Investor Needs for Transparency and Good Governance, and Insurance Reactions
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Investor Needs for Transparency and Good Governance, and Insurance Reactions Maurizio Lualdi European Insurance, Credit Suisse First Boston, One Cabot Square, London E14 4QJ, U.K. E-mail: [email protected]
This paper deals with the need for transparency and good governance in insurance companies in the wake of recent scandals in the financial services. It also shows that socially responsible investing can be a tricky activity because of how questionable products are often linked with socially acceptable ones. The Geneva Papers (2005) 30, 467–476. doi:10.1057/palgrave.gpp.2510044 Keywords: insurance; good governance; socially responsible investing
The recent turbulence experienced in equity markets has brought about a series of issues in relation to how capital markets work, how companies are managed and ultimately how countries react to unexpected events (natural or provoked). The events leading to the Sarbanes-Oxley Act of 2002 can be seen as the culmination of an era where self-regulation failed to prevent abuses that eventually produced significant damage to investors. There is in our view a clear conundrum to be solved. On the one hand investors pull their hair off when something wrong happens, on the other, there is a relentless pursuit for profits that has led to a significant increase of uncertainty and erratic equity market behaviour. Figure 1 shows the historical performance of the S&P 500 against the Treasury bond yield for the U.S. market. The comparison between bond markets and equity markets is necessary as the discount rate used in calculating fair values of stock are influenced by the risk free rate, and also by the required market risk premium. The first important point to make, we think, is to compare the way we value bonds and equities and see how behavioural patterns over time may be conducive to creating speculative bubbles on these classes of assets. Table 1 shows the minimum, maximum and average yield achieved by treasury bonds in the U.S. from 1927 on. In this chart, we show (assuming a bond with a set duration of 10 years with a coupon equivalent to the average yield since 1927) how the price of this bond would have changed with yields at the historical minimum (2.01 per cent), the historical maximum (13.72 per cent) and a theoretical minimum yield of 0.01 per cent. As can be seen, the variance on the price of the bond would have been þ 29 per cent from the issue point when bond yields touched the minimum and 45 per cent when bond yields hit a maximum. The minimum theoretical yield gives a maximum price for the bond that implies a 52 per cent upside potential from issue price. When we observe the behaviour of equity markets over the period, we can see that during this period the variance on the average of the S&P 500 index was þ 601 per
The Geneva Papers on Risk and Insurance — Issues and Practice
468 S&P 500 and T.Bond Rate
1600 S&P 500
16.0%
T.Bond rate [rhs] 14.0%
1200
12.0%
1000
10.0%
800
8.0%
600
6.0%
400
4.0%
200
2.0%
0
0.0% 1927 1929 1931 1933 1935 1937 193
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