managing risk: practical lessons from recent “failures” of ... p et al. (2002), prudential...

F i n a n c i a lS e r v i c e sA u t h o r i t y

Occasional Paper Series ◆ 20

December 2002

Managing Risk:Practical lessons fromrecent “failures” of EUinsurers

William McDonnell

FSA OCCASIONAL PAPERS IN FINANCIAL REGULATION

Foreword

The FSA is committed to encouraging debate among academics,practitioners and policy-makers in all aspects of financial regulation. Tofacilitate this, it is publishing a series of occasional papers in financialregulation, extending across economics and other disciplines.

These papers will cover such topics as the rationale for regulation, thecosts and benefits of various aspects of regulation, and the structureand development of the financial services industry. Since their mainpurpose will be to stimulate interest and debate, we welcome theopportunity to publish controversial and challenging material and topublish papers that may have been presented or published elsewhere.

The main criterion for acceptance of papers, which will be independentlyrefereed, is that they should make substantial contributions toknowledge and understanding in the area of financial regulation. We willencourage contributions from external authors as well as from withinthe FSA. In either case, the papers will express the views of the authorand not necessarily those of the FSA. Comments on these papers arewelcomed and should be addressed to the series editors.

Authors wishing to contribute to this series should contact Dan Watersor Sarah Smith at:

The Financial Services Authority25 The North ColonnadeCanary WharfLondonE14 5HS

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FSA Occasional Papers are available on the FSA website www.fsa.gov.uk

M A N AG I N G R I S K :

P R AC T I C A L L E S S O N SF RO M R E C E N T

“ FA I L U R E S ” O F E UI N S U R E R S

W I L L I A M M C D O N N E L L

FSA Occasional Paper

© December 2002

Biographical Note

William McDonnell is returning to Deloitte & Touche from his secondment to theInsurance Technical Risk team within the FSA’s Prudential Standards Division.

Acknowledgements

This paper is based on the work of the London Working Group1 of the EU InsuranceSupervisors Conference (reported in Sharma, 2002). For further information on theLondon Working Group, contact the Conference Secretariat by telephone (+33 1 55074125), fax (+33 1 5507 4292) or e-mail to [email protected]

The full report of the working group is also available on the FSA website athttp://www.fsa.gov.uk/pubs/occpapers/london_working_group_report.pdf

I am grateful to Clive Briault, Sue Kean, Bill Lowe, Chris O’Brien and Paul Sharma forcommenting on earlier drafts of this paper. Any remaining errors are entirely my own.This paper reflects my views and not necessarily those of the FSA.

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Managing Risk Practical lessons from recent “failures” of EU insurers

1 The London Working Group of the Conference of the Insurance Supervisory Services of the MemberStates of the European Union, chaired by Paul Sharma of the FSA.

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www.fsa.gov.uk/pubs/occpapers/op20.pdf

http://www.fsa.gov.uk/pubs/occpapers/london_working_group_report.pdf

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Contents

1. Executive Summary 5

2. Limitations 7

3. Context: regulatory approaches vary 8

4. Risk mapping: cause and effect 9

5. Findings from case studies 12

6. Lessons about toolkits: striking the balance 18

7. Conclusions 22

References 23

Appendix 1: Case studies 25

Appendix 2: Descriptions of main risks 50

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1. Executive Summary

The European Commission and a number of national regulators are taking a fresh lookat insurance regulation. To inform that debate, a working group2 of supervisors from15 European countries dissected recent experiences of failed insurance companies and‘near misses’3 , across the life and non-life sectors. The group identified the risks thathave threatened firms’ solvency in the last six years (since 1996), including howmultiple risks interacted in individual cases. It also assessed existing supervisorypractices, particularly those aimed at prevention and advance detection.

The unique contribution of this group arose from its ability to study confidentialinformation among peers. This included the detailed scrutiny of over twenty real,recent case studies of failing firms, in the light of many other comparable casesfamiliar to members of the group. It also included frank discussion of the efficacy ofexisting supervisory toolkits4 and ideas for developing them. The scrutiny anddiscussion exploited the substantial collective experience in the group, grounded inmany years’ supervision of insurers in 15 countries.

This paper aims to present some of the most valuable insights emerging from this work,explaining and making more accessible those likely to be of interest to firms,professional advisers and front-line supervisors. The case studies and risk analysis willbe of particular interest to those involved in the governance of regulated firms andthose within the firms who have particular responsibility for monitoring risk. Thefindings will also be of interest to regulators and others interested in policydevelopment, and show that this exercise gives considerable empirical support tomuch of the regulatory reform that is already under way in the UK (see Tiner, 2002)and elsewhere.

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2 See footnote 1. The group had 8 meetings between June 2001 and September 2002. References to thegroup should not be taken to imply unanimity in all cases.

3 Failure was taken to be breach of the Directive solvency requirement. This is consistent across the EEA,whereas other definitions such as ceasing to write business or to pay claims, or statutory insolvency,catch too many or too few firms with serious problems. Few firms managed to recover alone.

4 ‘Toolkits’ refers to the collection of rules and guidance, principles and practices in use or available tosupervisors to help prevent, diagnose or deal with problems.

This paper concludes that the group’s findings in relation to risk are indeed relevantfor firms and their advisers, supervisors and policy-makers (see chapter 7). Particularconclusions include:

• management problems appear to be the root cause of every failure or nearfailure, so more focus on underlying internal causes is needed;

• firms, supervisors and others need to anticipate how risks can interact incomplex ways, including causal links between different types of risk (for instanceoperational risks and underwriting risk or claims evaluation risk) and unexpectedcorrelations (particularly between certain asset and underwriting risks); thegroup’s risk-map is likely to be helpful for this;

• moving to a risk-based approach brings benefits and at the same time hasimplications for policy-making and supervision – the subjective nature of thesupervisory assessments means that different approaches may be needed,including more forward-looking tools as well as greater internationalcooperation; and

• it is important to strike the right balance between prescriptive rules, principles,incentives and diagnostic tools.

I should make clear that although I was a member of the London Working Group, theviews in this paper, particularly on the implications of the group’s findings, are my ownand not necessarily those of either the FSA or the other members of the group.

The European Commission is expected to publish a framework for the ‘Solvency II’directive in the first half of 2003, taking into account among other work therecommendations of Sharma (2002). The FSA’s supervisors and policy-makers are alsotaking note of the findings of that report, set out below, as they continue to enact thereforms described in Tiner (2002).

This paper is not of direct interest to retail consumers.

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2. Limitations

The group noted two main limitations to its work.

The first is the extent to which the findings can be regarded as universallyrepresentative. Sharma (2002) complements a previous European working group report(Müller, 1997), which looked at risks facing insurance firms in the early 1990s. At thattime the risk terrain was different; in particular insurers in many countries wereadjusting for the first time to the removal of tariffs5. The London working group’s workwas restricted to events in the last six years since 1996, under particular marketconditions that included investment bull and bear markets, lower interest rates andinflation, the rising cost of claims in certain classes, and changing shareholderattitudes. This does not represent a complete economic or insurance market cycle, andone cannot dependably extrapolate the findings even from a complete market cycle asfundamentals evolve and new risks may emerge.

Secondly, there are important areas that the working group did not focus on. It lookedin detail at firms’ risks and at supervisory practice, in other words the equivalent ofBasel pillar 26. It barely touched on the structure of capital requirements (pillar 1) andhow to harness market forces to achieve prudential aims (pillar 3). Harnessing marketforces might reduce to an extent the need for pillar 2 interventions, either to safeguardfirms’. Typically market forces are brought into play by public disclosure; normally thisis of financial outcomes, but may be extended to illuminate earlier stages in the causalchain, for instance disclosure of governance arrangements and of modellingassumptions. Earlier in 2002 the FSA published a discussion paper (Financial ServicesAuthority, 2002a) on reform of disclosure and reporting across the UK financialservices industry, with a particular emphasis on insurance, that explores these issuesfurther.

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5 Many EEA states set statutory insurance tariffs for certain business classes until 1994.

6 The three pillars of banking regulation under the proposed new Basel Capital Accord (Basel Committee,2001a) are capital rules, supervisory review and harnessing market forces.

3. Context: regulatory approaches vary

The working group was made up of insurance supervisors from 15 EEA countries7. Thevariety of approaches to regulation and supervision as surveyed among these countriesis considerable, which clearly poses challenges to progress towards a more harmonisedregulatory regime. This may seem especially surprising given that the 15 countries allhave the same current basis under EU Directives for their capital requirements.

The table below from Sharma (2002) summarises which regulatory objectives areshared by all countries and which by some.

Supervisory styles also vary markedly, from little use to predominant use of detailedinvestigations, and varying degrees of reliance on third parties, whether auditors oractuaries. Supervisors in some countries, including the UK, rely also on individualresponsibility of senior management and the threat of personal as well as corporatesanctions. And in dealing with issues, supervisors’ styles range from an almost totalreliance on an informal, consensual approach to extensive use of formal tools. At thesame time it was striking from discussion of practical cases how all supervisors sharedcommon concerns, particularly on quality of management and its grasp of and controlover the risks in the business. It was not the concerns that varied but how thoseconcerns are identified and addressed.

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7 European Economic Area (EEA) member states represented on the working group were: Austria,Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Liechtenstein, Luxembourg, theNetherlands, Portugal, Spain, Sweden and the UK. Iceland and Norway also contributed.

4. Risk mapping: cause and effect

4.1 Risk classification

The group identified about 50 generic risks that had led to or threatened to lead tosolvency problems at insurers in the last six years. In attempting to refine and classifythese into a useful framework, the group realised that the risks are linked in causalchains8. For instance, the risk of adverse claims development may arise from poor riskselection (underwriting risk), which may in turn arise from poor underwriting policy orcontrols (underwriting systems and controls risk), which may itself be due to lack ofexperience (management risk).

This led to the design by the group of the cause-effect risk-map as a practical tool tohelp in analysing the case studies. Although there are many other ways to classifyrisk9, the group looked at cause and effect because we wished to distinguish the rootof a firm’s problems from among all the issues that presented themselves. Cause-effectmethodologies are widely used10 to analyse failures in other fields and to understandbetter the underlying causes. This approach helps in assessing both the relativeimportance of the causes and how to control them, and also their ultimate impact.

4.2 Risk-map

The group’s risk-map template is reproduced in figures 1 and 2 below (from Sharma,2002) both at a high-level and in its detailed version showing how the different risk-types fit in.

The risk-types are defined in Appendix 2 of Sharma (2002). The risk-map is not anabstract construction but was compiled from risks that had recently caused difficultiesand was structured by supervisors with extensive experience of how these risks arise.

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8 It should be noted that ‘risk’ is used in this paper and in Sharma (2002) in two connected but subtlydifferent ways. It refers both to the possibility of an adverse event occurring and to the realisation ofthat potential when the risk materialises.

9 For the multi-dimensional nature of risk and some ways in which risks can be categorised see Culp(2001). For other approaches suggested by group members, see Appendix B of Sharma (2002).

10 For more on the value of understanding the causes and effects of risks see: Ashby and Diacon (2000),Waring and Glendon (1998), Blockley (1996) and Shrivastava et al. (1988).

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Practical lessons from recent cases in Europe

Figure 1: high-level risk-map

Figure 2: Detailed risk-map (generic)

Underlying causes- internal

(management, governance &

ownership)

Underlying or trigger causes - external(wider changes as well as event orinsurance market specific changes)

Inappropriaterisk

decisions

Inadequateor failedinternal

processes,people orsystems

Financialoutcomes

Policyholderharm

Risk appetite decision

Incorrectevaluation of

financial outcomes

Management risk

Internal governance & control risk

Controller / grouprisk

Economic cycle /condition risk

Social, technological, demographic,political, legal, tax etc. risks

Market competition risk

Data risk

Accountingrisk

Technologyrisk

Otheroperational risk

Distributionrisk

Investment /ALM risk

Insuranceunderwriting

risk

Reinsurance risk

Expenserisk

Businessrisk

Market risk

Credit risk

Claimsdeviation risk

Other liabilityrisk

Loss of goodwill /reputation risk

Participatingpolicyholder

loss

Liquidityrisk

(Insolvency)Balance sheet

loss

Catastrophe / extreme event risk

Risk appetitedecision

Technical provisions -evaluation risk

Other liabilities- evaluation risk

Administrationrisk

Asset evaluation risk

Underlying causes - internal: Underlying or trigger causes - external:

Policyholder harm:

Incorrect evaluation of outcomes:

Financial outcomes:Risk decisions:Failed processes:

It was tested empirically when the group used it as the basis for its analysis of thedetailed case studies (see chapter 5 below). It proved a good fit and significantlyenhanced the group’s analysis in helping:

• to make sure it considered issues at each stage of the problems’ development;

• to identify how each risk became significant and what consequent risks theremight be.

• to understand better the complex interactions of the various risks (see section5.4 below) by tracing common causes or patterns.

The group’s classification of risks and risk-map may also be useful as a benchmark orreference point for firms as they develop their own risk frameworks. The risk-mapraises the following points of interest:

(i) It is useful to distinguish the underlying internal chain of causes from theexternal trigger event. For instance a firm may not properly monitor potentialloss aggregations, due to poor data and complacent management whounderestimate the potential severity of a catastrophe. After a catastrophe sucha firm may fail when others do not, because the underlying internal causesmade it more vulnerable.

(ii) Traditionally firms and supervisors have focused mainly on technical outcomes,in other words results and financial position; but these are the later stages in acausal chain. Dealing with the earlier stages as well may bear considerable fruit(see section 5.3 finding (b)).

(iii) In my view, much of the causal chain falls under a broad definition ofoperational risk11, an area that is generally less well recognised in the insuranceindustry12. Operational risk can include:

• management and governance issues;• internal processes (systems and controls and strategic decisions);• planning for adverse external events;• validation of models and other evaluation methods and tools; and• other risks such as administration, outsourcing or legal risk.

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11 The definition suggested in Basel Committee (2001b) is “the risk of loss, resulting from inadequate orfailed internal processes, people and systems, or from external events”.

12 For more on operational risk for insurers, see FSA (2002b).

5. Findings from case studies

5 . 1 A p p r o a c h

The group asked its members to look at the complete population of life and non-lifeinsurer failures and near failures from 1996 to 2001, identifying the main cause foreach. From the total population of 270 cases it selected 16 cases likely to berepresentative of the whole, covering each of the main risks. It added five more casesduring the course of this work to focus on additional risks or aspects of risks as needed.

The 21 cases were presented by the delegation from each of the countries concernedin written and oral form, each followed by a detailed and robust discussion. And duringthe discussion of each case, the group cited other similar cases in its collectiveexperience where similar circumstances had not led to solvency problems. The groupcontrasted these with the case in question, to focus on the critical factors and rootcauses of failure.

The case studies are set out in Appendix 1. Similar features of cases have beenamalgamated into generic case studies and extraneous details removed, to preserveanonymity as well as to draw out the lessons more clearly; each of the 12 generic casestudies reflects more than one real case. Each is presented as a risk-map withaccompanying commentary.

5 . 2 M a n a g e m e n t p r o b l e m s a r e t h e r o o t c a u s e

Management or governance issues were at the root of every case, even in two caseswhere at first sight there were no management problems. Indeed one of these caseswas selected specifically to illustrate a failure where management was not at fault, butunder scrutiny underlying management weaknesses were identified. This is in commonwith the findings of EEA banking supervisors who studied banking difficulties between1988 and 1998 and concluded that management and control weaknesses wereunderlying, fundamental and contributory in almost all of the cases.

Management problems are often the most difficult to identify and treat – in only 2 of21 cases were these problems identified and dealt with before external events led to

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serious adverse outcomes. This is also illustrated above and in chart 1 which comparesthe profile of risks identified in the supervisor surveys with the output of the detailedcase studies.

In the initial analysis of the total population, supervisors identified underwriting orreserving risk as the main cause in most failures or near misses. Detailed study ofselected cases on the other hand revealed on average six different key risks interactingin each case, spread more evenly across risk-types. Similarly the EEA bankingsupervisors had found that most cases manifested themselves as credit problems, butusually resulted from a combination of contributory factors, often includingoperational risk and almost always management and control problems. This contrast isillustrated in chart 1.

This graph is based on the data in figure 4.1 in Sharma (2002), page 28, heresummarised into seven risk groups. These data are not fully comparable, as the surveyresults count 140 cases13 only once each, while the case study results include anaverage of six ‘hits’ for each of the 21 cases. This is because the surveys identified asingle main cause for each failure or near miss, whereas in the case studies the groupidentified all the main risks (from among the 29 sub-risks in figure 2) that contributedto the problems in each case.

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0

20

40

60

Management/governance

External causes Operational:People, systems

and controls

Underwriting /reserving risk

Reinsurance risk Asset risk Operational:Business risk

Surveys

Case studies

C h a r t 1 : M a i n c a u s e s i d e n t i f i e d

13 This is fewer than the 270 cases reported by supervisors as the causes were not analysed for the 95failing companies that were not wound up, and the ‘near misses’ have been adjusted for one case of36 smaller firms under a collective threat. For more on the data, see Sharma (2002), pages 27-28 andAppendices C-D.

Chart 1 implies that it is easier to see the technical effects, most visibly poorunderwriting or reserving, rather than the firm’s underlying problems and their rootcauses. Indeed all the case studies had significant underlying management orgovernance causes, and many had significant systems and controls issues (seeAppendix 1). The widespread underwriting and asset problems were able to arisebecause of these fundamental weaknesses, and the combination of poorly managedrisks made the firm particularly vulnerable to adverse external events. When the groupcompared problem cases with other firms who weathered similar circumstances better,a pattern emerged of the following four forms of management problems:

• incompetence, straying outside their field of expertise or uncritically followingherd instinct;

• excessive risk appetite or objectives that are at odds with prudent management ofthe business;

• lack of integrity; or

• lack of autonomy and inappropriate pressure e.g. from parent company.

These findings are consistent with other analyses of the key underlying issues forinsurers. For instance, it is interesting to note that the first three of these cover thesame ground as Buffett’s three basic rules for running an insurance company14 (groupissues are not covered). See below (section 5.4) for practical problems in acting on theabove.

5 . 3 T h e r e i s a n e e d t o f o c u s o n t h e e a r l y l i n k s i n t h e c a u s a lc h a i n

The last finding (section 5.2) has implications for the governance of firms as well asregulation. Dealing with the early links in the causal chain is desirable butproblematic, and supervisors’ approach to this will depend to an extent on their overallstyle (see chapter 3). Focusing on technical outcomes and their evaluation (in otherwords the later links in the causal chain) is generally easier than dealing with theearlier stages, as the later stages tend to be more tangible and easier to benchmark

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14 Warren Buffett, CEO of Berkshire Hathaway Inc, set these out in a letter to shareholders following the11 September 2001 US terrorist attacks. See Buffett (2001).

and assess objectively. For instance, setting and monitoring limits for certain assettypes is generally easier than assessing investment strategy or the competence of theinvestment manager. The internal issues earlier in the chain such as managementquality, governance arrangements or the robustness of systems and controls and riskmanagement are more subjective and open to challenge. This makes it harder for thosesuch as audit committees or supervisors to act upon concerns at an early stage.

Dealing with the underlying issues can prevent subsequent adverse financial impactson the firm. For instance, in my view those involved in governance of firms may wishto make sure that:

• the insurance entities in a group have enough autonomy and are not subject topressure to take imprudent decisions, for instance to use their balance sheet toinvest in or lend to other businesses for strategic reasons rather than managingtheir assets to optimise the balance of risks and rewards (e.g. case study 1,Appendix 1);

• key personnel not only have the appropriate skills and experience when they jointhe firm, but also maintain and develop their skills; and the firm reassesses itstotal available skill-base and experience as needed so that this remains up-to-date and appropriate (e.g. case study 7, Appendix 1);

• performance assessment and bonus policy for senior management do notencourage an excessive risk appetite – the key assumptions that are most criticalto pricing or reserving should be reasonable and not overly optimistic (e.g. casestudy 4, Appendix 1);

• any indication of lax risk management or systems and controls, excessive risk-taking or a lack of integrity generates a searching response in case it issymptomatic of a deeper malaise. Such symptoms can include15 minor breachesand infringements of policy, manipulation of results, or delays in implementingplans or dealing with an audit management letter. They can also include conductof business problems, evidenced perhaps in customer complaint levels (e.g. casestudy 2, Appendix 1).

Case studies 4, 7, 8 and 9 (Appendix 1) illustrate that when the business is changing,it is especially important to reconsider these underlying issues, in particular thecompetence of key directors and managers and the suitability of systems and controls.This can be when the firm moves into any new areas of business or there is any otherchange in the strategy of the business or a business combination or restructuring. In

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a number of cases the problems started when such a change happened and the seniormanagement could no longer marshal the full skills or experience they needed tounderstand, monitor and control the new risks arising, allowing severe problems todevelop unnoticed or underestimated until too late. And management problems canevolve gradually, making them harder to fix on as a problem, so regular reassessmentmay be the best approach.

It is well worth focusing on the earlier links in the causal chain, hoping to interruptthe chain before adverse events arise. Tiner (2002) p.37 describes sound managementas a ‘cornerstone’ of the regulatory regime. Where firms and regulators succeed in‘nipping problems in the bud’, they are likely to benefit significantly:

• firms will be less likely to fail or to face serious threats to their solvency ormarket standing that are a major drain on senior management resources;

• supervisors are more likely to achieve regulatory objectives and save the effortinvolved in taking more severe enforcement action at a later stage or coping witha failing firm; and

• consumers and other market participants will benefit from reduced risk of lossand inconvenience and market disruption that can arise when a firm is in trouble.

5 . 4 D e a l i n g w i t h m a n a g e m e n t p r o b l e m s i s p a r t o f a w i d e rr e s p o n s e

Supervisors will need to target preventative and diagnostic tools on the early links inthe causal chain as well as on the later stages (see chapter 6). The difficulty they faceis identifying which problems to treat; supervisors may often have some concernsabout management, but in many cases the perceived weakness will not lead to adversefinancial effects. And it is likely to be disproportionate, not to say impractical, forsupervisors to act in the hope of nipping every case in the bud. Nor can the marketexpect supervisors to eradicate management problems and their effects. In many casesthe supervisor’s response may instead be increased scrutiny, treating their concernsabout management as a potential early warning signal.

Tools for management problems will therefore supplement rather than replace otherprudential requirements; supervisors will continue to need these other requirements in

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order to deal with the intermediate and ultimate stages of the causal chain. In myview, this supports the approach the FSA and some other regulators are adopting ofgiving a high priority to governance, risk management and systems and controls (seeTiner, 2002, chapter 3), within a wider overall prudential framework.

5 . 5 R i s k s c a n i n t e r a c t i n c o m p l e x w a y s

It is important for any practical analysis of the risks a firm faces to take into accounthow those risks can interact to offset or augment each other. The group found fromanalysis of the various risks involved in individual case studies that often theyinteracted in relatively complex ways. These included causal relationships betweendifferent types of risks including feedback loops, and correlations between differentrisks that the firm had not anticipated.

Examples of interacting risks from the case studies (Appendix 1) include:

• Market and underwriting risks: A recession had a double-impact for a creditinsurer who had invested in commercial property as the same economicconditions caused losses to increase markedly and asset values to fall sharply.

• Market, underwriting and liquidity risks: An insurer had invested in other insurersin similar markets, and a downturn in the market caused the investee insurers tofall in value and draw in more capital from the investor firm at the same time asit faced increasing losses. This also led to a liquidity squeeze exacerbated by theilliquidity of its investments.

• Operational, expense, underwriting and reserving risks: A large firm, strugglingto digest yet another acquisition, had poor expense control and over-ambitioustargets. These led (indirectly) both to poor risk selection by underwriters, whowere under pressure to increase volume to cover expenses, and to under-reserving, perhaps due to similar pressures to achieve targets.

• Operational, expense, underwriting, reinsurance, claims deviation and reservingrisks: An insurer with poor internal systems and controls consequently gaveinappropriate and insufficient instructions when outsourcing to a claims

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15 A longer list of potential qualitative early-warning indicators is in Sharma (2002), p. 61.

manager. This led to overpayment of claims, loss of business from poor levels ofservice and delayed and garbled claims data. This in turn led to a vicious circle ofunder-pricing and poor risk selection, an ill-fitting reinsurance programme andunder-reserving as well as the high cost of attempted remedial action. The viciouscircle was made worse as customers learnt to exploit the firm.

5 . 6 C o m m o n f i n d i n g s

The above findings are similar to those reached by EEA banking supervisors in a reviewof recent banking difficulties. In summary, they found that:

• although credit problems were the main visible symptom, management andcontrol weaknesses were fundamental in almost all cases;

• operational risk was a significant factor in many cases;

• a major risk factor was over-ambitious expansion, often into new areas, withsystems and controls lagging behind;

• external risks are a significant factor, but usually expose other internal problemscontributing to the difficulties;

• difficulties usually arose from different factors in combination; and

• supervisors should not rely wholly on quantitative factors as these do not capturethe entire risk profile, in particular the underlying risks.

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6. Lessons about toolkits: striking the balance

6 . 1 S t u d y o f s u p e r v i s o r y t o o l k i t s

Having analysed the risks that firms face, the group put its supervisory toolkits underthe spotlight to see how they match up against those risks. The range of tools in useis surprisingly wide, with only a minority being reported by all or nearly all countries.The group found that although individual member states may not have a full range oftools, when all the tools are considered together they give good coverage at each levelacross all the main risk areas. Delegations also submitted a range of ideas for newtools. They agreed that pooling current practice and sharing ideas was extremelyuseful, to equip supervisors to respond more flexibly and appropriately.

The group considered which tools address which of the seven main risk areas (groupedas in chart 1 above). It then classified the tools further as operating mainly at one offour levels:

(a) organisation and governance;

(b) strategy and decision-making;

(c) monitoring and flow of information; and

(d) investigation and corrective action.

The group identified common principles both for firms and for supervisors, at eachlevel for each main risk area. These principles, the common and less common tools andmany of the ideas for new tools or new uses of existing tools, are set out in detail inSharma (2002), pages 44-57.

6 . 2 S u b j e c t i v i t y r a i s e s i s s u e s f o r s u p e r v i s o r y p r a c t i c e

Moving down through the four levels at which the principles and tools operate ((a) to(d) above), some trends are apparent: in general the lower-level tools, such asmonitoring of complaints or detailed analysis of returns, are more objective, more

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formal and easier to apply. But typically they operate later in the causal chain and maybe less effective. Conversely, the higher-level tools, such as fit and properrequirements or review of business plans, tend to be more subjective, informal anddifficult to use (as decisions are more open to challenge), but can be more powerfuland more forward-looking.

If supervisors are to focus more on the higher levels and the earlier stages in the causalchain, this will require more subjective judgements about the quality of managementand governance, systems and controls etc. In my view, this raises issues for supervisorsas they may need to adjust their mix of skills (see for example Tiner, 2002, pp.51-52),but acquiring the right skill sets may be costly as experience will be more and moreimportant to enable such judgements to be made reliably.

The group felt that, under a risk-based regime, informal supervisory tools may beincreasingly important as well as formal supervisory tools. Informal dialogue withfirms and others has been an important part of supervisory practice and is especiallyvaluable for assessing management quality. Generally the group felt that while it cansometimes be hard to prove that formal action is justified when it is based on concernsabout subjective areas such as a firm’s governance or risk management, informalaction can be highly effective. Such action might include making management awareof concerns and requesting changes, or allocating more supervisory resources to thatfirm and perhaps undertaking further investigations.

6 . 3 R e g u l a t o r y c o s t s a n d b e n e f i t s : i s p r e v e n t i o n r e a l l y t h eb e s t c u r e ?

Underlying causes, such as an excessive risk appetite, are hard to prevent. More weightis probably needed on early diagnosis. The group discussed perhaps also usingbenchmark solvency levels as triggers for investigation and intervention, so levels ofcapital could play a role here as well as acting as a buffer to cushion against risks.

It is important to weigh up the costs and benefits of different regulatory andsupervisory tools (see Alfon and Andrews, 1999). In my view, preventative measurescan seem to be an easy answer, for instance imposing prescriptive rules to restrictinvestment in riskier assets or requiring more capital; but such measures deal not withthe underlying problems but only with their effects. Such measures can also be costlyfor the industry, and thus indirectly for the customer, as well as restricting anddistorting the operation of a free market. The working group drew an analogy with

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speed limits: a lower limit reduces accidents but also generally reduces efficiency. Thisis an area where the difference in regulatory objectives of different countries (seechapter 3 above) became more apparent.

I would add further that a change in the balance of approach between prescriptiverules and a higher-level, principles-based approach may have an impact on competitionin the market. This has already happened with the removal of tariffs (chapter 2) whichmade the market freer. At the same time regulators can still influence the market, forinstance by reviewing firms’ strategies and seeking changes where these may adverselydistort the market. Or they may seek to influence the industry in situations wherecompetitive pressures might encourage many firms to take undue risks that couldotherwise pose a systemic threat (such situations arose case studies 6 and 10,Appendix 1).

Preventative tools can include incentives as well as restrictions. This could include arisk-based capital framework where the firm that can demonstrate good riskmanagement can obtain a lower capital requirement. Stretching the analogy, this hasparallels with different speed limits for different types of vehicles.

The working group’s work supports the use of preventative tools, but in a moreadvanced form. It developed a framework of principles for firms to follow which wouldin my view reduce the risk of failure. Rather than making prescriptive rules, thisreduces problems by requiring firms to abide by the principles; this of course dependson the principles having teeth, for instance from the threat of personal sanctionsunder the FSA’s approved persons regime. Most countries represented on the grouphave some personal sanctions available.

A principles-based approach is likely to help rebalance supervision towards the earlierstages of the causal chain, since principles may be more suited to the underlyinginternal causes due to their subjectivity whereas prescriptive rules are more suited todealing with the more objective technical outcomes. A further advantage of a moreprinciples-based approach is that a firm’s implementation of the principles will of itselfbe tailored to its own situation. Firms would need to adjust to this, as the FSA hasindicated to UK firms (see Tiner, 2002, pages 14 and 41).

21


6 . 4 S o u r c e s o f i n f o r m a t i o n

The group noted the sources of information for supervisors in the case studies, andother sources cited during discussions and in responses to the tools questionnaire.

The following points may be of interest for supervisors and policy-makers:

• Although time-consuming, on-site inspections are valuable as the supervisor canobserve and assess subjective factors such as culture and management qualityand can follow up interviews and corroborate key information more easily andreliably. Also, in some of the case studies supervisors came across importantinformation incidentally during an on-site inspection.

• Information volunteered by the firm is often crucial. One of the main objectivesof informal supervisory contact with firms’ management must be to educate themabout what information the supervisor would wish them to offer.

• Whistle-blowing by employees did not feature in any of the case studies, and thegroup agreed that in their experience it is often problematic. Motivation can becomplex, and the notification is also often either too late or too early and vagueto be useful.

• Qualitative early warning indicators are useful as well as quantitative indicators(see section 5.3 above). Supervisors should be alert to apparently minor matters,since these were the first indication of serious management problems in morethan one case study.

• A key challenge and wish expressed by a number of countries is to develop moreforward-looking tools, for better advance detection, as they focus more onstrategy and risk management. This includes stress and scenario testing as wellas submission to the supervisor of strategy and business plans, for example.

This last point is in common with the conclusions of EEA banking supervisors, who feltin 1999 that the banking solvency ratio can be a poor predictor of problems, and maybe insufficiently forward-looking.

A further potential source of information is other supervisory services across Europeand internationally, and not just insurance supervisors. The group noted in case study6 (see Appendix 1) that such communication is valuable for seeing the whole picture,particularly where different early warning signals may be visible in different countries.

22


23


The group also recommended international cooperation to plan for crisis management,which is a topic also being looked at by EEA banking supervisors and central banks.

Limits to resources mean that not all of the above sources of information can be usedfor all firms, but a wider range of sources may help supervisors to deal with problemcases.

7. Conclusions

The risk analysis and case studies merit consideration by firms and their advisers aswell as by supervisors and regulators. They should be used as a stimulant toimaginative thinking about risk, rather than as a definitive checklist.

Most of the conclusions below are not unique to the insurance industry and are similarto those reached by EEA banking supervisors in a recent review.

F i r m s

The risks facing insurers have much similarity across Europe, and with those facingbanks (see section 5.6). The case studies showed that management problems,operational risks and other risks other than insurance risk are prevalent andpotentially extremely damaging to insurance firms. Senior management of firms, auditcommittees and others concerned with their governance must therefore make sure thatthey give these risks full consideration.

The cause-effect risk-map was useful as an analytical tool, and proved a ‘good fit’ whenapplied in practice. It was particularly helpful in understanding the complex ways inwhich risks can interact, which is an important element of risk assessments andmodels.

P o l i c y - m a k e r s a n d s u p e r v i s o r s

In my view, the group’s work suggests that a risk-based approach will need to givemore weight to the underlying risks and root causes of failure that may not be capturedby a largely quantitative regime. A principles-based approach may be more suited tosuch a focus; but to be effective it would need teeth in the form of effectivesupervision, backed up for instance by the threat of personal sanctions.

Consideration of the costs and benefits of different approaches is likely to suggest thebest approach is a multi-faceted one. Such an approach might combine prevention(weighted towards principles, incentives and deterrents rather than prescriptive rules)with capital requirements tailored to reflect risk, and better diagnosis, particularly of

24


any underlying weaknesses in firms. This shift towards principles and more focus onmanagement and risk suggests a need for more qualitative information and moreforward-looking information. It also implies that a different mix of skills is likely to berequired of supervisors.

There are also increasing benefits to be gained from greater international cooperationbetween supervisors, both on individual supervision cases and broader policy-makingas well as planning for crisis management.

The issues identified above overlap with many of the issues the FSA has identified andis dealing with, as set out in Tiner (2002), particularly chapters 3 and 4.

25


References

Alfon I and Andrews P (1999), Occasional Paper 3: Cost-Benefit Analysis in FinancialRegulation. Financial Services Authority, London.

Ashby S and Diacon S (2000), Strategic Rivalry and Crisis Management. RiskManagement an International Journal, Vol 2, No 2, 7-15.

Basel Committee (2001a), Consultative Document: The New Basel Capital Accord. BaselCommittee on Banking Supervision, Basel.

Basel Committee (2001b), Consultative Document: Operational Risk. Basel Committeeon Banking Supervision, Basel.

Blockley D (1996), Hazard Engineering in Hood C and Jones D (eds) Accident andDesign. UCL Press, London.

Buffett W E (2001), Letter to the Shareholders of Berkshire Hathaway, November 9,2001. Omaha.

Culp C (2001), The Risk Management Process: Business Strategy and Tactics. WileyFinance, New York.

Financial Services Authority (2002a), Discussion Paper 12: The New RegulatoryReporting Environment. Financial Services Authority, London.

Financial Services Authority (2002b), Consultation Paper 142: Operating Risk Systemsand Controls. Financial Services Authority, London.

Müller H et al. (1997), Solvency of insurance undertakings. Conference of theInsurance Supervisory Services of the Member States of the European Union, Paris.

Sharma P et al. (2002), Prudential Supervision of insurance undertakings: Report ofthe London Working Group on Solvency II. Conference of the Insurance SupervisoryServices of the Member States of the European Union, Paris.

26


Shrivastava P et al. (1988), Understanding Industrial Crises. Journal of ManagementStudies, Vol 25, No 4, 285-303.

Tiner J et al. (2002), The Future Regulation of Insurance: a Progress Report. FinancialServices Authority, London.

Waring A and Glendon I (1998), Managing Risk: Critical Issues for Survival and Successinto the 21st Century. International Thomson Business Press.

27


Appendix 1: Case studies

This appendix reproduces the commentaries on the case studies and theiraccompanying risk-map diagrams from Sharma (2002) edited slightly to make clear thelessons being drawn from each generic case study.

12 generic case studies are presented in this appendix, prepared from the group’sanalysis of 21 real cases. The aim has been to preserve the essential characteristics ofthe cases but to preserve their anonymity by remove idiosyncratic details andcombining elements from different cases where patterns of causes and risks weresimilar. Each generic case study reflects elements from more than one real case.

The symbols in the case-study risk diagrams are explained in the following key:

29


Key to risk map symbols:

lessons learnt:diagnostic or

preventative toolthat could have

helped

causallink

supervisoryinformation

flow

diagnosis andsupervisory

action

Major elementof causal chainwith details of

risk

30

Gene

ric c

ase

stud

y 1:

Pa

rent

set

s in

appr

opria

te p

olic

y in

pur

suit

of g

roup

obj

ectiv

es (

stra

tegi

c in

vest

men

ts)

•Eco

nom

ic c

ondi

tions

cha

nge

forc

ing

sale

of

stra

tegi

c in

vest

men

ts;

•Ins

uran

ce m

arke

t det

erio

rate

s (w

hich

aff

ects

bot

h th

e in

sure

r its

elf

and

som

e of

the

othe

r in

sure

r in

whi

ch it

inve

sted

).

Dec

isio

n to

inve

stte

chni

cal

prov

isio

ns in

asse

ts w

hich

:•

are

larg

e,ill

iqui

d, lo

ng-

term

inve

stm

ents

;•

incl

ude

othe

rin

sure

rs in

the

sam

e in

sura

nce

mar

kets

; or

• pe

rfor

m p

oorl

yan

d dr

aw in

mor

eca

pita

l and

loan

s.

Gra

dual

or

sudd

enre

duct

ion

ofau

tono

my

oflo

cal

man

agem

ent

Inad

equa

tesc

rutin

y by

loca

lin

sura

nce

firm

man

agem

ent o

fth

e su

itabi

lity

ofin

vest

men

ts.

• In

vest

men

t los

sis

larg

e du

e to

earl

y re

alis

atio

nan

d ov

erco

ncen

trat

ion.

• In

vest

men

t los

sco

inci

des

with

unde

rwri

ting

loss

es.

• O

ther

deb

t los

esva

lue

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

on•

Mar

ket v

alue

har

d to

ass

ess

• cr

edit

prov

isio

ns to

o sm

all

Ow

ners

/ gr

oup

man

agem

ent d

irec

t the

insu

rer’

s in

vest

men

tst

rate

gy in

pur

suit

of g

roup

obje

ctiv

esR

ules

to r

estr

ict t

ypes

of

inve

stm

ent a

nd r

ules

on

asse

t-lia

bilit

y m

atch

ing

are

inad

equa

te

Det

ecte

d by

on-s

itein

spec

tion

Det

ecte

d by

regu

lato

ryre

port

ing

and

on-

site

insp

ectio

n

Det

ecte

d by

on-s

itein

spec

tion

Reh

abili

tatio

npl

an r

equi

red

Impr

oved

loss

eval

uatio

nre

quir

ed

Impr

ovem

ents

in p

roce

dure

sre

quir

ed

Aut

onom

y of

insu

rer’

sm

anag

emen

tto

be

asse

ssed

regu

larl

y

Case

stu

dy 1

: Pa

rent

set

s in

appr

opri

ate

polic

y in

pur

suit

of

grou

p ob

ject

ives

(st

rate

gic

inve

stm

ents

)

In t

hese

cas

es t

he in

sure

r’s p

aren

t un

dert

akin

g se

t an

asp

ect

of p

olic

y w

hich

had

a d

etrim

enta

l eff

ect

on t

he in

sura

nce

firm

bec

ause

the

y ha

d ob

ject

ives

oth

er t

han

prud

ent

man

agem

ent

of t

he in

sura

nce

firm

. Gro

up m

anag

emen

t ov

erro

deor

dire

cted

loca

l dec

isio

ns, s

o lo

cal m

anag

emen

t eit

her l

ost s

ome

auto

nom

y or

they

did

not

pro

perly

che

ck th

e su

itab

ility

of t

heir

inve

stm

ents

.

In th

ese

case

s th

e gr

oup

man

agem

ent u

sed

the

insu

rer’s

bal

ance

she

et to

mak

e st

rate

gic

inve

stm

ents

. Thi

s ha

s a

num

ber

of p

robl

ems:

(i)

the

inve

stm

ents

are

typi

cally

con

cent

rate

d an

d m

ay b

e ill

iqui

d du

e to

the

lack

of a

trad

ed m

arke

t or t

he la

rge

size

of

the

hold

ing

– al

so t

his

ofte

n m

akes

the

m h

ard

to v

alue

;

(ii)

gro

up s

trat

egy

is li

kely

to

dete

rmin

e th

eir

disp

osal

rat

her

than

opt

imal

ass

et m

anag

emen

t;

(iii)

the

re m

ay a

lso

be a

‘pro

cycl

ical

’ eff

ect

as in

vest

men

ts, p

artic

ular

ly t

hose

in o

ther

insu

rers

, may

fal

l in

valu

e w

hen

mar

ket

cond

ition

s ar

e ha

rsh;

(iv)

thi

s m

ay b

e m

ade

even

wor

se b

y gr

oup

pres

sure

to

prov

ide

mor

e lo

ans

and

capi

tal t

o th

e in

vest

ee r

athe

r th

an le

ss–

inad

equa

te c

redi

t pr

ovis

ions

may

als

o be

com

e a

prob

lem

; and

(v)

this

als

o ca

rrie

s a

syst

emic

con

tagi

on r

isk,

i.e.

tha

t th

e co

llaps

e of

one

insu

rer

is m

ore

likel

y to

brin

g do

wn

othe

rs.

Less

ons:

Con

flict

wit

h gr

oup

obje

ctiv

es a

nd lo

ss o

f aut

onom

y ca

n ar

ise

grad

ually

, mak

ing

them

har

der t

o de

tect

and

act

on. R

egul

ator

y re

port

ing

was

impo

rtan

t in

som

e ca

ses,

but

sup

ervi

sors

iden

tifie

d th

e re

al p

robl

em m

ainl

y th

roug

h on

-si

te in

spec

tions

. Re

gula

r as

sess

men

t of

the

fir

m’s

aut

onom

y w

as s

ugge

sted

, an

d tig

hter

rul

es o

n ty

pes

of in

vest

men

tan

d as

set-

liabi

lity

mat

chin

g.

31

32

Gene

ric c

ase

stud

y 2:

Pa

rent

set

s in

appr

opria

te p

olic

y th

roug

h po

or u

nder

stan

ding

of i

nsur

ance

• In

tere

st r

ate

mov

emen

ts•

Cla

ims

beha

viou

r

Und

erw

ritin

g ri

skto

o hi

gh, d

ue to

unso

phis

ticat

edpr

icin

g.

Ass

et-l

iabi

lity

mis

mat

ch e

xpos

esth

e fi

rm u

ndul

y to

mar

ket s

win

gs.

Prop

er a

sset

-lia

bilit

ym

atch

ing

is n

otca

rrie

d ou

t

Poor

unde

rwri

ting

stra

tegy

sel

ecte

d

•Bal

ance

she

etlo

ss

•Und

erw

ritin

glo

ss

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

on

•Tec

hnic

al p

rovi

sion

und

er-

valu

ed•a

sset

s ov

erva

lued

Gro

up m

anag

emen

tha

ve li

ttle

insu

ranc

eex

peri

ence

Det

ecte

d by

regu

lato

ryre

port

ing

and

on-

site

insp

ectio

n

Rel

ianc

eon

exp

erts

to h

elp

Add

ition

alre

port

ing

requ

ired

whi

leon

‘cl

ose

wat

ch’

Impr

oved

loss

eval

uatio

nre

quir

ed

Not

all

supe

rvis

ors

are

able

tore

quir

e th

is

Rel

evan

tex

pert

ise

need

ed

Impl

emen

tru

les

on A

sset

-L

iabi

lity

mat

chin

g

Case

stu

dy 2

: Pa

rent

set

s in

appr

opri

ate

polic

y th

roug

h po

or u

nder

stan

ding

of

insu

ranc

e

In t

hese

cas

es t

he i

nsur

er’s

par

ent

unde

rtak

ing

had

a no

n-in

sura

nce

focu

s an

d se

t an

asp

ect

of p

olic

y w

hich

had

ade

trim

enta

l eff

ect

on t

he in

sura

nce

firm

bec

ause

the

y la

cked

a p

rope

r un

ders

tand

ing

of t

he in

sura

nce

busi

ness

and

its

regu

lato

ry r

equi

rem

ents

.

In o

ne c

ase

a ba

nk s

et u

p a

gene

ral

insu

rer.

Desp

ite t

he f

inan

cial

aw

aren

ess

of t

he p

aren

t, m

anag

emen

t ha

d lit

tlein

sura

nce

expe

rtis

e an

d pu

t in

pla

ce i

nade

quat

e un

derw

ritin

g sy

stem

s, s

o un

derw

ritin

g lo

sses

aro

se.

Rapi

d gr

owth

sugg

este

d un

der-

pric

ing

to th

e su

perv

isor

, who

als

o no

ted

paid

and

out

stan

ding

cla

ims

ratio

s ou

t of l

ine

wit

h th

e m

arke

tge

nera

lly.

Man

agem

ent

wer

e co

oper

ativ

e, a

nd t

he s

uper

viso

r on

ly n

eede

d to

act

inf

orm

ally

and

brin

g th

e is

sues

to

man

agem

ent’s

att

entio

n.

In a

noth

er c

ase

the

insu

rer d

eleg

ated

ass

et m

anag

emen

t to

a ba

nkin

g pa

rt o

f the

gro

up, a

nd fa

iled

to s

uper

vise

it. T

heba

nkin

g si

de w

ere

expe

rienc

ed a

sset

man

ager

s, b

ut w

ere

not

awar

e of

the

insu

ranc

e re

gula

tory

req

uire

men

ts n

or h

owto

mat

ch a

sset

s to

the

insu

rer’s

liab

ilitie

s, e

xpos

ing

the

com

pany

to

inte

rest

rat

e m

ovem

ents

.

The

supe

rvis

ory

resp

onse

to

thes

e ca

ses

was

to

requ

ire a

dditi

onal

, fr

eque

nt r

epor

ting

whi

le t

he f

irm

was

on

‘clo

sew

atch

’, an

d to

intr

oduc

e ex

pert

s to

hel

p im

prov

e po

licie

s an

d ev

alua

tion

proc

edur

es.

Less

ons:

A k

ey r

isk

fact

or i

s la

ck o

f re

leva

nt e

xper

tise,

whi

ch i

s an

ear

ly w

arni

ng s

ign

to w

atch

for

whe

n ev

enex

perie

nced

ope

rato

rs m

ove

into

a n

ew a

rea.

Req

uirin

g ap

prop

riate

exp

ertis

e co

uld

serv

e as

a p

ower

ful

prev

enta

tive

tool

.

33

34

Gene

ric c

ase

stud

y 3:

M

utua

l ins

urer

face

s co

nflic

ting

obje

ctiv

es

•Adv

erse

cla

ims

expe

rien

ce•E

cono

mic

con

ditio

ns a

nd in

sura

nce

mar

ket d

eter

iora

te, f

orci

ng s

ale

ofin

vest

men

ts

Dec

isio

n to

inve

stte

chni

cal

prov

isio

ns in

asse

ts w

hich

:•

are

larg

e,ill

iqui

d, lo

ng-

term

inve

stm

ents

• pe

rfor

m p

oorl

yan

d dr

aw in

mor

eca

pita

l and

loan

s.

Prem

ium

s se

t too

low

and

cla

ims

settl

ed g

ener

ousl

y

•Use

ass

ets

inap

prop

riat

ely

to b

enef

itm

embe

rs

•Gen

erou

sun

derw

ritin

gst

rate

gy

• In

vest

men

t los

sis

larg

e du

e to

earl

y re

alis

atio

nan

d ov

erco

ncen

trat

ion.

• O

ther

deb

t los

esva

lue

•Und

erw

ritin

glo

sses

ero

deso

lven

cy m

argi

n

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

on

• L

oss

of in

vest

men

t val

ueno

t rec

ogni

sed

as it

was

occu

rrin

g. •

cred

it pr

ovis

ions

too

smal

l

Man

agem

ent s

eek

tobe

nefi

t mem

bers

/po

licyh

olde

rs a

s w

ell a

sm

anag

ing

the

busi

ness

prud

ently

Rul

es to

res

tict

type

s of

inve

stm

ent

are

inad

equa

te

Det

ecte

d by

on-s

itein

spec

tion

Det

ecte

d by

regu

lato

ryre

port

ing

and

on-

site

insp

ectio

n

Det

ecte

d by

on-s

itein

spec

tion

Reh

abili

tatio

npl

an r

equi

red

Impr

oved

loss

eval

uatio

nre

quir

ed

Impr

ovem

ents

in p

roce

dure

sre

quir

ed

Case

stu

dy 3

: M

utua

l ins

urer

fac

es c

onfl

icti

ng o

bjec

tive

s

A m

utua

l in

sure

r’s m

anag

emen

t m

ay h

ave

soci

al a

nd o

ther

obj

ectiv

es b

esid

es p

rude

nt m

anag

emen

t of

the

ins

uran

cebu

sine

ss. I

n on

e ca

se s

tudy

thi

s le

d th

em t

o us

e th

e in

sure

r’s b

alan

ce s

heet

to

inve

st in

oth

er a

ctiv

ities

for

the

bene

fit

of th

eir m

embe

rs. T

his

led

to a

con

cent

ratio

n of

inve

stm

ents

in g

roup

com

pani

es, r

eal e

stat

e an

d, a

s it

turn

ed o

ut, l

arge

cred

its t

o th

ose

com

pani

es,

wit

h si

gnif

ican

t ba

nk d

ebts

. Th

ese

fact

ors

led

to a

num

ber

of p

robl

ems

sim

ilar

to t

hose

desc

ribed

in th

e fi

rst c

ase

type

abo

ve. T

he s

olut

ion

was

a p

rogr

amm

e of

dis

posa

ls a

nd b

ette

r ass

et d

iver

sifi

catio

n ag

reed

wit

h th

e fi

rm.

Anot

her c

onfli

ct a

rises

sim

ply

betw

een

the

need

for p

rude

nce

and

the

wis

h to

kee

p ra

tes

low

for m

embe

rs. M

utua

ls w

hoca

n m

ake

supp

lem

enta

ry c

alls

on

thei

r m

embe

rs m

ay r

ely

too

muc

h on

tha

t an

d re

lax

thei

r vi

gila

nce

on r

isk

sele

ctio

nan

d m

onito

ring

of c

laim

s de

velo

pmen

t, w

hich

may

in

turn

lea

d to

buy

ing

too

little

rei

nsur

ance

cov

er.

They

may

fac

eer

osio

n of

cap

ital

and

dif

ficu

lty in

cal

ling

in a

dditi

onal

pre

miu

ms,

esp

ecia

lly w

hen

this

is s

ubje

ct t

o a

vote

by

mem

bers

or w

hen

a si

gnif

ican

t nu

mbe

r of

mem

bers

hav

e si

nce

left

.

Less

ons:

Inv

estm

ent

rule

s ar

e in

adeq

uate

at

prev

entin

g su

ch p

robl

ems.

It

may

be

impo

rtan

t to

exa

min

e in

vest

men

tst

rate

gy a

nd o

bjec

tives

as

an a

ltern

ativ

e to

mak

ing

rule

s m

ore

rest

rictiv

e.

35

36

Gene

ric c

ase

stud

y 4:

La

rge

insu

rer –

bus

ines

s ris

k: d

isec

onom

ies

of s

cale

• m

erge

r op

port

unity

ari

ses

Exp

ense

ris

k(m

erge

r ex

pens

eson

top

of a

lrea

dyhi

gh e

xpen

ses)

Und

erw

ritin

g ri

sk(p

ress

ure

toac

hiev

e vo

lum

eto

cov

erex

pens

es)

Ope

ratio

nal

risk

:•

poor

acco

untin

g•

optim

istic

fore

cast

ing

and

repo

rtin

g•

poor

exp

ense

cont

rol

• C

laim

sde

viat

ion

• hi

gh m

erge

rco

sts

Bal

ance

she

etlo

ss

Ris

k ap

petit

e de

cisi

on

• as

set e

valu

atio

n, te

chni

cal

acco

unt e

valu

atio

n

•Man

agem

ent s

acri

fice

prud

ence

in th

e fa

ce o

fpr

essu

re to

ach

ieve

res

ults

•Mer

ger

as ‘

way

of

life’

•Man

agem

ent a

llow

str

uctu

reof

fir

m to

bec

ome

unw

ield

ySt

ress

test

ing

shou

ld b

e do

ne o

nex

pens

es a

ndun

derw

ritin

g

Det

ecte

d as

are

sult

ofm

erge

r re

ques

t

Det

ecte

d by

due

dilig

ence

pro

cess

(use

of

expe

rts)

and

inte

rvie

ws

Cap

ital

inje

ctio

nre

quir

ed

Impr

oved

loss

eval

uatio

nre

quir

ed

Res

tric

t ass

etho

ldin

gs (

size

etc)

Ado

ptpr

opos

edm

easu

res

Supe

rvis

ors

need

sys

tem

of e

arly

war

ning

indi

cato

rs

Case

stu

dy 4

: La

rge

insu

rer

– bu

sine

ss r

isk:

dis

econ

omie

s of

sca

le

Larg

e co

mpo

site

fir

ms

can

be h

ard

to m

anag

e ef

fici

ently

, pa

rtic

ular

ly t

hose

tha

t ha

ve g

row

n up

thr

ough

a s

erie

s of

acqu

isiti

ons

and

mer

gers

. Of

ten

firm

s fa

ce m

ultip

le l

egac

y sy

stem

s an

d on

goin

g sy

stem

int

egra

tion

prob

lem

s, s

opr

oduc

tion

of c

onso

lidat

ed m

anag

emen

t inf

orm

atio

n is

unr

elia

ble.

Thi

s ha

mpe

rs e

ffec

tive

runn

ing

of t

he g

roup

from

the

cent

re.

The

part

s m

ay h

ave

dive

rse

type

s of

bus

ines

s, s

truc

ture

and

cul

ture

, w

hich

may

aga

in m

ake

cent

ralis

ed c

ontr

oldi

ffic

ult

and

lead

to

poor

fin

anci

al a

nd u

nder

writ

ing

disc

iplin

e. T

his

may

cau

se a

hig

h ex

pens

e ra

tio a

nd la

rge

loss

es a

sth

e fi

rm c

ompe

nsat

es fo

r pr

evio

us u

nder

-pric

ing

and

unde

r-re

serv

ing.

Mer

ger

cost

s ar

e fr

eque

ntly

hig

her

than

exp

ecte

dan

d fi

rms

may

str

uggl

e to

ach

ieve

the

fore

cast

cos

t-si

de s

yner

gies

.

Early

war

ning

ind

icat

ors

are

the

high

exp

ense

s co

mbi

ned

wit

h po

or r

esul

ts w

hich

ind

icat

e th

at m

anag

emen

t m

ay b

eun

der p

ress

ure

to a

chie

ve v

olum

e (a

t the

exp

ense

of u

nder

writ

ing

prof

itab

ility

). M

anag

emen

t may

als

o be

und

er p

ress

ure

to r

epor

t be

tter

res

ults

in

the

light

of

nego

tiatio

ns f

or f

urth

er m

erge

rs o

r ac

quis

ition

s, o

r to

mee

t ca

pita

l m

arke

tex

pect

atio

ns a

s su

ch f

irm

s ar

e of

ten

liste

d.

And

the

mer

ger

carr

ies

the

risk

of h

igh

rest

ruct

urin

g co

sts,

whi

ch o

ften

over

run.

Fin

ding

new

mer

gers

and

acq

uisi

tions

can

bec

ome

alm

ost

a w

ay o

f lif

e, e

ach

tran

sact

ion

obsc

urin

g th

eun

derly

ing

perf

orm

ance

of t

he e

xist

ing

busi

ness

es.

Less

ons:

Pro

blem

s w

ere

dete

cted

as

a re

sult

of in

crea

sed

scru

tiny

whe

n a

mer

ger

was

pro

pose

d. A

sch

eme

of o

pera

tions

incl

udin

g fu

ll bu

sine

ss p

lans

and

rig

orou

s st

ress

tes

ting

was

rec

omm

ende

d on

a c

hang

e of

con

trol

.

37

38

Gene

ric c

ase

stud

y 5:

Cr

oss-

bord

er m

anag

emen

t of i

nsur

ance

gro

up

Man

agem

ent h

ave

high

risk

app

etite

and

poo

rco

mm

itmen

t to

tran

spar

ency

in f

inan

cial

repo

rtin

g.

•Adv

erse

cla

ims

expe

rien

ce•p

oor

inve

stm

ent p

erfo

rman

ce -

fal

ling

equi

ty m

arke

ts

Agg

ress

ive

unde

rwri

ting

stra

tegy

,in

clud

ing:

•nov

el r

isks

•mar

gina

l ris

ks(r

ejec

ted

byot

hers

)•e

ndem

icun

derp

rici

ng

•Agg

ress

ive

purs

uit o

f m

arke

tsh

are

•Wea

k fi

nanc

ial

repo

rtin

g co

ntro

ls

Und

erw

ritin

glo

sses

ero

deso

lven

cy m

argi

n.

Inte

rnal

cont

agio

n: p

aren

tse

eks

fund

s fr

omin

sure

r to

sup

port

stru

gglin

gov

erse

asop

erat

ion

Polic

yhol

ders

face

incr

ease

dri

sk o

f in

solv

ency

Ris

k ap

petit

e de

cisi

on

Tec

hnic

al p

rovi

sion

sev

alua

tion

risk

.C

apita

l res

ourc

esev

alua

tion

- ig

nori

ngot

her

stra

ins

ongr

oup

capi

tal.

Det

ecte

d on

-si

te a

nd th

roug

hre

gula

tory

repo

rtin

g

No

cons

olid

ated

supe

rvis

ion

Det

ecte

d by

regu

lato

ryre

port

ing

and

on-s

itein

spec

tion

Cou

ld im

prov

ein

tern

atio

nal

com

mun

icat

ion

betw

een

supe

rvis

ors

Ear

ly w

arni

ngin

dica

tors

-ag

gres

sive

mar

ketin

gst

rate

gy, m

arke

tkn

owle

dge

Case

stu

dy 5

: Cr

oss-

bord

er m

anag

emen

t of

insu

ranc

e gr

oup

One

cros

s-bo

rder

ins

uran

ce g

roup

stu

died

had

a p

oor

man

agem

ent

attit

ude

cent

rally

whi

ch a

ffec

ted

the

cond

uct

ofop

erat

ions

in m

ore

than

one

mem

ber s

tate

. Ini

tial s

ympt

oms

of th

e ba

d at

titud

e w

ere

notic

ed b

y su

perv

isor

s in

dif

fere

ntco

untr

ies,

for

inst

ance

agg

ress

ive

pric

ing

and

unde

rcut

ting

of c

ompe

titor

s, a

ggre

ssiv

e m

arke

ting

and

purs

uit

of m

arke

tsh

are,

acc

eptin

g bo

rder

line

risks

rej

ecte

d by

oth

er f

irm

s an

d co

ncen

trat

ion

on h

igh-

risk

clas

ses.

Unt

il in

form

atio

n w

asex

chan

ged

betw

een

coun

trie

s, a

t a

late

r st

age,

the

sup

ervi

sors

did

not

see

the

big

ger

pict

ure

of c

ultu

ral

prob

lem

sth

roug

hout

the

inte

rnat

iona

l fir

m. I

n th

is c

ase

ther

e w

as n

o co

nsol

idat

ed s

uper

visi

on a

s th

e In

sura

nce

Grou

ps D

irect

ive

was

not

yet

in fo

rce.

In a

noth

er c

ase

the

pare

nt c

ompa

ny w

as a

n in

term

edia

ry a

nd s

et u

p a

subs

idia

ry i

n an

othe

r m

embe

r st

ate

to s

ell

insu

ranc

e no

t lo

cally

but

bac

k in

to t

he p

aren

t’s c

ount

ry.

This

is

allo

wab

le u

nder

the

Dire

ctiv

es b

ut c

reat

es s

peci

alpr

oble

ms:

the

firm

lack

ed in

side

exp

erie

nce

of u

nder

writ

ing

in th

e pa

rent

’s m

arke

tpla

ce a

s th

e pa

rent

was

not

an

insu

rer

and

the

unde

rwrit

ers

wer

e m

ainl

y re

crui

ted

loca

lly. I

t can

als

o be

har

der f

or t

he f

irm

to s

ee c

urre

nt m

arke

t per

form

ance

and

beha

viou

r fr

om a

far.

Less

ons:

The

gro

up i

dent

ifie

d th

e po

tent

ial

for

impr

oved

com

mun

icat

ion

betw

een

supe

rvis

ors

to s

hare

con

cern

s an

ddo

ubts

, in

clud

ing

durin

g th

e st

age

befo

re t

rigge

rs f

or f

orm

al a

ctio

n ar

e re

ache

d, a

nd t

o ai

d ris

k as

sess

men

t of

fir

ms

oper

atin

g in

eac

h ot

her’s

mar

ketp

lace

. Sup

ervi

sors

wou

ld n

eed

a hi

gh d

egre

e of

mut

ual t

rust

to b

e ab

le to

com

mun

icat

esu

bjec

tive

judg

emen

ts a

nd u

nsub

stan

tiate

d co

ncer

ns a

bout

fir

ms

at t

his

stag

e, a

nd t

here

are

con

fide

ntia

lity

and

data

prot

ectio

n is

sues

tha

t w

ould

nee

d to

be

deal

t w

ith.

Such

coo

pera

tion

and

com

mun

icat

ion

is p

artic

ular

ly im

port

ant w

here

, as

in t

he c

ase

stud

ies,

som

e of

the

ear

ly-w

arni

ngin

dica

tors

are

mor

e ap

pare

nt in

a f

irm

’s fo

reig

n m

arke

t th

an in

its

hom

e te

rrito

ry.

39

40

Gene

ric c

ase

stud

y 6:

Li

fe in

sure

r - h

igh

expe

ctat

ions

/ lo

ng-t

erm

inte

rest

rate

gua

rant

ee

Man

agem

ent c

ompl

acen

t,fo

llow

‘he

rd in

stin

ct’,

fail

to s

uper

vise

act

uari

es /

inve

stm

ent t

eam

pro

perl

y.

Tak

e kn

own

risk

und

erm

arke

t pre

ssur

e.

• M

arke

t int

eres

t rat

es f

all;

• T

ax r

ates

on

inte

rest

inco

me

are

incr

ease

d; a

nd•

Leg

al u

ncer

tain

ty a

s to

the

mea

ning

of

the

guar

ante

es.

• L

ife

polic

ies

unde

rwri

tten

with

pre-

tax

or p

ost-

tax

inte

rest

rat

egu

aran

tee.

•Hig

h di

stri

butio

nan

d hi

gh b

onus

expe

ctat

ions

• as

sets

not

mat

ched

to th

atgu

aran

tee

orex

pect

ed b

onus

.•H

igh

risk

inve

stm

ent p

olic

y

• U

nsop

hist

icat

edri

sk m

anag

emen

tpr

oced

ures

- lo

ngte

rm m

arke

t,ec

onom

ic, t

axex

posu

res

not

iden

tifie

d.•

Ove

r-re

lianc

e on

actu

ary

• in

adeq

uate

supe

rvis

ion

ofin

vest

men

tst

rate

gy

Gua

rant

eecr

ysta

llise

s in

sign

ific

ant l

oss

Inve

stm

ents

unde

rper

form

, so

retu

rn f

alls

bel

owbo

nus

rate

Los

s w

orse

ned

byfi

nanc

ial

rein

sura

nce

Polic

yhol

ders

’re

ason

able

expe

ctat

ions

unde

r th

reat

of

not b

eing

met

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

on

Not

all

insu

rers

fully

rec

ogni

seth

is lo

ss w

hen

itoc

curs

.

Impr

oved

str

ess

test

ing

for

inte

rest

rate

cha

nges

nee

ded

Res

ilien

ce te

stin

trod

uced

/st

reng

then

ed

New

max

imum

valu

atio

n ra

teof

inte

rest

set

.

Impr

oved

sce

nari

ote

stin

g ne

eded

for

tax

chan

ges

and

lega

l unc

erta

intie

s

Det

ecte

d by

regu

lato

ryre

port

ing

Cle

arer

rul

esne

eded

on

tech

nica

lpr

ovis

ions

for

guar

ante

es.

Not

ifie

d by

firm

aft

erin

tern

al r

evie

w

Stro

nger

rule

s ne

eded

on f

inan

cial

rein

sura

nce

Case

stu

dy 6

: Li

fe in

sure

r -

hig

h ex

pect

atio

ns /

long

-ter

m in

tere

st r

ate

guar

ante

e

In t

hese

cas

es, m

anag

emen

t of

life

insu

rers

set

pol

icie

s th

at g

ambl

ed o

n fu

ture

eco

nom

ic c

ondi

tions

. The

inte

rest

rat

egu

aran

tees

con

tain

ed l

ong-

date

d op

tions

tha

t co

uld

be e

xpen

sive

to

serv

ice

if ra

tes

fell

sign

ific

antly

. In

oth

er c

ases

insu

rers

cre

ated

hig

h ex

pect

atio

ns o

f di

scre

tiona

ry b

onus

es,

and

had

low

res

erve

s du

e to

hig

h di

strib

utio

n of

pro

fits

;th

ese

firm

s w

ere

expo

sed

to f

allin

g as

set

retu

rns.

The

gua

rant

ees

and

high

exp

ecta

tions

als

o in

crea

sed

the

firm

s’ex

posu

re t

o ta

x ch

ange

s, le

gal u

ncer

tain

ties

or in

crea

ses

in li

abili

ties

due

to lo

nger

life

-exp

ecta

ncy.

But,

alt

houg

h th

e dr

amat

ic s

hift

in

inte

rest

rat

es w

as f

elt

acro

ss t

he m

arke

t, i

n so

me

case

s th

e pr

oble

ms

wer

eco

mpo

unde

d by

a r

eluc

tanc

e by

man

agem

ent

to a

dmit

the

prob

lem

, un

ders

tand

able

as

this

wou

ld h

ave

serio

usre

perc

ussi

ons

on th

e ne

w b

usin

ess

rate

. Thi

s re

luct

ance

led

to h

ighe

r-ris

k in

vest

men

t str

ateg

ies

or fi

nanc

ial e

ngin

eerin

gas

man

agem

ent

atte

mpt

ed t

o ge

nera

te t

he h

igh

retu

rns

nece

ssar

y in

the

sho

rt-t

erm

whi

le h

opin

g th

e m

arke

t w

ould

mov

e in

the

ir fa

vour

. You

nger

and

fas

ter-

grow

ing

firm

s fe

lt th

e ef

fect

s of

the

rat

e ch

ange

s m

ore

as t

hey

had

a sm

alle

rpr

opor

tion

of t

heir

port

folio

s in

vest

ed in

old

er, h

ighe

r-yi

eld

bond

s to

mat

ch t

he c

hang

ing

liabi

litie

s.

An e

xcus

e is

that

it h

ad b

een

the

mar

ket n

orm

to tr

eat l

ong-

term

gua

rant

ees

at w

ell b

elow

his

toric

al le

vels

as

not b

eing

oner

ous;

but

it w

as fe

lt th

at in

the

wor

st c

ases

man

agem

ent

wer

e la

te t

o un

ders

tand

or

to a

ckno

wle

dge

the

natu

re a

ndex

tent

of t

he r

isks

in t

he b

usin

ess.

In

one

case

the

sup

ervi

sor

circ

ulat

ed a

sur

vey

to a

sk f

irm

s ab

out

thei

r ex

posu

re t

ofa

lling

int

eres

t ra

tes,

par

ticul

arly

for

gua

rant

ees;

the

fir

m’s

man

agem

ent

and

inte

rnal

act

uary

per

form

ed o

nly

asu

perf

icia

l rev

iew

and

rep

orte

d no

pro

blem

s, b

ut b

reac

hed

thei

r so

lven

cy m

argi

n sh

ortly

aft

erw

ards

.

Less

ons:

In s

uch

situ

atio

ns a

n ex

tern

al a

ctua

ry m

ight

giv

e a

bett

er o

pini

on. T

he ri

sks

mig

ht h

ave

been

iden

tifie

d th

roug

hst

ress

tes

ting

the

port

folio

und

er a

var

iety

of a

ssum

ptio

ns a

bout

futu

re e

cono

mic

and

mar

ket c

ondi

tions

, or i

n th

e ca

seof

the

gua

rant

ees

by a

pply

ing

soph

istic

ated

val

uatio

n m

etho

ds t

o th

e em

bedd

ed d

eriv

ativ

es,

e.g.

cap

ital

mar

ket

tech

niqu

es.

Whe

re e

xpec

tatio

ns h

ave

been

cre

ated

, th

e fi

nanc

ial c

ost

of m

eetin

g th

ese

shou

ld a

lso

be e

stim

ated

and

prov

ided

for,

to e

nsur

e th

at t

he f

irm

can

tre

at it

s cu

stom

ers

fairl

y.

41

42

Gene

ric c

ase

stud

y 7:

St

agna

ting

insu

rer d

iver

sifie

s

Nic

he in

sure

r ha

sm

anag

emen

t with

littl

ew

ider

exp

erie

nce

who

dive

rsif

y ou

tsid

e ar

ea o

fex

pert

ise

Lon

g te

rm s

ocia

l tre

nds

lead

to a

red

uctio

n in

trad

ition

al b

usin

ess.

Dec

isio

n to

dive

rsif

y in

to:

• ill

iqui

d, o

ver-

conc

entr

ated

,ri

sky

inve

stm

ents

• no

n-in

sura

nce

activ

ities

.•

Spec

ialis

tbu

sine

ss c

lass

es•

purc

hase

of

inap

prop

riat

ere

insu

ranc

epr

ogra

mm

e

• In

appr

opri

ate

focu

s on

gro

wth

• In

adeq

uate

proc

edur

es &

cont

rols

for

non

-co

re a

ctiv

ities

.•

Poor

mon

itori

ng a

ndco

ntro

l of

unde

rwri

ting

inne

w a

reas

• po

or g

rasp

of

risk

pro

file

of

new

bus

ines

s

• In

vest

men

tspe

rfor

m p

oorl

y +

forc

ed s

ale

lead

sto

fur

ther

loss

es.

• N

on-i

nsur

ance

activ

ities

und

er-

perf

orm

• cl

aim

s de

viat

ion

on n

ew b

usin

ess.

• Po

or m

atch

ing

of r

eins

uran

ce to

dire

ct r

isks

.

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

onL

osse

s no

t rec

ogni

sed

prom

ptly

.

Det

ecte

d by

on-s

itein

spec

tion

Det

ecte

d by

regu

lato

ryre

port

ing

Det

ecte

d by

on-s

itein

spec

tion

Reh

abili

tatio

npl

an r

equi

red

Rep

lace

men

tof

dir

ecto

rsre

quir

ed

Reg

ulat

ory

rule

son

ass

et-l

iabi

lity

mat

chin

g ar

ein

adeq

uate

Not

all

regu

lato

rsha

ve th

ispo

wer

Impr

oved

loss

eval

uatio

nre

quir

ed

Impr

ovem

ents

in p

roce

dure

sre

quir

ed

Det

ecte

d on

lyon

site

-vis

it du

eto

mis

repo

rtin

g

Case

stu

dy 7

: St

agna

ting

insu

rer

dive

rsif

ies

The

stag

natin

g fi

rms

soug

ht t

o gr

ow, a

nd m

oved

into

non

-cor

e bu

sine

ss. T

he p

robl

em, p

artic

ular

ly fo

r ni

che

firm

s, w

asth

at m

anag

emen

t ha

d lit

tle w

ider

exp

erie

nce

and

mov

ed o

utsi

de t

heir

fiel

d of

exp

ertis

e. A

reas

the

y m

oved

into

wer

e:

∑ n

on-i

nsur

ance

act

iviti

es t

hat

unde

rsho

ot b

usin

ess

targ

ets

and

over

shoo

t ex

pens

e bu

dget

s, l

eadi

ng t

o lo

sses

whi

chth

reat

en s

olve

ncy;

∑ il

liqui

d, r

isky

, con

cent

rate

d in

vest

men

ts t

hat

perf

orm

poo

rly a

nd w

here

furt

her

loss

es t

hat

had

not

been

pro

vide

d fo

rar

ise

on s

ale;

or

∑ n

ew c

lass

es o

f in

sura

nce

(for

ins

tanc

e sp

ecia

list

lines

or

new

geo

grap

hica

l ar

eas)

: sy

stem

s an

d co

ntro

ls o

ver

unde

rwrit

ing

are

poor

, so

the

firm

is u

nabl

e to

ass

ess

risks

pro

perly

lead

ing

both

to in

corr

ect p

ricin

g an

d to

a re

insu

ranc

epr

ogra

mm

e po

orly

mat

ched

to

the

clai

ms

prof

ile o

f th

e bu

sine

ss.

Loss

es a

re s

uch

that

the

sol

venc

y re

quire

men

t is

brea

ched

.

In o

ne c

ase

the

true

pro

blem

was

dis

cove

red

only

thr

ough

on-

site

vis

its a

s re

gula

tory

rep

ortin

g di

d no

t re

veal

the

ful

lex

tent

of

the

prob

lem

bec

ause

of

unde

r-re

port

ing

of lo

sses

. In

oth

er c

ases

how

ever

reg

ulat

ory

repo

rtin

g se

rved

as

anea

rly w

arni

ng o

f new

are

as a

nd o

f con

cent

rate

d in

vest

men

ts.

Less

ons:

The

mai

n to

ol r

ecom

men

ded

is v

ettin

g of

man

agem

ent

expe

rtis

e w

hen

firm

s m

ove

into

new

are

as –

not

all

mem

ber

stat

es h

ave

this

pow

er. A

lso

asse

t ru

les

coul

d be

tig

hten

ed u

p, a

s in

sev

eral

oth

er c

ase

type

s.

43

44

Gene

ric c

ase

stud

y 8:

Un

derw

ritin

g ris

k: n

iche

pla

yer w

ith a

n ev

olvi

ng m

arke

t

•eco

nom

ic d

eclin

e•p

oliti

cal i

nter

vent

ion

in m

arke

t•s

ocio

econ

omic

cha

nges

aff

ect l

oss

patte

rn•c

usto

mer

s le

arn

to e

xplo

it co

ver

•und

erw

ritin

gst

rate

gy r

eact

sla

te a

nd/o

rin

appr

opri

atel

y to

deve

lopm

ents

;•

poor

ris

kse

lect

ion;

• re

insu

ranc

epo

orly

mat

ched

topr

ofile

of

risk

sac

cept

ed

• po

orin

form

atio

n on

polic

yhol

ders

and

clai

ms

deve

lopm

ent

•poo

r co

ntro

lov

er d

istr

ibut

ion

•slo

ppy

data

hand

ling

and

othe

r in

tern

alpr

oces

ses

• U

nder

wri

ting

loss

es

• po

orre

insu

ranc

ere

cove

ry r

ate

• H

igh

expe

nses

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

. Slo

wse

rvic

e in

pay

ing

clai

ms.

Ris

k ap

petit

e de

cisi

on

•Tec

hnic

al p

rovi

sion

eval

uatio

n w

rong

Man

agem

ent a

reco

mpl

acen

t des

pite

a la

cksk

ills

and

wid

erex

peri

ence

, and

fai

l to

appr

ecia

te th

e ne

ed f

orhi

gh-q

ualit

y in

form

atio

nto

fla

g pr

oble

ms

Form

alqu

alif

icat

ions

are

not e

noug

h

Det

ecte

d by

rout

ine

repo

rtin

gan

d ad

ditio

nal

clos

e w

atch

Det

ecte

d by

regu

lato

ryre

port

ing

Reo

rgan

isat

ion

plan

need

ed

Impr

oved

loss

eval

uatio

nre

quir

ed -

use

of e

xper

ts?

Not

all

supe

rvis

ors

are

able

tore

quir

e th

is

Rel

evan

tex

pert

ise

need

ed

Mon

itor

chan

ges

vpl

an

Cap

ital

inje

ctio

nre

quir

edT

akeo

ver

need

ed

Qua

lity

and

timel

ines

s of

MI

is v

ital f

orea

rly

war

ning

Case

stu

dy 8

: Un

derw

riti

ng r

isk:

nic

he p

laye

r w

ith

an e

volv

ing

mar

ket

In t

hese

cas

e st

udie

s m

anag

emen

t to

ok a

naï

ve a

ppro

ach

igno

ring

deve

lopm

ents

in

thei

r m

arke

t w

hich

cha

nged

the

natu

re o

f the

risk

s ta

ken

on. T

his

was

com

poun

ded

by la

te a

nd in

adeq

uate

info

rmat

ion

on ri

sks

and

clai

ms

as a

resu

lt of

oper

atio

nal

wea

knes

ses

whi

ch m

eant

poo

r un

derw

ritin

g ris

k de

cisi

ons

wer

e m

ade

and

the

mar

ket

deve

lopm

ents

wer

eov

erlo

oked

. Ri

sks

coul

d no

t be

pric

ed c

orre

ctly

, as

the

re w

as p

oor

hist

oric

al d

ata

and

insu

ffic

ient

ana

lysi

s an

dse

gmen

tatio

n of

the

mar

ket

so e

ffec

tive

pric

e di

scrim

inat

ion

was

not

pos

sibl

e. T

his

was

typ

ical

ly m

ade

wor

se b

y a

focu

son

gro

wth

. Ri

sk s

elec

tion

was

poo

r, th

e ris

k pr

ofile

bec

ame

too

high

or

lum

py,

and

too

little

rei

nsur

ance

cov

er w

asbo

ught

. The

se e

ffec

ts h

ad a

kno

ck-o

n ef

fect

on

the

relia

bilit

y of

tec

hnic

al p

rovi

sion

s.

In o

ne c

ase

the

key

oper

atio

nal w

eakn

ess

was

man

agem

ent’s

failu

re to

mon

itor a

nd c

ontr

ol o

utso

urce

d ac

tiviti

es p

rope

rly–

see

case

stu

dy 1

2 be

low.

Less

ons:

As

in t

he p

revi

ous

case

typ

e, r

equi

ring

suff

icie

nt e

xper

tise

is a

key

pre

vent

ativ

e to

ol. D

urin

g on

-site

vis

its t

hesu

perv

isor

sho

uld

wat

ch o

ut fo

r the

qua

lity

and

timel

ines

s of

man

agem

ent i

nfor

mat

ion,

par

ticul

arly

set

ting

good

bud

gets

and

mon

itorin

g va

rianc

es r

obus

tly.

45

46

Gene

ric c

ase

stud

y 9:

In

sure

r mat

ches

liab

ilitie

s w

ith c

orre

late

d in

vest

men

ts

• E

xter

nal e

vent

cau

ses

asse

t los

ses

and

unde

rwri

ting

loss

essi

mul

tane

ousl

y•A

dver

se m

arke

t con

ditio

ns a

nd lo

ss e

xper

ienc

e af

fect

insu

rer

and

caus

e in

vest

men

ts in

oth

er in

sure

rs to

lose

val

ue.

Inve

stm

ent r

isk

coin

cidi

ng w

ithun

derw

ritin

g ri

sk(e

.g. f

or a

cre

dit

insu

rer

who

inve

sts

inco

mm

erci

alpr

oper

ty a

nec

onom

icdo

wnt

urn

has

ado

uble

impa

ct)

Fail

to c

orre

late

risk

pro

file

s of

asse

ts a

ndlia

bilit

ies

or to

incl

ude

that

as

ast

anda

rdco

nsid

erat

ion

• A

sset

val

ues

fall

• L

iabi

litie

sin

crea

se

Polic

yhol

ders

put

at r

isk

ofin

solv

ency

.

Ris

k ap

petit

e de

cisi

on

• as

set e

valu

atio

n, te

chni

cal

acco

unt e

valu

atio

n

Man

agem

ent i

s na

ïve

abou

t inv

estm

ents

and

doub

le-g

eari

ng

Stre

ss te

stin

gsh

ould

be

done

for

asse

ts a

nd li

abili

ties

toge

ther

Det

ecte

d by

on-s

itein

spec

tion

Det

ecte

d by

regu

lato

ryre

port

ing

and

on-

site

insp

ectio

n

Det

ecte

d by

on-s

itein

spec

tion

Impr

oved

loss

eval

uatio

nre

quir

ed

Impr

ovem

ents

in p

roce

dure

sre

quir

ed

Res

tric

t ass

etho

ldin

gs (

size

etc)

Tra

nsfe

rbu

sine

ss

Case

stu

dy 9

: In

sure

r m

atch

es li

abili

ties

wit

h co

rrel

ated

inve

stm

ents

In t

hese

cas

es n

iche

ins

urer

s ha

d m

anag

emen

t w

ho w

ere

naïv

e in

not

con

side

ring

the

corr

elat

ion

betw

een

the

risk

prof

iles

of t

heir

asse

ts a

nd li

abili

ties.

The

y al

low

ed a

con

cent

ratio

n of

inve

stm

ents

in a

sset

s w

hose

val

ue w

as li

kely

to

be a

ffec

ted

sign

ific

antly

by

the

sam

e ev

ents

whi

ch w

ould

lead

to la

rge

insu

ranc

e cl

aim

s, e

xpos

ing

the

firm

to a

‘dou

ble-

gear

ing’

eff

ect.

E.g

. in

one

cas

e a

fina

ncia

l gua

rant

ee in

sure

r in

vest

ed in

com

mer

cial

pro

pert

y –

both

wer

e ad

vers

ely

affe

cted

by

a de

ep e

cono

mic

dep

ress

ion

whi

ch le

d to

sev

ere

unde

rwrit

ing

and

inve

stm

ent

loss

es,

exac

erba

ted

by t

hepo

or li

quid

ity o

f the

inve

stm

ents

. In

anot

her i

nsta

nce

a sp

ecia

list i

nsur

er b

acke

d lo

ng-t

ail l

iabi

litie

s w

ith

an in

vest

men

tin

ano

ther

lon

g-ta

il in

sure

r. Pr

ocyc

lical

eff

ects

sho

uld

be a

par

ticul

ar c

once

rn t

o su

perv

isor

s of

cre

dit

and

fina

ncia

lgu

aran

tee

insu

rers

.

Less

ons:

The

mos

t im

port

ant

tool

s ar

e to

set

out

the

prin

cipl

es f

or f

irm

s to

fol

low,

and

to

have

a f

orw

ard-

look

ing

diag

nost

ic t

ool,

to e

xam

ine

firm

s’ in

vest

men

t str

ateg

ies

and

thei

r str

ess

test

ing

scen

ario

s an

d pr

oced

ures

to

mak

e su

reth

ey te

st a

sset

s an

d lia

bilit

ies

toge

ther

and

con

side

r cor

rela

tions

. It w

as n

ot fe

lt to

be

desi

rabl

e fo

r reg

ulat

ors

to re

stric

tin

vest

men

ts in

cor

rela

ted

asse

ts, n

or p

ract

ical

to

so s

peci

fica

lly, a

s su

perv

isor

s sh

ould

not

tak

e ris

k de

cisi

ons

for f

irm

s,bu

t sh

ould

set

gui

delin

es fo

r fi

rms

to m

anag

e th

eir

own

risks

.

47

48

Gene

ric c

ase

stud

y 10

: Fi

rms

have

inap

prop

riate

dis

trib

utio

n st

rate

gies •F

ragm

ente

d di

stri

butio

n in

dust

ry

• ba

d se

lect

ion

ofri

sks

due

toin

adeq

uate

info

rmat

ion;

• hi

gh a

cqui

sitio

nco

sts

not l

inke

d to

port

folio

res

ults

•mis

selli

ng

• bu

sine

ss r

isk

from

poo

rcu

stom

er s

ervi

ce

•Litt

le p

ower

over

inte

rmed

iari

es•l

ack

of g

oal

cong

ruen

ce w

ithin

term

edia

ries

•dis

tant

fro

mcu

stom

ers

•poo

rin

form

atio

n on

polic

yhol

ders

and

clai

ms

deve

lopm

ent

• cl

aim

s de

viat

ion

and

unde

rwri

ting

loss

es

• L

ost g

oodw

ill

• H

igh

expe

nses

•Poo

r ad

vice

toco

nsum

ers

•ina

dequ

ate

cust

omer

ser

vice

Ris

k ap

petit

e de

cisi

on

•Tec

hnic

al p

rovi

sion

eval

uatio

n w

rong

•Man

agem

ent l

ack

entr

epre

neur

ial d

rive

togr

appl

e w

ith th

e m

arke

tis

sue

•‘H

erd

inst

inct

’ to

sta

yw

ith th

e st

atus

quo

in th

ere

st o

f th

e m

arke

tD

etec

ted

by m

arke

tob

serv

atio

n, d

ata

gath

erin

g an

dan

alys

is

• su

perv

isor

ste

ers

indu

stry

on

mar

ket

refo

rms

need

ed•

supe

rvis

orpu

blis

hes

find

ings

•sup

ervi

sor

colle

cts

mar

ket d

ata

for

the

rele

vant

bod

y.

Act

ion

depe

nds

on s

cope

of

supe

rvis

ory

dutie

s an

dpo

wer

s

•lin

kbr

oker

age

leve

ls to

outc

omes

Case

stu

dy 1

0: F

irm

s ha

ve in

appr

opri

ate

dist

ribu

tion

str

ateg

ies

In t

his

case

stu

dy a

gen

eric

iss

ue w

as e

xam

ined

rat

her

than

a s

ingl

e fi

rm.

An i

napp

ropr

iate

str

ateg

y co

ncer

ning

inte

rmed

iarie

s (a

gent

s an

d br

oker

s) w

as h

avin

g a

num

ber

of a

dver

se e

ffec

ts o

n th

e in

sure

rs,

nota

bly

high

dis

trib

utio

nco

sts

not

linke

d to

por

tfol

io o

utco

mes

, poo

r cu

stom

er s

ervi

ce, b

ad o

r no

n-ex

iste

nt s

elec

tion

of r

isks

, poo

r in

form

atio

non

cus

tom

ers

and

pric

ing

cont

rol,

high

cla

ims.

Thi

s le

d to

und

erw

ritin

g lo

sses

, poo

r cl

ient

ser

vice

and

, in

cons

eque

nce,

lost

goo

dwill

.

An in

tern

al r

oot

caus

e w

as id

entif

ied

whi

ch w

as t

he la

ck o

f en

trep

rene

uria

l driv

e an

d de

sire

for

cha

nge

amon

g se

nior

man

agem

ent

of i

nsur

ance

fir

ms,

so

ther

e w

ere

few

att

empt

s to

im

prov

e th

e pr

ofes

sion

alis

m o

f di

strib

utio

n an

dra

tiona

lise

the

med

iatio

n ch

anne

l.

Less

ons:

In

this

cas

e th

e m

ost

obvi

ous

solu

tion

is fo

r th

e su

perv

isor

to

mon

itor

mar

ket

tren

ds a

nd a

dopt

an

educ

atio

nal

role

, di

ssem

inat

ing

this

inf

orm

atio

n. N

ever

thel

ess,

the

sup

ervi

sor

can

take

rel

evan

t st

eps

such

as

requ

iring

im

prov

eddi

sclo

sure

of

com

mis

sion

lev

els,

app

licat

ion

of i

nter

nal

syst

ems

and

cont

rols

or

gett

ing

man

agem

ent

to f

ocus

mor

ecl

early

on

the

need

for

ince

ntiv

es t

o m

ake

inte

rmed

iarie

s ac

t in

the

fir

m’s

inte

rest

s an

d on

the

info

rmat

ion

defi

cien

cies

that

lead

to

poor

und

erw

ritin

g.

49

50

Gene

ric c

ase

stud

y 11

: Ca

tast

roph

e /

inad

equa

te re

insu

ranc

e pl

anni

ng

•Sev

ere

cata

stro

phe

caus

es w

ides

prea

d lo

sses

. Cat

astr

ophe

issi

gnif

ican

tly m

ore

seve

re th

an th

e pr

evio

us w

orst

eve

nt o

f th

atna

ture

in r

ecen

t mem

ory.

•Und

erw

rite

too

grea

t an

aggr

egat

ion

•Pur

chas

ein

suff

icie

ntca

tast

roph

ere

insu

ranc

e•P

urch

ase

rein

sura

nce

whi

chdo

es n

ot p

erfo

rmas

dis

clos

ed

• In

adeq

uate

aggr

egat

ion

mon

itori

ng a

ndre

port

ing

•ove

r-op

timis

ticas

sum

ptio

ns•i

ncor

rect

acco

untin

g fo

rre

insu

ranc

eco

ntra

cts

•Lar

ge g

ross

unde

rwri

ting

loss

es n

otco

vere

d by

insu

ranc

e, s

odi

rect

impa

ct o

nca

pita

l.

Thr

eat t

opo

licyh

olde

rsfr

om in

crea

sed

risk

of

inso

lven

cy

Ris

k ap

petit

e de

cisi

on

•Une

xpec

ted

gros

sun

derw

ritin

glo

sses

Rea

listic

disa

ster

scen

ario

mod

ellin

g,gr

oss

and

net

Det

ecte

dth

roug

h ad

hoc

spec

ial

repo

rtin

gre

ques

ted

•Man

agem

ent f

ail t

oid

entif

y po

tent

ial

aggr

egat

ions

of

risk

or

toas

sess

thei

r lik

elih

ood

corr

ectly

.•M

anag

emen

tm

isre

pres

ent a

rran

gem

ents

Seni

orm

anag

emen

tex

plic

itly

mon

itor

key

assu

mpt

ions

Ask

inw

ritin

g if

ther

e ar

e an

ysi

de le

tters

or o

ther

rele

vant

docu

men

ts

Case

stu

dy 1

1: C

atas

trop

he /

inad

equa

te re

insu

ranc

e pl

anni

ng

Whe

n ca

tast

roph

ic lo

sses

occ

ur, f

irm

s m

ay f

ind

that

the

y ha

ve in

suff

icie

nt r

eins

uran

ce. I

t m

ay b

e th

at t

he f

irm

mad

e a

corr

ect

asse

ssm

ent

of t

he r

isks

and

its

exp

osur

e to

the

m,

and

whe

re f

or i

nsta

nce

it ha

s a

risk

appe

tite

such

tha

t its

rein

sura

nce

prog

ram

me

will

be

insu

ffic

ient

onc

e in

100

yea

rs, t

his

is t

hat

1/10

0 oc

casi

on. M

ore

ofte

n, h

owev

er, i

n th

eca

ses

stud

ied

the

firm

s ha

d fa

iled

to a

sses

s th

e ris

ks a

nd i

ts e

xpos

ures

cor

rect

ly.

Reas

ons

may

inc

lude

fla

wed

assu

mpt

ions

, in

com

plet

e da

ta o

n po

tent

ial

aggr

egat

ions

am

ong

risks

acc

epte

d, f

ailu

re t

o m

odel

rea

listic

ally

or

over

-re

lianc

e on

his

toric

al d

ata

and

failu

re t

o ap

prec

iate

cha

ngin

g ris

k ch

arac

teris

tics

(e.g

. evo

lvin

g w

eath

er p

atte

rns)

.

Anot

her

prob

lem

tha

t oc

curr

ed w

as p

urch

ase

of r

eins

uran

ce w

ith

addi

tiona

l co

ntra

ctua

l ar

rang

emen

ts i

n si

de l

ette

rsw

hich

hav

e a

mat

eria

l eff

ect

on h

ow t

he r

eins

uran

ce w

ill p

erfo

rm b

ut a

re n

ot d

iscl

osed

to

audi

tors

and

sup

ervi

sors

.

Less

ons:

We

iden

tifie

d th

at s

enio

r m

anag

emen

t sh

ould

exp

licitl

y m

onito

r th

e ke

y as

sum

ptio

ns b

eing

mad

e in

dete

rmin

ing

the

exte

nt o

f the

rein

sura

nce

cove

r nee

ded

by th

e fi

rm. F

irm

s sh

ould

als

o m

odel

real

istic

dis

aste

r sce

nario

san

d as

sess

the

max

imum

like

ly g

ross

loss

es a

nd th

en m

ap th

ese

agai

nst t

he re

insu

ranc

e pr

ogra

mm

e to

est

imat

e th

e lik

ely

net

posi

tion.

The

y sh

ould

reg

ular

ly r

eass

ess

the

max

imum

pos

sibl

e lo

ss, a

nd r

epor

t th

is a

s a

key

assu

mpt

ion.

Undi

sclo

sed

side

-let

ters

are

har

d to

det

ect.

The

mos

t ap

prop

riate

sol

utio

n is

pre

vent

ativ

e m

easu

res

such

as

obta

inin

gex

plic

it di

sclo

sure

in w

ritin

g of

all

such

arr

ange

men

ts,

supp

orte

d by

eff

ectiv

e pe

rson

al s

anct

ions

aga

inst

man

agem

ent

who

mis

repr

esen

t su

ch m

atte

rs, a

nd b

y sa

fe w

hist

le-b

low

ing

rout

es.

51

52

Gene

ric c

ase

stud

y 12

: Ou

tsou

rcin

g of

key

func

tions

Man

agem

ent f

ail t

oad

dres

s ri

sks

of a

nd r

etai

nre

spon

sibi

lity

for

outs

ourc

ed f

unct

ions

•Adv

erse

cla

ims

expe

rien

ce•p

oor

inve

stm

ent p

erfo

rman

ce -

fal

ling

equi

ty m

arke

ts

•Poo

r m

anag

emen

tin

form

atio

n fr

omou

tsou

rcin

g le

ads

to, e

.g.

•ina

ppro

pria

tein

vest

men

ts•m

isha

ndle

dcl

aim

s•p

oor

pric

ing

orun

derw

ritin

gpo

licy

•cos

t ove

rrun

s on

outs

ourc

ing

•Fai

lure

to s

etpr

oper

rul

es f

orou

tsou

rced

activ

ities

, and

requ

irem

ents

/st

anda

rds

for

serv

ice

prov

ider

s

•fai

lure

ade

quat

ely

to m

onito

rpe

rfor

man

ce o

fou

tsou

rced

act

ivity

•Los

t goo

dwill

•inv

estm

ent

loss

es o

rm

ism

atch

•und

erw

ritin

glo

sses

Thr

eat t

opo

licyh

olde

rsfr

om in

crea

sed

risk

of

inso

lven

cy

Ris

k ap

petit

e de

cisi

on

Eva

luat

ion

risk

e.g.

for

tech

nica

lpr

ovis

ions

Det

ecte

d on

-si

te a

nd o

ff-

site

Min

imum

requ

irem

ents

for

cont

rols

over

outs

ourc

edac

tiviti

es

Det

ecte

dth

roug

hre

gula

tory

repo

rtin

g

Det

ecte

d at

on-s

itein

spec

tion

Case

stu

dy 1

2: O

utso

urci

ng o

f ke

y fu

ncti

ons

In t

hese

cas

es m

anag

emen

t of

fir

ms

outs

ourc

ed a

n ac

tivity

and

fai

led

to m

aint

ain

prop

er c

ontr

ol o

ver

it. M

anag

emen

tsh

ould

reta

in o

vera

ll re

spon

sibi

lity

for t

he fu

nctio

n, a

nd m

onito

r its

per

form

ance

wit

h su

ffic

ient

rigo

ur b

oth

so th

at th

efu

nctio

n its

elf i

s pe

rfor

med

in li

ne w

ith

supe

rvis

ory

and

com

mer

cial

nee

ds (f

or e

xam

ple

not b

reac

hing

rule

s or

alie

natin

gcu

stom

ers)

and

it d

oes

not

adve

rsel

y af

fect

oth

er p

arts

of

the

busi

ness

. Th

is d

id n

ot h

appe

n in

the

se c

ases

. Th

e fi

rmei

ther

had

not

com

mun

icat

ed t

he s

uper

viso

ry a

nd c

omm

erci

al r

equi

rem

ents

to

be m

et,

or f

aile

d to

mon

itor

them

. Th

eou

tsou

rced

ser

vice

pro

vide

r w

as t

here

fore

not

focu

sing

on

the

need

s of

the

insu

ranc

e fi

rm.

Whe

re t

he o

utso

urci

ng w

as c

laim

s m

anag

emen

t, s

ever

al p

robl

ems

aris

e fr

om t

his,

inc

ludi

ng l

ost

cust

omer

and

inte

rmed

iary

goo

dwill

, inf

late

d cl

aim

s pa

ymen

ts, h

ighe

r cla

ims

hand

ling

cost

s, a

nd (p

erha

ps m

ost d

ange

rous

) wea

k da

taon

his

toric

al c

laim

s ex

perie

nce,

whi

ch c

an le

ad t

o fla

wed

und

erw

ritin

g st

rate

gy.

Less

ons:

A u

sefu

l too

l wou

ld b

e to

set

out

min

imum

sta

ndar

ds fo

r co

ntro

ls o

ver

outs

ourc

ed a

ctiv

ities

.

53

Appendix 2: Descriptions of main risks

The descriptions in the tables below, quoted from Appendix A of Sharma (2002), are ofthe risks shown in figure 2.

54


UUUUnnnnddddeeeerrrrllllyyyyiiiinnnngggg ccccaaaauuuusssseeeessss –––– iiiinnnntttteeeerrrrnnnnaaaallll

Management & staffcompetence risk

The risk that management, staff or other “insiders” lack the skills,experience or other personal or professional qualities to enablethem perform their tasks adequately and successfully. It includesthe risk of over-reliance on one or more persons (“key personrisk”).

Internal governance &control risk

The risk of inadequate or failed systems of corporate governanceand overall control, including the risk that arises from aninadequate control culture.

Controller & group risk The risk of inadequate or inappropriate direction, control orinfluence from connected persons (natural or corporate) includingfrom major shareholders, parent undertakings and other groupundertakings and the management of those undertakings.

UUUUnnnnddddeeeerrrrllllyyyyiiiinnnngggg ccccaaaauuuusssseeeessss –––– eeeexxxxtttteeeerrrrnnnnaaaallll

Economic cycle/conditionrisk

The risk of adverse change in the economy, including adversechanges in economic variables such as interest, inflation andexchange rates.

Market competition risk The risk of adverse change within the insurance markets, includingincreases or decreases within a market of the demand for, or supplyof, insurance products.

Social, technological,demographic, political,legal, taxation etc. risks

The risk of adverse change in the social, technological,demographic, political, legal, tax etc. environment.

Catastrophe/extremeevent risk

The risk of a catastrophe or other extreme event, including anextreme accumulation of events from the same or relatedoriginating cause.

55


56


57


The inconvenience and market disruption that can arise when a firm is in trouble (seesection 6.3) should also be included under policyholder harm. These can lead forexample to a policyholder transferring their policy to another provider ondisadvantageous terms.

58


FSA Occasional Papers in Financial Regulation

1 The Economic Rationale for Financial Regulation April 1999David Llewellyn

2 The Rationale for a Single National Financial Services Regulator May 1999Clive Briault

3 Cost-Benefit Analysis in Financial Regulation September 1999Isaac Alfon and Peter Andrews

4 Plumbers and Architects: a supervisory perspectiveon international financial architecture January 2000Huw Evans

5 Household Sector Saving and Wealth Accumulation: Evidence from balance sheet and flow of funds data February 2000Iftikhar Hussain

6 The Price of Retail Investing in the UK February 2000Kevin R James

7 Some Aspects of Regulatory Capital March 2000Jeremy Richardson and Michael Stephenson

8 Saving for Retirement May 2000Malcolm Cook and Paul Johnson

9 Past Imperfect? August 2000The performance of UK equity managed fundsMark Rhodes

10 A More Market Based Approach to MaintainingSystemic Stability August 2000David Mayes

11 CAT standards and Stakeholders September 2000Paul Johnson

59

12 Some cost-benefit issues in financial regulation October 2000David Simpson, Geoff Meeks, Paul Klumpesand Peter Andrews (Editor)

13 Paying for pensions November 2000Edward Whitehouse

14 Low inflation April 2001Ed Harley and Stephen Davies

15 The Regulation of Funded Pensions - December 2001A Case Study of the United KingdomE Philip Davis

16 Revisiting the rationale for a single national February 2002financial services regulatorClive Briault

17 The impact of fees and levies on non-networked February 2002Independent Financial Adviser (IFA) firmsDavid O’Neill

18 To switch or not to switch, that’s the question September 2002An analysis of the potential gains from switching pension providerIsaac Alfon

19 Losing interest: How much can consumers save by October 2002 shopping around for financial products?Malcolm Cook, Fionnuala Earley, Jody Ketteringham, Sarah Smith

Available fromFSA PublicationsFinancial Services Authority25 The North ColonnadeCanary WharfLondon E14 5HS

Tel 0845 608 2372and on the FSA website www.fsa.gov.uk

The Financial Services Authority25 The North Colonnade Canary Wharf London E14 5HSTelephone: +44 (0)20 7676 1000 Fax: +44 (0)20 7676 1099Website: http://www.fsa.gov.uk

Registered as a Limited Company in England and Wales No. 1920623. Registered Office as above.

ISBN 0117043206

managing risk: practical lessons from recent “failures” of ... p et al. (2002), prudential...

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