On Black Holes
Insurance Experts' Forum, November 25, 2013
What a week for Royal Sun Alliance, already unpopular with investors following their decision earlier this year to cut their dividend payout. The impact of the St. Jude storm particularly on their large Danish subsidiary forced the company to release a profits warning. Worst still was their second warning four days later after revealing irregularities in the accounts of their company in Ireland. The subsequent share price collapse and downgrade by the rating agencies added to the firm’s misery.
Yet the current troubles at RSA are nothing compared to what has been going on at Bermuda based Tower Group. Its failure to file financial statements after announcing huge reserve charges and impairment to goodwill is now raising substantial doubts over whether they can continue to operate as a going concern, according to Insurance Insider. The problems at RSA and Tower are of a different magnitude relatively speaking but the root cause appears to be much the same; each seems to have experienced a breakdown in financial controls.
Since most insurers are cash-positive and adopt some fairly opaque devices to recognise long-term liabilities, financial inaccuracies can go undetected for a surprisingly long period. By the time it is discovered that claims reserve amounts have been ignored or suppressed or premium earning patterns distorted, the impact can be quite devastating. Even after raising the capital required plugging a black-hole, it may take years for a management team to untangle a business strategy built upon a false expectation of profit: Ireland being a case in point; RSA must now be seriously reconsidering its aggressive growth plan in that market.
Despite the best efforts of regulators, even with a much greater degree of oversight these days, mistakes of course still happen and will continue to do so. It is nevertheless perhaps too convenient to characterise incidents like those at RSA and Tower simply as ‘one-offs’. Arguably as we slide further into a market downturn and over-stretched insurers push for growth in weak pricing conditions, the more vulnerable companies will be prone to making errors. The new system of corporate governance that has evolved over the past few years to prevent financial mismanagement is sure to be tested.
This blog was originally published on Roger Bickmore's website, "The Lookout."
Roger Bickmore is the Group Business Development Director at Kiln Group, insurance underwriters at Lloyd's of London.
Readers are encouraged to respond to Roger using the “Add Your Comments” box below. He also can be reached at firstname.lastname@example.org.
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