Assessing risk: Aon’s 2012/13 Australasian Risk Survey

Rapid moves in technology and climate change pose a whole new set of challenges

An evolving understanding of a significantly changed operating landscape is leading to changes both in the way organisations define risk – and the way they address it.  In global terms, Australian and New Zealand companies are ahead of the pack, taking a more structured approach to tackling a growing number of issues than many of their international counterparts.

These are just a few of the deeper findings of the eleventh annual survey involved 133 Australian and New Zealand companies across 19 industries. And a number of its findings demonstrate a focus on entirely new risks.

“It is highly interesting to see how innovation, or a lack thereof and technology systems failure have now entered the top 10 risk concerns for Australasian organisations,” said Jason Disborough, Managing Director, Global, for Aon Risk Solutions Australia.

“In an economic environment where organisations are fighting for growth, we are seeing that a general ability to adapt and respond strategically to change are more critical than ever.”

Mr Disborough went on to cite a host of new challenges arising from changed technological, regulatory and environmental factors that barely even made it onto the risk landscape a few years ago.

“Technology has brought with it an enormous change in the way we do business – which translates directly to a whole new set of risks that we are only just beginning to grapple with, for example,” he said.

Even aside from the impact of technology-fuelled social media on brand and image – which ranked as the number one concern in the Australasian survey – other major technology-related issues such as lack of innovation, technology or system failure and lack of technology infrastructure to support business needs, are all creeping into the top 20 concerns – and some much higher.

Mr Disborough said that, given these technology-based concerns, Aon was surprised to see that Cyber Risk did not make the top 20 rankings – especially in the face of upcoming privacy and other legislative change likely to call into question the integrity of many organisations’ information management systems.

“I think it’s fair to say on the basis of our own research and consultancy that many organisations are underdone when it comes to cyber risk. We expect a growing move to address this once there’s greater awareness of the practical impact of privacy laws and how they mesh with new technology such as cloud-based systems,” he said.

Liability issues arising from other forms of regulation are also playing an increasing role in reshaping the risk landscape.

“Risks for company directors are almost unrecognisable from what they were 10 years ago, with sanctions from fines through to incarceration now on the table for a range of breaches across numerous areas, in particular occupational health and safety,” Mr Disborough added.

He also flagged that while the higher ranking of natural disasters as a risk was understandable due to events such as the Christchurch earthquakes, and floods and bushfires fires in many parts of Australia, these may well continue to grow alongside concerns about climate change and its ultimate long term impact on our living and working environments.

While there are undoubtedly significant challenges ahead, the survey showed that, in global terms, Australian and New Zealand companies are increasingly well placed to address them.

“It’s heartening to see that despite strong economic headwinds, Australasian organisations continued to increase their investment in risk management and risk mitigation at above global averages,” he said.

“This year, for example, 70% of organisations surveyed reported that they have a formal risk management or insurance department, which is 10% higher than last year’s survey, and 12% higher than the global average of 58%,” he explained.

Mr Disborough also pointed out that research shows a positive correlation between advanced risk maturity and the ability to add greater shareholder value for organisations. A separate study conducted by the Wharton School of Business and Aon from 2010–2012, identified that those organisations with the highest Risk Maturity Rating (5.0 – Advanced) exhibited a stock price volatility 50 percent lower than the group of organisations with the lowest Risk Maturity Rating (1.0).

Mr Disborough concluded by saying that the aim of the survey had always been to provide Aon clients with deeper insights into risk management and risk financing trends.

“The fact that the survey continues to uncover new risks really reinforces the need to remain vigilant and open to the broader implications of the rapidly changing environment in which we operate.”

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The key points are as follows:

• The “risk on/risk off” pattern that has prevailed in investment markets since the global financial crisis (GFC) is showing signs of breaking down.
• This reflects reduced risks associated with the US and Europe and should be seen as a good sign.
• It means that individual assets and investments can go back to better reflecting their underlying fundamentals.
• It should also mean that the benefits of having a diversified portfolio should start to become more evident in the years ahead.

To read this edition of Oliver’s Insights, click here.

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Mr Ramsay warned that, while he supported the concept of a standard measure of risk, the current version was already producing anomalies because it allowed funds wide discretion in what methodology they used to calculate it. 

The SRM was adopted for all new super fund product disclosure statements issued after June 2012. It requires super funds to state the likely number of negative annual returns a fund will experience in 20 years.

“We have already found examples where equities funds have been given similar risk measures to bond funds, despite the vastly different risk profile of these asset classes, simply because different funds are using different methodologies to calculate the SRM,” Mr Ramsay said. 

In another example, fund provider A gave an SRM for its bond fund of 3-4, while fund provider B gave its bond fund an SRM of 1-2, despite both funds having similar benchmarks and performance objectives. 

“Any rational consumer looking at the SRM would choose the product being promoted by Fund B, even though they are both very similar funds,” Mr Ramsay said. “The only difference is the way the SRM has been calculated.”

The SRM allows funds to deviate from a standard methodology as long as they explain and justify their reasons for doing so. 

But Mr Ramsay warned this could defeat the very purpose of a Standard Risk Measure. 

“It introduces complexity that has the potential to confuse many retails investors, if indeed they bother to go beyond the headline SRM when reading the PDS,” he said. 

Mr Ramsay said if consumers could be trusted to interpret detailed and often complicated nutritional information on food packaging there was no reason they could not benefit from a slightly more detailed standard measurement of investment risk. 

He proposed a new SRM that not only took into account the risk of negative returns but also showed how far the value of an investment was likely to fall during a drawdown and how many years it was expected to take to recover. This would be of particular value to those investors nearing retirement. 

Funds should also be required to publish historical figures for these measurements where available, as well as their own estimates, so they could be judged on those estimates. 

“While this may seem like a lot of information to some, it’s less than you would find on the back of a packet of chips,” Mr Ramsay said.

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The Standard Risk Measure disclosures the level of risk in superannuation and provides consumers with greater transparency about the risks associated with their investment choices in superannuation.

It is the product of an ASFA and FSC working group, and is supported by ASIC and the Australian Prudential Regulation Authority (APRA).

ASIC Chairman Greg Medcraft said: ‘The Standard Risk Measure is a useful tool for both consumers and industry. It will help people to understand the risks in superannuation and make confident and informed decisions. It will also provide the industry with a Standard Risk Measure to use when calculating risk and help these important gatekeepers make disclosures to members.’

APRA will require superannuation funds to identify and disclose the risk of negative returns over a 20-year period for each of their investment options on a standardised basis. This was first outlined in APRA’s letter of 29 June 2010.

The Standard Risk Measure will have seven risk bands, ranging from ‘very low’ to ‘very high’, and sets out what these terms will mean in regards to the chances of a negative return in a twenty year time period. Super fund members can more easily compare investment options within their fund, as well as make comparisons across superannuation funds.

It is expected that the risk measure will be included in super fund Product Disclosure Statements (PDS). The start date for disclosing this information on a standardised basis will be 22 June 2012, to align with the timeframes by which all trustees must be using a shorter Product Disclosure Statement (PDS).

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In addition, the AMP Capital Infrastructure Debt Fund has made its first investment, securing a £40 million high yielding loan to a leading UK based rolling stock company specialising in the leasing of passenger trains and freight locomotives.

AMP Capital Global Head of Infrastructure Debt Andrew Jones said fundraising had exceeded expectations.

“We are very pleased to achieve subscriptions of €241 million against the backdrop of what remains a very challenging fundraising market. Demand has been strong from institutional investors in Asia, Europe, North America and Australia. In particular, interest from investors in Japan has been so strong we now offer a Japanese Yen feeder fund to go along with the US Dollar feeder funds,” Mr Jones said.

“This early success means AMP Capital is well positioned to take advantage of the attractive risk adjusted returns available in the infrastructure debt space. We anticipate this investment will provide attractive risk adjusted returns for our investors in the form of regular cash coupons underpinned by a very stable and experienced borrower,” Mr Jones said.

The portfolio will consist of investments in the subordinated debt of 10 to 15 companies headquartered in OECD countries in the essential services of water, gas, electricity, transport and hospitals. The Fund will target defensive assets with high barriers to entry, a regulated environment, highly visible cash flows and strong industry positions.

“We expect to take a lead arranging role in the majority of transactions, with our focus on adding value through originating, structuring and leading pricing and terms discussions. Through our role as a key provider of subordinated debt to the infrastructure sector for over a decade, we are currently partnering with leading sponsors to pursue an exciting deal pipeline of current opportunities,” Mr Jones concluded.

The largest insurance group in China and the world’s largest listed life insurance company, China Life Insurance (Group) Company, through its subsidiaries, was a cornerstone investor in the Fund alongside Funds managed by AMP Capital. AMP and China Life formed a strategic partnership in 2009 to explore areas for partnership in pensions and asset management. The investors in the AMP Capital Infrastructure Debt Fund include life insurance, pension funds and multi manager investment funds based in Japan, Hong Kong and Australia.

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• The Australian sharemarket has significantly underperformed other major overseas markets this financial year. Some of the factors that have led to this under-performance include higher domestic interest rates, the strength of the Australian dollar and the lack of near term growth.
• CommSec still expects the Australian share market to rise over the rest of 2011, however we have cut the end year forecast from 5,400 points to 5,200 points.

Aussie shares out of favour?

• Many investors would be disappointed at the performance of the domestic share market this year in comparison with overseas indices, especially given that last year the domestic economy showed far more promise and seemed to be well ahead of its peers. Since the start of 2011 the ASX200 has fallen by 2.1 per cent while the broader All Ords index has lost 2.3 per cent. In contrast the US Dow Jones has gained 3.8 per cent, while the US S&P500 is up almost 3.0 per cent.
• No doubt the heightened sense of risk aversion in the last couple of weeks has resulted in the considerable under-performance of domestic equities. However even on a longer time scale the under-performance is easy to see. Since the start of the financial year the ASX 200 has risen just shy of 8 per cent, well below the Dow Jones which has gained a staggering 23 per cent. Similarly the S&P500 has risen almost 26 per cent, while the techheavy Nasdaq has out-performed, rising over 27 per cent. Even in Europe the London FTSE has gained more than 17 per cent, while the German Dax has managed to eke out an increase of almost 14 per cent. Whichever way you cut it, the under-performance of domestic equities is plain to see.

Why have Aussie shares lagged?

• The level of under-performance certainly seems to suggest that there are couple of factors at play. No doubt the strength of the Australian dollar has played a significant part in the weak result – especially given that around 40 per cent of our market is owned by foreign investors.

• In fact in US dollar terms the MSCI-Australia index has gained 32 per since the start of the 2010/11 financial year – clearly highlighting the strength of the currency. However since the start of 2011 the MSCI Australia index in US dollar terms has under-performed the MSCI World (ex Australia) index, also in US dollar terms, despite the fact that the currency has effectively tracked sideways. This would suggest that overseas investors have been trimming positions of Australian shares.
• The uncertainty surrounding government policy is also clearly a driver of lack of overseas interest in domestic equities. The contentious debate about both a carbon and mining tax has added a further element of uncertainty to the economic landscape and as such overseas investors remain on the sidelines or are choosing to invest elsewhere.

• Another reason for the weakness in domestic equities has been the fact that both domestic investors and fund managers have been spoilt for choice. The Reserve Bank’s rapid rate hikes last year and the intense competition for domestic funds by the major banks has resulted in very attractive term deposit rates, carrying virtually no risk. In fact superannuation fund holdings of cash assets were at record highs $162.9 billion in the September quarter 2010. And the proportion of super fund’s assets held in cash was 15.4 per cent in the September quarter, well above the decade average of 9.2 per cent. Domestic, risk-averse investors have been attracted by the high rates on offer, diverting funds away from equity markets.

Sector winners & losers

• While domestic equity markets have under-performed in a global sense, the weakness has not been broad-based with only seven out of the 21 sectors recording losses since the start of the 2010/11 financial year. Telecommunications has been the weakest sector, down 17 per cent, while on the flipside Auto & components has recorded the strongest gains, up 23.1 per cent. Notably, given the global cyclical recovery that is taking place, energy, material and resources stocks have also recorded healthy gains.
• Earlier this year the gap between the All Ordinaries index and S&P/ASX 200 was at its widest in 30 months, standing at 110 points, but this has since eased to 95 points. So what does it all mean? Essentially it highlights the fact that smaller companies have been driving our benchmark indexes higher while the ‘big caps’ have been taking a breather. Over the past six months the Small Ordinaries index powered higher by almost 22 per cent while the ‘big cap’ ASX50 index lifted just 6.8 per cent. In part, the out-performance of small caps suggests an underlying confidence in the market. However it also occurred at the same time that the Aussie dollar lifted sharply, making Aussie big cap companies less competitive for global fund managers.
• As the Aussie dollar eases in coming quarters and the global recovery builds momentum it is likely that the larger capitalised shares will once again be outperform “small caps” especially given the continued improvement in corporate profits.

Corporate earnings

• The latest earnings season highlighted the fact that corporate Australia is primed for growth. In aggregate, the ASX 200 companies that reported their half-yearly results had earnings up 25 per cent on a year ago with cash on hand up almost 24 per cent. And when you add in the companies reporting full-year earnings, cash on hand at the 152 companies stood at $102.5 billion, up 25 per cent on a year earlier. In short, Aussie companies have cut debt and lifted cash levels to ensure that they are well prepared to meet the difficulties ahead – and there are a few. The Aussie dollar is still high, making life difficult for exporters, import-competing businesses, global companies and retailers. Then there are the vagaries of the weather, providing further challenges. Consumers still won’t spend. And raw material prices remain at lofty levels.

• Overall company profits are still outpacing share prices. The gap should close by share prices lifting to meet the higher earnings, but of course the difficulty is working out when, and how quickly, this will occur. CommSec believes that a combination of solid earnings and a lower Aussie dollar will serve to drive the sharemarket higher in the second half of 2011 – especially given that the second half of the year is expected to be the growth driver for the economy.

Valuations

• In light of the fear-driven sell-off on global sharemarkets in response to the crisis in Japan, it is always useful to come back to fundamentals. We have assessed 12-month forward price-earnings ratios for a raft of markets across the globe provided by FactSet.
• Of the 70 regions assessed, only 14 have PE ratios that are higher than their 5-year averages. For the “world” market, the current PE ratio of 13.61 is almost 10 per cent lower than the decade average and stands at a seven month low. Interestingly the most under-valued region is Austria with the PE ratio 64 per cent below the 5-year average. More understandable is the next cheapest – Japan – with the forward PE ratio (15.28) more than 53 per cent below the 5-year average.
• The forward PE ratio for the Australian market stands at a seven-month low of 12.8, which is well below the 5- year average of 14.5. Now clearly with investors far more conservative across the globe, the current lower PE ratios may prove the “new normal.” Unfortunately we won’t know the answer on this one for some time.

Outlook

• Looking forward our currency strategists expect the Aussie dollar to ease over the rest of this year falling to around US92 cents by end year, largely due to the increasing perception of US interest rate hikes down the track. A weaker Australian dollar will certainly be an added incentive for foreign funds looking to invest in our share market. And also it will be much more supportive of merger and acquisition activity given valuations will be cheaper.
• The Reserve Bank is likely to remain on the sidelines over the next few months given that the domestic economy has certainly lost some momentum in the short term. The floods have robbed the economy of much need momentum at a time when the multiple rate hikes were already taking a toll consumer activity. As such CommSec anticipates the Reserve Bank is likely to hold off on interest rate hikes in the near term, a further support for equity markets.
• CommSec believes that a combination of solid earnings and a lower Aussie dollar will serve to drive the sharemarket higher in the second half of 2011. However given the near term weakness and the impact of left field events like the Japanese nuclear crisis and unrest in the Middle East, we have revised down our forecasts modestly. We now expect the All Ordinaries/ASX 200 to lift to around 5,200 points by end year.

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AMP Director of Wealth Protection Products Michael Paff said the enhancements will be offered to new as well as over 170,000 existing customers, who will be automatically upgraded at no additional cost.

“These developments are designed to ensure AMP’s insurance offering continues to be contemporary and compelling to our existing and new customers,” Mr Paff said.

Over 30 enhancements have been made to AMP Flexible Lifetime – Protection. These are strengthened by the product’s Automatic Plan Enhancement feature, which ensures claims that existing customers make after 28 March will not be denied for the new enhancements on the basis of a pre-existing condition.

Enhancements to AMP Flexible Lifetime – Protection include definition changes to Trauma insurance, changes to the Guaranteed Future Insurability feature for Income Protection and additional inbuilt Trauma features.

The Trauma insurance upgrade includes changes to five key trauma definitions, including Angioplasty and Cancer.

“Cancer is the most common form of Trauma claim with 76 per cent of AMP claims in 2010 attributed to cancer, so we wanted to broaden the cover available to our customers,” Mr Paff said.

Income Protection enhancements include increasing the maximum monthly benefit under the Guaranteed Future Insurability feature from $1,000 to $1,500 and the addition of occupationally acquired HIV and Hepatitis B or C as part of the inbuilt Trauma feature.

AMP has also made four significant improvements to its group insurance offer, including allowing Automatic Acceptance on plans with five or more members and increasing premium discounts on plans with up to 800 members.

“These upgrades are about making it easier for new group clients to gain access to insurance,” Mr Paff said.

Covering both retail and group insurance is the launch of an online claims concierge service, an extension of the phone-based service launched in May last year. This online service can be accessed via www.amp.com.au/claims and enables customers and planners to lodge a claim 24
hours a day and receive a response within 24 hours.

AMP has also realigned its underwriting teams to further enhance the support it provides its planners.

“As part of our commitment to make underwriting easier, we have recruited a number of regional underwriters and created dedicated underwriting teams for all planners,” Mr Paff said.

For more detailed information about all the enhancements please refer to http://www.amp.com.au/ampriskofferlaunch.

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Victoria Simpson has been appointed as Group Risk Product Strategy Manager, Jenny Vaitsas as Group Risk Product Manager and Chris Taylor as Group Insurance Business Relationship Manager (BRM).

AMP Director of Wealth Protection Products Michael Paff said, “These appointments will further strengthen our Group Risk business, boosting AMP’s ability to offer high quality, competitive insurance packages to groups of individuals, such as those through employer sponsored super.”

Victoria Simpson’s appointment as Group Risk Product Strategy Manager follows five years at AMP as an actuary within product manufacturing, most recently within Pricing and Value Analytics. Prior to joining AMP, Victoria worked in actuarial finance at Canada Life Insurance in Dublin.

“In her new role Victoria will be focused on developing and implementing the strategic and operational plans for AMP’s Group Risk product set,” Mr Paff said.

Jenny Vaitsas joins AMP from MLC, where she held the position of Service Manager for the Master Key Business Super Insurance team. Before this, Jenny held several senior operations positions at CommInsure.

“Jenny brings to AMP a wealth of experience in risk and corporate superannuation products, having worked in the life insurance industry for almost 13 years. Jenny will play a key role in strengthening AMP’s Group Insurance proposition,” Mr Paff said.

Chris Taylor’s appointment as Group Insurance BRM comes after Chris joined AMP in 2009 as Group Life Product Manager. Chris previously held various roles in Group Risk Claims at PrefSure Life and Tower.

“Chris brings extensive experience to this position given his background across many aspects of Group Insurance. Chris will be primarily focused on life insurance and salary continuance,” Mr Paff said.

Mr Paff said that Chris will also be responsible for managing strategic relationships within the business.

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The latest ‘Financial Services Council Chief Investment Officer Investment Index’ shows Chief Investment Officers (CIOs) are growing more optimistic about investment performance over the next 12 months.

 The quarterly Index, based on CIO responses from a sample of Financial Services Council members, scored 25 from a range of -100 to 100, where a score of 0 is considered neutral. This is up from the score of 11 in the last quarter.

John Brogden, CEO of the Financial Services Council, said the Index showed CIOs were much less concerned about risks associated with the US economy than they were last quarter and more focussed on the Asia region.

“There is now increasing attention being given to the risk of a slowdown in China over the next 12 months,” Mr Brogden said.

“The possibility of a default in the Eurozone still weighs on the minds of CIOs, however sentiment towards the region is improving as fears of a contagion risk fail to materialise.

“On the whole, sentiment among CIOs is fairly positive with many respondents noting that sufficient risk is already built into investment markets.” In terms of specific asset classes:

• Australian and international equities are again expected to be the best performers over the next 12 months;
• Australian property is expected to perform slightly better than international property, a reversal from last quarter; and
• Australian fixed income assets are expected to perform better than international fixed income, which was the only asset class to receive a negative score this quarter.

While this quarter’s findings indicate a growing optimism among CIOs, the risk of a slowdown in the Chinese economy is a developing concern for the year ahead.

Over the longer term (five years), CIOs consider inflationary pressures and moves to control these, especially in China, to be risk factors. Possible volatility associated with the increasing significance of emerging markets is also of concern.

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Bozenna Hinton, Institute President, said the Institute supports the concept of an identifiable risk reserve for superannuation funds held separately from member account balances. She said the minimum level for this should be set on a risk assessed basis consistent with other financial services industries.

“We are pleased that the Government will consider a risk based system for all APRA regulated super funds requiring them to hold financial resources against operational risk, as we recommended this in our submissions to the Cooper Review,” Ms Hinton said. “We note that the Government will consult with relevant stakeholders on whether such a system should require resources to be held in the form of trustee capital or an operational risk reserve in the fund.”

The Institute confirms that as part of this process, a Financial Condition Report for accumulation super funds should eventually become compulsory, but in the meantime should be considered best practice. Such a report would allow trustees to stress test a super fund under different market conditions.

Support for idea that super funds consider longevity risk but more work needed The Institute also supports the recommendation that both MySuper and choice super funds be explicitly required to consider longevity and inflation risk. However, Ms Hinton said more concrete measures were needed.

“As a next step, we encourage the Government to remove the roadblocks preventing innovation and product development in the post retirement product market including social security and tax barriers.

Development of new post retirement products will better equip Australians to protect themselves against their own longevity risk,” Ms Hinton said.

The Government has also indicated that while it does not support mandatory retirement forecasts for MySuper products, it will ask the Australian Securities and Investments Commission to continue working on developments in this area.

“The Institute strongly supports the idea of retirement forecasts being provided to super fund members so is disappointed about this outcome. However, we look forward to working with ASIC particularly in relation to the assumptions used for such forecasts and how the results could be presented,” Ms Hinton said.

“Similarly, we look forward to working with APRA and ASIC regarding the publication of superannuation data designed to improve transparency and comparability in relation to net investment performance fees and costs,” Ms Hinton said.

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