HIH Debacle: A Global Perspective

A wave of insurance companies going to the wall as a result of high inflationary trends and high variability in long-tail liabilities.


The recent collapse of HIH is not an isolated failure on the global scene. Recent years have seen a wave of insurance companies around the world going to the wall. Some have hit the wall harder than others. These companies all write long-tail liabilities, and have under-priced and under-provisioned for these liabilities.

I believe there are a number of technical insurance threads linking all these failures. This belief is based on analysis of long tail liabilities for numerous global clients that include insurers, reinsurers, brokers (retail and wholesale) and consultants. The most important of these threads is likely to be the phenomenon of superimposed inflation. Another important thread, especially for companies writing relatively low exposures, is high variability. The present report presents a credible scenario in which these companies could have been cash flow positive for many years without actually recognising that their capital was being eroded by superimposed inflation.

Had the long-tail liabilities been evaluated using better statistical and financial tools, it is highly likely that the losses could have been avoided or at least mitigated.

In respect of HIH, the substantial differences between the liquidator’s estimates of losses (liabilities) and the estimates shown in the accounts for year-end June 30th 2000 are more likely to be due to the differences in loss reserving methodologies than any other factor.

The financial markets have experienced a similar chain of events. Some of the world’s largest financial entities (Orange County, Barings…) lost billions of dollars as a result of poor risk management. This triggered a revolution in the methods used to assess market (investment) risks. The various regulatory authorities converged on Value-at-Risk (VaR) as an acceptable measure of risk.

What is needed in the general insurance and reinsurance markets is a revolution in assessing long-tail liability risks that parallels the revolution that is taking place in assessing market risks. However, the revolution in these insurance industries has to reach far beyond that in the financial markets, as VaR, even if soundly constructed, is grossly inadequate as a single measure of risk for long-tail liabilities.

APRA has decided to fast-track general insurance reforms that are vastly inadequate. The proposed reforms are only a small step in the right direction. Statistical quantities such as the estimated mean, standard deviation and 75th percentile of the liabilities are indeed important (provided the estimates are soundly based). However, given the changes in risk assessment currently taking place in the financial markets, it is surprising that the proposed new regulatory general insurance regime does not even mention the concept of VaR. More importantly, these statistical quantities (including VaR) do not in themselves provide sufficient information to assess the financial condition of the company.

In the USA the National Association of Insurance Companies (NAIC) and in the UK the Department of Trade and Industry (DTI) (to a lesser extent) make schedule P data available to the public, for a fee. I believe it should be incumbent on APRA to adopt the American model of collating schedule P loss development data (triangulations) and other relevant data on a yearly basis, for each line of business, for each company, making it readily available to anyone for a fee. This way APRA, rating agencies, brokers and any other organization can conduct their own independent assessment of the adequacy of a company’s provisions as set out in the balance sheet.

It is therefore of concern that the proposed reforms will not result in the best possible framework for monitoring the general insurance and reinsurance industry.


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