Light At The End Of The Tunnel

The financial crisis and the resultant economic recession are chilling reminders that insurance companies are exposed to risks well beyond insurance policies. These tumultuous times have taught us that extreme risk events can catch even well-prepared executives and companies off-guard. Although the insurance sector was less directly affected by the financial crisis than other financial services businesses, most insurers were still surprised by the depth of the downturn.

Property and casualty (P&C) insurers did not suffer major loss events in comparison to those in the life and health sector. From June 2008 to June 2009, Standard and Poor’s life and health insurance index decreased by 52.1%, while its P&C insurance index decreased only 33.6%.

Regardless, all companies that want to remain in the lead over the long term must learn from the financial crisis and the market changes that have resulted. Applying these lessons to future plans will enable insurers to navigate the months ahead, and thrive when the upturn takes hold. Insurers should consider five key strategies to manage and protect their business:

Secure a capital buffer beyond what’s predicted

Some insurers suffered severely during the financial crisis because they were unable to anticipate and manage the sheer magnitude of the event. The lack of a safety net for many insurance companies emphasized the need for wide-ranging, up-front planning and capital management strategies to work through each stress event.

What’s more, firms that relied on consolidated, enterprise-wide measures of risk and capital now recognize that capital available in local subsidiaries in good times may not be accessible when a crisis hits.

It’s time to reassess modelling and hedging strategies and develop sound mitigation processes. Properly used, economic risk and capital measures are powerful tools that can help insurers understand their financial position and develop effective risk management strategies.

Planning and developing strategies up front is a first step. Once this is done, companies should build a capital cushion by establishing and maintaining auxiliary capital over and above the amounts predicted by economic capital models. Capital preservation, measurement and reallocation to other businesses are crucial to securing stability. Insurers should also keep adequate “flexible” capital at all times to maintain rating agency and regulatory requirements, and eliminate further erosion of financial stability.

Build an enterprise-wide approach for managing risk

Insurers with the right asset-protection mechanisms in place emerged among the strongest in the downturn. Others can learn from this successful strategy by building an actionable, measurable risk management plan that can handle the expected and the unexpected.

Insurers should ask themselves tough questions:

• Do we understand the risks facing our company?

• Do we have a comprehensive risk framework in place?

• Do we have duplicative or overlapping risk functions?

• Are the risks we take aligned to our business strategies and objectives?

• Are we taking the right risks to achieve a competitive advantage?

Companies should then move risk management out of its silo and into the wider business strategy. Organizations in all sectors sometimes tend to make decisions in isolation, which can lead to unfortunate surprises later on. Business units must keep the risk component in mind when making strategic and operational decisions.

The chief risk officer must be involved in decisions to increase or decrease risk exposures. He or she should ensure a balance of power between the risk takers and those charged with independently monitoring risk.

Solid risk management now needs to stretch further than ever before, and cover off risks that haven’t yet shown up on the radar. That means embracing stress testing and scenario planning to manage these broad threats effectively. Scenarios help decision-makers anticipate change by taking into account many future options simultaneously. Solid risk management plans will address numerous scenarios to visualize the most important external uncertainties.

Re-evaluate the business’s size and shape from the top down

It’s increasingly difficult for traditional, vertically integrated companies to respond effectively in this type of market. In many cases, long-term success will depend on companies seizing the opportunity to build leaner, more flexible and adaptable organizations now — or else risk being unprepared to compete in the post-recession world.

Insurers should ask themselves whether or not their current operating model — the combination of people, organization, processes and systems — is best suited to the current business environment. Is it flexible and scalable for market upturns? Is it truly aligned with the strategic objectives of the business?

This is about more than mere cost savings. Although it is easy to take costs out of a business, it is harder to keep them from creeping back in. Progressive companies succeed by adopting sustainable cost reduction that focuses on the softer issues like value (delivering the best options will generate the greatest savings and build momentum for the future), pace (companies can effect change by balancing measurable results with immediate wins) and culture (it’s important to change the mindset around how money is being spent and embed cost management into all aspects of the business).

Of course, balancing cost cutting with the need for human capital is crucial. Insurance organizations have always relied on human capital as a critical component of a successful business strategy. Even in the most difficult economic times, insurers need to ensure they don’t lose their best people to better-situated competitors. Insurers must always have the big picture in mind.

Strengthen your organization by focusing on market share

Insurance companies can emerge stronger from the downturn by capitalizing on opportunities to extend their market reach and take market share away from their competitors.

Insurers that fared better in the downturn are emerging with strong balance sheets. As the economy improves and market volatility decreases, insurers may be able to buy businesses others are shedding at reduced prices. By taking the opportunity to divest non-core businesses, they can reinvest in areas of expertise. Sellers need to raise capital and exit underperforming businesses — this is the impetus for the increased number of insurance properties for sale. One company’s need to downsize could be another’s chance to expand.

Capitalize on new market and product opportunities

Insurance companies expect to emerge stronger from the downturn by capitalizing on market opportunities. These could come in many forms.

Insurers can expand into new geographic markets. Changing demographics mean many companies are looking to Latin America, the Middle East and Eastern Europe for growth. These emerging markets represent an opportunity for insurance companies to launch new products, expand their customer base and build a better infrastructure.

Success lies in choosing the right strategy and mode of market entry, along with the right local partners, products and reliable distribution channels. In addition to potential regulatory constraints, there are cultural, language and religious barriers to overcome.

Enhancing product lines is another viable option. Consumer attitudes have changed, creating significant opportunities to redesign and offer new products that meet their needs.

For example, consumers’ increasing demands for tradeoffs between guarantees, fees and risks are pushing insurance companies to design products with more features. As a result, clients often need more advice on the complex features of insurance products, and may be less willing or able to make their own informed decisions. This creates another opportunity for insurers to meet changing needs and evolve their offerings.