KPMG Insurance update 15 TOOLS FOR PREPARING FOR THE NEW NORM IN THE INSURANCE INDUSTRY All stakeholders: investors, regulators, government and customers within the insurance industry, particularly those in the non-life sector, are going through significant change due to: • an overwhelming level of unexpected catastrophes this year; • the ongoing effects of the global financial crisis; and • new local regulatory obligations for insurers. These three key factors have profoundly impacted the industry and brought about change more rapidly and from more directions than ever before. Areas significantly impacted are the enormous claims flow from the Canterbury earthquakes which have eroded profits; the credit crunch and the resulting tightening of credit markets; market volatility; and regulators who will soon be demanding higher levels of capital. Insurers who are able to identify and overcome these challenges and adapt to them quickly, will have an advantage over their competitors. One of the key issues is that no matter what broad strategy an insurer takes, whether an innovator or follower, these events will significantly impact the way they do business going forward. Existing business models and value chains will need to be reviewed in order to understand where these events will have the most impact. An ongoing challenge facing insurers is the aftershocks that continue to hit Canterbury, despite many commentators believing they are tailing off. The worry is how will reinsurers respond after October’s 5.5 magnitude shake, particularly when they already viewed New Zealand’s natural-disaster risk as an area of concern after the June aftershock. What will this mean for insurers if reinsurance rates spike prohibitively high, as speculated by some in the industry, or policies are not renewed? Speculation on these issues will no doubt continue, however, it is unlikely anyone can predict what scenario will finally play out. Scenario planning What insurers can do right now is start to prepare, based on the possible outcomes of multi-dimensional events. This type of scenario planning seeks to explain how the future will look depending upon how multiple interrelated events will impact the business 1 . For example, what would it mean if reinsurance rates spike and markets continue to be volatile? Scenario planning helps to answer how this would impact on risk pricing, investment returns, customer affordability in an already depressed economy, product development, operational efficiency and profitability. Quantitative scenarios are the next step and explain the hypothetical impacts based on the multi-dimensional event scenarios. Quantitative scenario planning is done on a medium or long term basis depending upon whether the event is a strategic game-changing event or medium term product modification event. Using scenario planning to consider a range of potential consequences can help an insurer make sense, and bring meaning to the impact of uncertain external events on the organisation and where competitive advantage will come from in the future. Timothy Gacsal Associate Director Financial Risk Management T: +64 (9) 363 3504 E: [email protected] 1 Manage the future through scenario planning. KPMG Australia, 2011 © 2011 KPMG, a New Zealand partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Kpmg: Tools for preparing for the new norm in the insurance industry

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Investors, regulators, governments and customers within the insurance industry, particularly those in the non-life sector, are going through significant change due to: • an overwhelming level of unexpected catastrophes; • the on-going effects of the global financial crisis; and • new local regulatory obligations for insurers.

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KPMG Insurance update 15

Tools For PrEPariNg For THE NEw Norm iN THE iNsuraNCE iNdusTry

All stakeholders: investors, regulators, government and customers within the insurance industry, particularly those in the non-life sector, are going through significant change due to:

• anoverwhelminglevelofunexpectedcatastrophes this year;

• theongoingeffectsoftheglobalfinancialcrisis;and

• newlocalregulatoryobligationsforinsurers.

These three key factors have profoundly impacted the industry and brought about change more rapidly and from more directions than ever before. Areas significantly impacted are the enormous claims flow from the Canterbury earthquakes which have eroded profits; the credit crunch and the resulting tightening of credit markets; market volatility; and regulators who will soon be demanding higher levels of capital. Insurers who are able to identify and overcome these challenges and adapt to them quickly, will have an advantage over their competitors.

One of the key issues is that no matter what broad strategy an insurer takes, whether an innovator or follower, these events will significantly impact the way they do business going forward. Existing business models and value chains will need to be reviewed in order to understand where these events will have the most impact.

An ongoing challenge facing insurers is the aftershocks that continue to hit Canterbury, despite many commentators believing they are tailing off. The worry is how will reinsurers respond after October’s 5.5 magnitude shake, particularly when they already viewed New Zealand’s natural-disaster risk as an area of concern after the June aftershock. What will this mean for insurers if reinsurance rates spike prohibitively high, as speculated by some in the industry, or policies are not renewed? Speculation on these issues will no doubt continue, however, it is unlikely anyone can predict what scenario will finally play out.

scenario planningWhat insurers can do right now is start to prepare, based on the possible outcomes of multi-dimensional events. This type of scenario planning seeks to explain how the future will look depending upon how multiple interrelated events will impact the business1. For example, what would it mean if reinsurance rates spike and markets continue to be volatile? Scenario planning helps to answer how this would impact on risk pricing, investment returns, customer affordability in an already depressed economy, product development, operational efficiency and profitability.

Quantitative scenarios are the next step and explain the hypothetical impacts based on the multi-dimensional event scenarios. Quantitative scenario planning is done on a medium or long term basis depending upon whether the event is a strategic game-changing event or medium term product modification event. Using scenario planning to consider a range of potential consequences can help an insurer make sense, and bring meaning to the impact of uncertain external events on the organisation and where competitive advantage will come from in the future.

Timothy gacsalAssociate Director Financial Risk Management T: +64 (9) 363 3504 E: [email protected]

1 Manage the future through scenario planning. KPMG Australia, 2011

© 2011 KPMG, a New Zealand partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.