings benefits to consumers which outweigh their costs.
However, it also means that the volatility of prices for insurance services cannot be
constrained by the Central Bank.
Ultimately, insurance rates are driven by the money coming into insurance companies
relative to the costs they subsequently experience, in a similar way to any other commercial
concern. But year-to-year insurance rates are also strongly impacted by the competitive
environment faced by insurance firms. Prices are affected by the underwriting or insurance
cycle which plays out over a number of years.
Insurance firms may fail when poorly selecting risks or underpricing their policies, which is
known as 'underwriting risk'. This, together with limited shareholder support, is likely to have
been the main driver of the failure of Setanta in Malta and Enterprise Insurance in Gibraltar,
although only their local prudential supervisors are in a position to tell. The Central Bank has
adopted an intrusive, forward looking and proactive supervisory approach, including in
relation to underwriting risk. Our supervision is conducted through a combination of
approaches, including off-site activities and comprehensive on-site inspections. When we are
not satisfied with the governance, monitoring and management of risks, including
underwriting risks, we issue time-bound requests for remedial action. Such requests can
include revised business and capital plans, forms of contingent capital such as parental
support and strengthened reinsurance cover.
In discharging our statutory objective in Consumer Protection to ensure that, in regulating
firms, the best interests of consumers are protected, the Central Bank has focused on: clarity
of price disclosure by firms; strong suitability requirements to make sure that any product
sold is suitable for the consumer's needs, and that any product recommended to a consumer
from a range of products is the most suitable from the range available (having regard to the
consumer's individual circumstances and needs); and ensuring that consumers get relevant
information sufficiently in advance to equip them to shop around.
Motor insurance market
Let me now turn to the motor insurance market and the way it operates. The Irish motor
insurance market is concentrated across 8 firms, which are mostly part of large international
groups. There is also an active intermediary sector selling motor insurance on behalf of the
insurers. These non-life firms sell a variety of property and casualty insurance policies -
there are no pure motor insurance companies among them.
These firms receive premiums from policyholders and investment income from their
investments, while they pay out claims to policyholders and injured third parties, commission
to their distributors, expenses to their staff, interest and dividends to their capital providers,
and premiums to their reinsurers.
For non-life insurance companies in Ireland, the balance of costs and revenues has been off
kilter for several years. Premiums and investment income have decreased while claim costs
have increased, leading to sustained losses. Regulatory returns submitted to the Central
Bank for companies subject to prudential regulation in Ireland for Irish motor risk shows
combined underwriting losses of €684 million for the years 2013, 2014 and 2015.
The returns submitted to the Central Bank by companies subject to prudential regulation in
Ireland or operating as a branch show that the gross premium for Irish motor business was
€1.26 billion in 2015. This represents a reduction of 25 per cent from the 2005 gross
premium. On the other hand in 2015, gross claims incurred (which represent the total of
claim payments and changes to reserves for the expected cost of settling outstanding claims)
were €1.3 billion, which represents an increase of 42 per cent from 2005 with much of this
increase arising since 2012.
The non-life insurance industry has also been significantly impacted by the prolonged low
interest rate environment. Non-life insurers balance their underwriting results with investment
income, mostly interest income from investments in government and highly rated corporate
bonds. In a low interest rate environment, a much lower investment income cannot
compensate underwriting losses to nearly the same extent.
The bulk of the insurance firms' payouts are through claim costs. Injury claim costs account
for the majority of motor claim costs and, due to the length of time it can take to settle these
claims, the true or final cost for an insurer does not emerge for a number of years after they
have set the premium and sold a policy. However, there are a number of changes in the
claims environment in recent years contributing to a greater overall cost. These changes
include an increase in claims frequency as a result of increased economic activity and miles
travelled. Average claim costs are also increasing, particularly for bodily injury claims
because of a number of factors, including changes in court limits, the introduction of Periodic
Payment Orders and the potential impact of lower discount rates. The Aspiro judgement is an
additional factor of claim cost inflation.
In the face of increasing premium rates, the consumer protection framework provides that
consumers must be given at least 15 working days' notice prior to renewal providing an
opportunity to choose an alternative provider. Based on external market research, it is clear
that price is the main driver of consumer switching behaviour.
Supervisory areas of focus
Last year the Central Bank conducted a bodily injury review to investigate the trends in
frequency and severity of these claims and the quality of firms' approach and governance
around the issue. We found a clear if disparate trend towards both greater frequency and
cost of bodily injury claims. We also found slower settlement rates, uneven data
management quality, and instances where boards exercised less monitoring and oversight
than required. This highlighted that some firms were lagging behind peers in taking the full
measure of emerging claims in their technical provisions and estimates of ultimate claim
costs. We issued recommendations to individual firms and made clear our expectation that
up-to-date claims data inform reserving as appropriate.
This year the Central Bank undertook a sample review of motor insurance underwriting and
pricing to investigate each firm's governance of its underwriting and pricing methodology,
assumptions and decision making. We found that there was a significant time lag between
increasing claim costs being experienced and the revision of pricing assumptions. Some of
this was due to firms underestimating the extent to which claim cost increases were
structural and not cyclical, and some was due to firms taking commercial decisions to delay
increasing prices in order to hold market share in the face of some competitors pricing much
lower than break-even. The delay in incorporating fully in premiums rates the current trends
in claims experience contributed to suppressed premium increases, followed by a large
upswing in premiums. Had prices risen earlier and more gradually, some of the heavy losses
firms have experienced here over the last few years, in particular those firms that engaged in
very low pricing, would have been avoided, and consumers would have started to pay higher
premiums earlier, albeit at a more gradual pace.
In addition, given the patchy experience of foreign firms selling motor insurance into Ireland
on a freedom of establishment or freedom of services basis, the Central Bank is engaging
directly with the relevant home state regulators to ensure that they have a full understanding
of the issues affecting the Irish market and to request they act accordingly. The Central Bank
is strongly proactive in this regard. We provide our counterparts with clear information about
claims in Ireland and remind foreign regulators of their responsibilities towards Irish
policyholders. Indeed, as already mentioned, the Solvency II directive squarely places the
sole responsibility of financial supervision of foreign firms on foreign regulators, and
prescribes that the home state regulator verifies for the entire business the state of solvency,
its assets and its technical provisions.
Working toward a solution
As I mentioned at the outset, average premium rates over the cycle are driven by the overall
claims charge, if not exclusively. Policy actions that would result in a reduced level and
uncertainty of claims would contribute to reducing the rise of average premium levels or
might even reverse the trend.
This Committee has heard the many strands that would contribute to that worthwhile goal.
Let me start with comments that are relevant to the topic but lie outside the remit of the
financial supervisor. All actions that would reduce the number of road traffic accidents would
be welcome. Typical among those are improved infrastructure, stringent enforcement of road
safety rules, or continued enhancement of public awareness about the preventable causes of
accidents.
This Committee has heard as well the extent of fraudulent claims and uninsured driving that
is said to prevail. Policy actions that would help reduce either would also help reduce the
claims charge that is ultimately to be borne by premiums.
Finally, the Committee has heard about the role and effectiveness of the Injuries Board, and
how it has contributed to speedy and fair settlements that avoid unnecessary legal costs.
I would now stress that greater certainty and reduced volatility of the claims factors would
benefit consumers and create a more stable reserving environment. Multiple decisions over
the last three years, although taken for valid reasons, have had an opposite side-effect.
Since insurance companies need to book reserves with a risk margin, the greater the
uncertainty, the greater the claims estimates. I can only welcome the publication of the
revised Book of Quantum and hope it will steer very broadly compensation settlements and
decisions in the future.
All these policy actions would give a foundation for more sustainable insurance premiums.
Because of the many strands of work involved, the Department of Finance is leading a
multidepartmental 'Insurance Policy Review'. The Central Bank contributes to this work and
shares what information it has at an aggregate level to assist the Government to decide on
next steps.
Closing remarks
The Central Bank will continue to focus on the adequate protection of policy holders and
beneficiaries in accordance with its dual role of ensuring the solvency of Irish insurers and
adherence to its consumer protection framework.
The Central Bank recognises that the significant increases in the price of insurance have an
impact on consumers, and is committed to working with this Committee, the Department of
Finance working group and other stakeholders as is appropriate to the mandate of the
Central Bank.