Untying the insurance industry’s Gordian knot

BACK in the mid to late ‘80s a significant group of stakeholders raised the alarm that the insurance industry’s tariff pricing guidelines for certain classes of businesses — namely the fire, motor and surety lines — were a form of cartelization. They therefore posed legal challenges to the Industry and the regulators, as well, for supposedly condoning the practice. The case was never heard on its merits as the regulators in a bid to defuse the situation acquiesced and allowed individual insurance companies to come up with their own rating guides loosely based on the established, proven, transparent and defensible tariff, arrived at by the industry, based on years of historical data, and approved by the regulators. The only set price that the regulators left standing was that of the catastrophic perils of earthquake, typhoon and flood. In effect, each company now had its own set of rates except for the CAT peril rates, which effectively stood as the minimum rate to which all the other peril rates were added.

For those in the know, tariff pricing is not new and unique to the Philippines. You will find that tariff pricing regimes are common across the globe from mature markets such as the United States, Japan and some European countries to developing markets such as those in neighboring Asean countries, as well. Some countries have already started to detariff with various results, the most worrying of which is that competition can drive prices to unsustainable lows jeopardizing the ability of insurers to service their claims.

Fast forward to the present almost four decades later, the tariff (which insurers still maintain as the basis of their own rates) is no longer accurate and defensible as numerous factors have changed over the years, building codes have been improved, flood-prevention projects have been put in place, technology has improved not only in construction, quantity surveying, materials testing, but in many related areas as well. In other words, risks are deemed safer, and perils have become more manageable, signifying that lower rates may be in order. On the other hand, other underwriting factors such as the ones for CAT perils in particular demand a review in the face of global warming and climate change, both of which may adversely affect the results of the industry.

Since there is a strong case for detariffication, given that regulatory safeguards are in place, primary of which is the current risk-based capitalization model version 2 (RBC2) and the soon to be instituted PFRS17, which will make financial reporting even more transparent, the debate on whether the industry should hold on to a tariff (which must be first reviewed and updated), or to discard it altogether and allow a liberalization where free market forces will prevail, is in full swing.

Papers for the retention of or the scrapping of the tariff are being prepared by the champions of either side, which the fence sitters in the industry will study and use to help make an informed choice.

The one thing that remains clear though is that there is an imperative need for the industry to take stock of the situation and decide whether to continue under a tariff regime with a studied, updated and therefore defensible rates once again, or to scrap the tariffs and go purely free market. This is not as simple as it sounds given the study it will entail, the tons of data the industry would have to pour through, mathematical and statistical models to consult, not to mention taking into consideration current reinsurance market realities which is proving to be hardening.

The decisions stakeholders would have to make on account of the many moving parts are going to be tough. This is a process where the regulators will have to chime in and make such a process possible, with outcomes for the good of not one, but all stakeholders, to ensure a viable industry that can continue its role in protecting assets, and helping the economy grow with its significant contribution. A precarious balancing act, but one in which the incumbents at the Insurance Commission are eminently equipped for. With the combined expertise and the Solomonic bent of those at the helm, the industry is hopeful that a resolution is not far off.