The Insurance Revolution

Convergence, global expansion, risk diversification, and competing in an increasingly competitive marketplace were common threads woven into the views of the senior insurance speakers at this year’s International Insurance Association (IIA) annual seminar. However, a new market force has appeared on the industry’s horizon, that being capital risk management.

Although the impact of capital risk management was viewed differently by company leaders operating primarily in either Europe, North America, or the Pacific Asian Rim, the message was clear that the stage setting of the global insurance marketplace has to change following the dismal financial returns resulting from the soft business pricing cycle. As such, capital risk management was seen to fall into two operational areas: a focus on profitable underwriting and risk diversification, and secondly, effective deployment of capital for organic and/or acquisitional growth. The net result will have to be significantly improved financial returns, and those companies who choose to ignore the shift from past business practices will likely fall by the wayside, the speakers warn.

A survey conducted by the IIA of the seminar attendees also identified managing capital and risk as being the top issues of concern for insurers. This ranked as a first priority for Asian companies, a second priority (out of three) for European insurance companies, and third within the U.S. and Canadian marketplaces. The survey results highlighted four major challenges shared by insurance management around the globe: managing capital and risk, meeting customer demands, competing amid consolidation and concentration, and keeping talent suitable for today’s markets. U.S. and Canadian insurers saw “competing amid consolidation and concentration” as being the most significant challenge they will face in coming years.

Commenting on the survey results, the IIA’s chair Kees Storm (chairman of AEGON N.V.) notes that “technology” and the Internet played low-key in the list of company priorities. Specifically, he adds, industry direction on the online technology front has moved from the euphoria of Internet sales that dominated a year ago, to a more mature business application approach. “Last year there was still a lot of talk of using the Internet as a selling tool, it’s amazing the difference in attitude of companies this year who are refocusing their technology investments away from selling to [B2B] productivity enhancement.”

Patrick Kenny, the newly appointed CEO of the IIA, observes, “what really stands out [in this year’s survey results] against last year is that e-commerce has dropped off the list [of company priorities]. I think the industry has sobered up a bit.”

Kenny points out that “attracting the right talent” remains a key concern of insurers, but the most interesting turn in the survey results lies in the high prominence given to “capital management”. This signifies a turning point for management of the industry, he speculates, “a movement from the rhetorical to substance”. Also, he notes, greater attention has shifted to customer relations, a clear sign that the industry is advancing from a product focus to customer service. This, Storm says, is a dramatic turn for an industry which has been steadfast in its traditional thinking patterns. “CRM [customer relationship management] was a term you hardly ever heard, now it’s all over the industry.”

Managing capital

A significant factor which presumably contributed to the weakness of the property and casualty insurance industry globally has been the “capital glut” that has built up over the past ten years. Excess and under-employed capital, combined with new money entering the business from outside competitors such as the capital markets and the banks, weakened the resolve of companies to respond to deteriorating underwriting results – leading to the most recent soft market cycle. Now, after years of compounding underwriting losses coupled with weak investment returns, shareholders of the global insurance holding companies have demanded appropriate corrective action – hence the latest industry-wide move to firm prices.

It is primarily for this reason that Douglas Leatherdale, the newly appointed chair of the IIA and CEO of St. Paul Companies, USA, says he is confident of a recovery in growth within the p&c sector. Although capital management remains a concern, particularly as shareholders exert pressure for higher returns from the employment of capital, he believes the North American market has achieved sufficient pricing momentum to maintain the correction underway.

Furthermore, Leather-dale believes the “capital glut” seen to be within the U.S. p&c insurance industry has been greatly exaggerated. Recent years of company under-reserving in an attempt to boost bottom-line figures, combined with long-tail liability claim costs now arising from the 1980s and early 1990s, have led to a significant reserve shortfall. Leatherdale estimates that U.S. insurers could now be facing a reserve deficiency of about US$50 billion. “This is focussing the industry drive on profitability, and that’s why I think the business will grow.”

Bob Gunn, CEO of Royal & SunAlliance, Americas, says the market conditions in Canada are somewhat different to the U.S. The Canadian p&c insurance industry remains highly fragmented, he notes, and although firmer pricing is beginning to take hold, the rebound has not been as pronounced as in the U.S. and European markets. Notably, Canadian insurers are not facing the reserve deficiencies of their U.S. cousins, and the amount of capital chasing premiums remains strong. “I tend to sit on the fence in this regard [whether the industry remains over-capitalized].” However, he adds, there is no question to whether the Canadian market will have to follow the lead of the international marketplace, “returns are inadequate, and the pressure is on”.

Global strategies

At the global level, convergence of financial services has become the driver of company strategies, says Dr. Henning Schulte-Noelle, chairman of Allianz AG Holding (Germany). Allianz recently acquired Dresdner Bank AG in a multi-billion dollar deal which has resulted in the combined insurance/banking group being among the top financial players in Europe – Allianz is now compared with the Citi Bank Group in the U.S. as an integrated financial services operation.

A significant factor driving convergence in financial services is deregulation of the markets, to some extent the result of forming trade blocks such as the European Union, Pacific Asia, and North America. This has opened the doors for global players to diversify and focus their business strategies, he adds. A key factor behind convergence is the ability to meet “customer needs”, and from a strategic standpoint, “customer interface” has become paramount to the new business model. “Does an insurance company have to buy a bank to get there? Not necessarily, but for us it was the most effective model to achieve this customer relationship.”

As a result, the traditional insurance model of focusing on underwriting is no longer effective, the future lies in service, Schulte-Noelle suggests. “It’s all about an integrated model [of product development and service],” he adds, with Allianz having adopted a multi-distribution approach (Dresdner Bank being a key element in the group’s distribution plans). “Multi-channel distribution is crucial to the success of our operations.”

Fragmentation among the global insurance players remains a vexing problem, observes Henri de Castries, president of Axa Group (France). “When you think about it, none of us [being global insurers] have more than 3% marketshare. [Industry] consolidation has been in the process for more than 10 years, but the market is still too fragmented.”

As such, de Castries believes that global convergence through consolidation is still to come. This, he believes, will be spurred forward by the move toward global deregulation of financial services. In this environment, de Castries says Axa’s core focus is to gain “critical size” in the various market segments and geographic positions the group takes. “Our business model is based on being a ‘specialist’.” This means developing a marketing niche, which in Axa’s case is based on “financial protection”. He explains this concept as being “giving everything through a customer’s life-span from general insurance to estate planning – with emphasis on advice. This is the ‘value-added chain’.” In this respect, Axa has shied away from being what de Castries describes as those companies who are “product pushers”.

Axa also supports a multi-channel distribution approach, depending on the nature of its operations, as well as the local business environment. However, he points out that the “traditional broker” is far from dead-in-the-water. “We believe it’s [broker channel] is more effective than banking, we’re dealing with entrepreneurial people, but you have to train them.”

Takeo Inokuchi, president of Mitsui Marine & Fire (Japan), points out that international barriers to business are falling. He expects deregulation will see increased competition between foreign and local insurers in the Japanese market, as well as Asia as countries such as mainland China convert to free market principles (China faces a deadline for membership to the World Trade Organization which will require broad deregulation of commerce). Inokuchi also expects Japanese insurers will play a greater role on the international insurance stage.

From a business strategy perspective, Inokuchi notes that recent years of technology investment by insurers is beginning to produce dividends, operating expenses are beginning to decline, while companies are better positioned to maximize on customer relations. In this respect, he believes that the industry’s competitive driver in the short to medium-term will be building client data bases and data mining tools. Another factor on the horizon will be “dealing with a cashless society”, he predicts.

Leatherdale sees capital management as being the single biggest factor influencing the North American insurance market. The current business cycle suggests at improving returns, he adds, and this is likely to remain in place for the next four-plus years, with rate increases likely to be the order of the day for the next two years. But, although the insurance industry is still very much influenced by the traditional business cycle, the environment has changed, Leatherdale believes. “There is an evolution taking place, which is being driven by convergence. Companies that don’t maximize on capital management will not be competitive. The winners will have strong balance sheets and effective capital management in how they deploy capital to assume risk.”

In line with this future scenario, Lea-therdale expects to see increased competition between the various financial service players. “There’s nothing more powerful than the guiding hand of economics.” As such, he stresses the point that insurers have to prepare for convergence within the financial services arena.

P&C future growth

In a “question/answer session”, the CEO insurer panel were asked how they view the potential growth ability of the p&c insurance sector in coming years. All four of the speakers were optimistic over the longer-term performance of the industry, but the European financial services market will likely see stronger growth in wealth management, the Axa and Allianz speakers agreed.

Schulte-Noelle believes that Europe is only now beginning to see the benefits of the “baby boomer” wealth accumulation drive. The maturing baby boomer generation in North America signaled explosive growth in wealth management services, he points out. While this is tapering off in North America, the wave is only starting to build in Europe. Wealth management will be at the forefront of European financial services, he predicts.

That said, Schulte-Noelle notes that p&c business still accounts for roughly 53% of Allianz’s worldwide business, and the group does not have any plans to divest its interests.

Although outside competition in the top-end commercial lines market could grow through alternative risk transfer (ART) solutions, Schult-Noelle does not believe that this will spread into the more general types of insurance. The Sony group is a recent exception, he notes, but retailers have not been successful in past endeavors. “They haven’t been able to add value beyond what insurers have provided. But, we need to stay alert.”

Axa’s p&c interests currently account for about 25% of the group’s business, says de Castries. He believes there are selective growth opportunities in the sector, depending on critical marketshare mass. Axa also has no intentions of getting out of the p&c market, he says.

In addition to firming pricing in the North American p&c market, Leatherdale’s confidence in the future is bolstered by the fact that the business is becoming increasingly difficult to enter. “I don’t think the current firming of the price cycle will attract new capital. The expertise requirements of today’s market is different compared with 10 years ago.” Furthermore, the last upturn in the insurance price cycle was driven by large catastrophic losses and company insolvency, today’s industry is secure from a capital standpoint which suggests there will not be any sudden reductions in capacity – thereby allowing outsiders to move in.

Technology switch

Internet technology was supposed to equalize competitiveness between large and small enterprises, observes Jack Funda of ChannelPoint, U.S. Funda served on a technology panel moderated by Robert Mendelsohn, group CEO of Royal & SunAlliance Plc. (U.K.). Funda points out, “the big are just getting bigger and the smaller are having an increasingly tough time trying to compete”.

The initial approach to online technology was to see the medium as an alternative distribution channel, he adds. This has not worked mainly as insurers attempted to “shoe-horn” existing products and operating methods into the Internet. This provided neither the operating savings expected, and just as importantly, did not result in lower end-user pricing. The consumer buying online is not stupid, Funda notes, and they will not buy unless they perceive value in doing so. Another factor behind the failure of online selling of insurance is the piecemeal approach insurers adopted to their Internet projects. “In otherwords, there hasn’t been straight through processing [between company systems] to Internet projects, as well as links with third-party systems.

The mindset to online technology is changing, Funda says, with companies turning their attention to how e-commerce can improve the productivity efficiency of their operations. The switch to business-to-business (B2B) technology investment is currently underway, he adds, with the next step being a shift to “e-marketplaces” where groups of companies will collaborate on initiatives to find a common solution. “These solutions are more likely going to be driven by large distributors.”

Online sellers of insurance, whether they be insurers or agents, have not been successful in the U.S., confirms Bruce Marlow, president of 21st Century Insurance (regarded to be the most successful online seller in the U.S.).

The basic reason for this failure is that consumers have not been given a sufficiently compelling offer to buy online. “Consumers don’t see Internet products as offering value.” Which is not to say that the Internet is dead, he adds, “the Internet is not over with the bust of the “dot.coms”, all we’ve done is get rid of the hucksters. The Internet is about power, it’s about customer relationships.” In addition to inadequate “consumer value” in buying online, Marlow believes the biggest obstacle to advancing Internet insurance is that the technology is “simply not there”. Online technology applications are not up to what he describes as “industrial strength”, pointing out that they “do not deliver”. Until the technology catches up with the business concept, and someone finds a way to add value to buying online, “then we’re safe, at least until someone finds that ‘right’ consumer package,” he adds.

Marlow ca utions insurers looking to expand their distribution modes to the Internet. The cost of “channel conflict” can be crippling, he adds, with few companies having attempted to marry multiple distribution achieving the desired cost-savings and increased revenue stream. In fact, Marlow says, “my experience is that insurers embracing multi-distribution channels have simply created ‘sub-optimized’ environments”.