There is an old joke in which a man is observed throwing screwed up pieces of paper out of the train window. It's to keep the elephants away, he explains. But there are no elephants. See, he retorts, it works!
No one will really know whether the millennium bug was a real risk that only a flurry of information technology (IT) activity over the last few years of the century averted or a preposterous confidence trick by computer manufacturers. Whatever, most involved in the insurance industry went to bed on 31 December 1999 concerned that what would greet them the next morning would be somewhat more chaotic than a few empty champagne bottles; and 2000 will go down in most insurance memories for the claims that were never filed.
Not, of course, that there were insufficient claims at that time to worry about. The storms which blew through France and neighbouring countries in the days after Christmas created quite a problem for the industry, not just because of the size but also the timing. The holiday period created delays and, anxious to maintain their results announcement timetables, many re/insurers seriously underestimated the size of the problem. The correction of these underestimates has been a significant feature in results in 2000. Indeed, so light has 2000 been for catastrophes that, until the floods of recent weeks, the over-run of storm losses from these and the early December Danish storms were the year's most significant catastrophe item.
But perhaps the most striking event for the European insurance industry of last Christmas was the announcement, two days before Christmas Eve, by Hans Eichel, German finance minister. The total abolition of the taxation of capital gains by German companies was, to most observers and the companies themselves, a completely unforeseen event. After a period of disbelief - only weeks before, Eichel had abandoned plans to raise the tax on life insurance - German insurers reacted with understandable enthusiasm. After all, their balance sheets were full of long-standing investments that, thanks to time and hyper-inflation between the wars, had a negligible cost. Their sale would have involved over half the proceeds being paid in tax and, as a consequence, they were never sold. The consequent ossification of German corporate finance has been much complained of and there is no doubt that to address this by abandoning a tax that was never paid was a justifiable move.
However, it does pose some challenges for German insurers, mostly on what to do with their new-found freedom. Allianz, which had recruited a suspiciously appropriate new finance director in 1999, argued it would use its stakes to create value. Some idea of what it meant came in March when it tried to engineer the merger of Dresdner and Deutsche Bank, in which it held stakes of 22% and 5% respectively. Allianz shareholders were delighted when they saw how the proposed terms awarded generous prizes to them. Deutsche's shareholders, however, were rather cross and the deal collapsed in acrimony.
This has not been an easy year for corporate finance in insurance. Generali finally completed its acrimonious battle for control of INA but the only significant merger completed was that of the UK's CGU and Norwich Union. Even disregarding the appalling name, CGNU, this was not regarded as an inspiring move, particularly when it was justified as creating a British national champion for the insurance industry by the group's chairman (a Swede) and its CEO (an Australian). One clear problem was that, apparently to satisfy the sensibilities of NU's board, the merger document announced that CGU's US non-life business would be sold. With its asbestosis-related exposures, this was never going to be an easy task and, approaching the bottom of the US cycle, the timing looked dreadful. Ominous silences through the summer prepared investors for the worst and, when it came, the price was as bad as had been feared. Moreover, NU's board had quickly spotted that CGU's US business was not the only repository of nasty long-tail exposure. News of a massive £1bn reinsurance of its London market exposure and the sale of Marlborough Underwriting, the Lloyd's business into which the ongoing business had been injected, duly followed. Interestingly, the counter-party of all three transactions was Berkshire Hathaway.
The only other significant merger in 2000 was that of the two parents of the Zurich group. The original idea of two listed vehicles - one in Switzerland and one in the UK - did seem a neat solution to a number of problems when Zurich originally merged with BAT's insurance businesses in 1998. The problem was that 1999 saw both shares substantially underperform, led by the UK-listed one. There seemed no mystery in this: while Swiss investors had grown to regard Zurich as a wonderful business and rated it accordingly, the new investors saw only an underperforming non-life insurance business whose financial returns were only held up by realised investment gains that were rapidly being exhausted. Increased disclosure, reluctantly provided for the 1999 profits, only confirmed this. Divergent views created divergent demand and, thus, divergent share prices. However, Zurich decided to shoot the messenger and 2000 saw the three entities merge to form one, listed back in safe old Zurich.
Another group of deals were primarily tidying up operations. Sun Life & Provincial's shares had never really recovered from the GRE deal in 1999, in which SL&P's parent, AXA, seemed to do rather better than SL&P. AXA is not noted for its generosity but, clearly, a quoted minority is only useful if it has highly regarded paper to issue and AXA duly put the SL&P minorities out of their misery with an offer which just passed the test of decency. Later in the year, AXA offered to buy the minority in AXA Financial in the US. This is the former Equitable Life, a mutual that AXA “rescued” in 1991 and, under AXA's ownership, it has recovered to be a substantial, profitable and valuable US life insurer. Predictably, there was a tussle over the price, particularly since AXA had concurrently announced the sale of one of Equitable's successful investments, the investment bank Donaldson, Lufkin & Jenrette (DLJ) for a cool $12.5bn.
There was a US flavour to deals elsewhere, which included two US life insurance acquisitions by ING, the insurance and banking group. Whether inspired by the general adulation heaped on fellow Dutchman AEGON for its substantial position in this market (increased in 1999 with its purchase of Transamerica) or goaded into doing something with its pile of excess capital, ING has certainly made a bold statement. The acquisitions of ReliaStar and Aetna's life business will, for $12.8bn, catapult ING from its modest position to number three in the US life and annuity market, with strong positions in all the major product areas.
As most understand, investors far prefer life insurance to non-life because of the growth trend and the relatively stable earnings. Particularly interesting is Europe because falling birth rates mean that governments are going to need to massively encourage savings for pensions before over-generous state schemes overwhelm their finances. However, quite why European insurers are ignoring the enormous potential of their own markets and expand in the US is a mystery to some observers, notably those in the US.
The explanation is certainly valuation. Most insurers would like to get into the Italian life market but the price of entry is high. Royal & SunAlliance recently sold its Italian life operations, because it did not feel they had great prospects, at around ten times net assets. Aetna's business cost ING around three times. The US may not have an over-generous state pension scheme but many Europeans believe that most of the other growth parameters are just as valid. Moreover, profit margins are as high as in many European countries. US investors, on the other hand, cannot believe the prices that the Europeans are prepared to pay. One US life insurer, which would like to expand by acquisition, has threatened - only half jokingly - to relocate its head office to The Hague so that it can have the highly valued paper to compete with AEGON.
Prospects in the US life market have certainly been one area of debate among European insurers, none more than for the once high-flying Swedish insurer, Skandia. This group's US life subsidiary has grown so fast as to now dominate the group and its vestigial non-life business had become an irrelevance. In 1999, it pooled its business with fellow Nordic insurers Storebrand and Pohjola to form the bizarrely named “If...”. All seemed to be going well but, late last year, Pohjola was involved in a tussle for control and, in March, changed its mind and pulled out of the “If...” deal.
Almost as soon as Skandia decided to focus on its US life success, doubts started to emerge about it. For the first half of 2000, Skandia caused a fright among its shareholders by announcing that its sales had risen by 78%. The problem was that sales had risen by 118% in the first quarter and so were only up by 47% in the second. While hardly a disaster, this is a highly valued share and most understand that Skandia's success in the unit-linked life market is very sensitive to stock market confidence. Its primary product is a life/pension policy where the policyholder selects what investment manager he wants for his money and can switch at will. In the hi-tech boom of 1999 and the first quarter of 2000, Americans - and Britons, Italians, Swedes, Colombians and, even, Japanese - were frantically buying Skandia policies so that they could punt the latest fashionable mutual fund with their policy.
Understandably, when the dot.com bubble burst in March, so did the confidence of all those investors who had become used to share prices only going up. Apart from Skandia, the only concern this brought in the insurance sector was for Prudential, which had planned the flotation of its internet bank, Egg, to ride the dot.com fever and transform its own dull image. By the time the prospectus was published, however, the shine had gone out of this and, while the flotation did go ahead, Prudential did not join the list of dot.com millionaires as it had hoped.
In general, however, the bursting of the stock market's enthusiasm has been positive news. Prior to March, insurers had been seen resolutely as part of the “old economy”, destined to be wiped away by the e-commerce revolution. Not only were insurance shares ignored but, desperate to prove that this was not the case, every insurer felt it necessary to explain to its shareholders how much they were part of the e-commerce revolution and how good their strategy was. This author sat through a number of presentations, complete with slides with incomprehensible boxes and arrows. They all looked as though they were written by the same management consultant - and they probably were.
Since the end of March, however, matters have improved. In fact, insurers will benefit from e-commerce but not, of course, in the simplistic ways that were imagined last year. Many companies are investing wisely and it remains the case that, as a product that does not need to be put in a truck and sent round the M25, financial services will change.
The final and most important question about 2000 is, perhaps, the one that cannot be answered yet. Will it have proved the “bottom of the cycle”? In many markets, prices started rising in 1999 and there is powerful evidence that 2000 saw this trend accelerate. Most areas of the reinsurance market experienced this. In direct markets, the US has seen a significant upturn in commercial lines pricing in 2000 and, in the UK, this seems to be the case too, adding to the strong rise in personal motor rates that has been a feature since the end of 1998. In other markets, however, trends are less clear. In France, rate rises are patchy and, while rates have risen in Italy, the government's price freeze on motor rates may see results fall back. Germany, perhaps, is the most worrying market, with no sign of action in commercial lines at all and precious little in motor despite very poor results. Many fear that Germany is going through a tariff break-up change, much as the UK did in the early 1970s.
The bottom of the cycle, however, is the year of the worst results. This is typically the year after rate rises start and there is evidence from the US that 2000 is seeing the deterioration in results, centred on back-year issues, that characterises the trough. In reinsurance, however, there simply do not seem to have been enough catastrophes. There are still a few weeks before the end of the year but some think that it might have been better if the millennium bug had bitten, just a bit.
Chris Hitchings is an investment analyst, specialising in the European insurance industry, with Commerzbank Securities in London. He has spent most of his career as an analyst of the insurance industry, previously with UBS Phillips & Drew and Hoare Govett.