Michael Laporta, Owen Ryan and Chris Gentle see polarisation, optimisation and innovation as the key factors for the success of re/insurers into the future.
The early years of the new millennium have proved to be extremely eventful for the re/insurance industry, and the coming months will see continuing volatility - both inside and outside the industry. The majority of players have continued to post, at best, lacklustre profits in recent years, culminating in the catastrophic losses of 2001. The terrorist attacks in September last year, combined with natural and man-made disasters, have put extreme pressure on the industry's capital and have raised questions as to how re/insurers will meet these new challenges. The future does not look particularly reassuring for many re/insurance players; only those businesses that optimally align their business with future trends and don't repeat the mistakes caused by past market cycles will survive and prosper in the future.
The industry has seen an increase in the level of competition and a flood of capital into the market, which has moderated otherwise steep price hikes. In general, the market has seen a divergence in fortunes between those players that have struggled after the events in September 2001 - witness Japanese insurer Taisei Fire & Marine Insurance Co which collapsed - and those that have benefits from the so-called `flight to security'.
In the meantime, a handful of players have forged ahead and made the most of their strong balance sheet positions and credit ratings to accumulate significant revenue streams. A steep rise in prices, coupled with companies reassessing their insurance needs in the wake of the events of late 2001, is expected to translate only into only modest profits for the majority over the next couple of years. Market leaders can expect bumper revenues in the near term, but the good times won't last long. It is critical, therefore, that they adopt a two-pronged strategy for the future - understanding market trends and thereby maximising profitability, while planning and investing for the future by optimising business operations. Let us turn first to optimising business operations. Re/insurers need to place a greater emphasis on their business processes, optimising their current operations - sweating the assets more effectively. On every board agenda should be a more fundamental issue: can we optimise our current business model or do we need to reengineer our operations to be more efficient and effective? Over the coming months we anticipate a further polarisation within re/insurance between the global giants and specialist operators.
The trend towards consolidation and the creation of a handful of large diversified re/insurers offering products and services across the range of industries and risks will continue. Equally expect to see a continuing shift away from the middle in the other direction, with the growth of specialist risk providers. These companies will thrive on the growing complexity of risk, offering innovative and specialist products focused around specific niches. Several factors will be key to reconfiguring business models in 2002.
First, investors and customers alike will demand access to financial information in real-time. In addition, there will be greater pressures to clarify the audit trail of how large risks have been underwritten. Indeed, as re/insurance firms respond to a world where the customer is king, a key enabler of success will be a transparent business. Re/insurers need to build translucent straight-through business processes based around interoperable technology platforms. Building such a transparent firm requires a complete overhaul of information technology infrastructures and business processes. A handful of leading firms are already adopting see-through business models based around open-standard financial accounting and technology systems; increasingly these standards will become the industry norm.
Innovative risk techniques
Next, successful re/insurers will utilise innovative tools to manage their risks and re-allocate capital. The effective management of capital has never been more important for re/insurers. Around the globe, re/insurers' financial strength has weakened due to a combination of jittery markets and low interest rates. Many firms' balance sheets are under severe pressure, with falling solvency levels focusing attention on optimising the allocation of capital across the business activities. Expect re/insurers to focus on enterprise risk management (ERM) and utilise innovative tools such as dynamic financial analysis (DFA) and stochastic modelling to uncover vital information on the risks within different parts of their business and optimise the allocation of capital accordingly.
Finally, re/insurers are likely to usher in a `new' world of M&A transaction. The fundamental transition of many financial services markets means that the traditional insurance value chain will continue to fragment. Many re/insurers will focus on specific parts of the value chain, and many will shift from absolute size to building scale in particular industry sectors such as oil and gas, or particular operational capabilities such as advisory services for assessing and pricing specialist risks.
As a result, re/insurers are likely to reconfigure their business models focusing on core competencies, and divest non-core operations.
In meeting this challenge, re/insurers are likely to use a range of corporate transactions. Traditional M&A strategies have not always yielded the income and cost benefits promised, often arising from clashes of culture between the two organisations. The future will see successful organisations optimising a portfolio of transactions from joint ventures and asset swaps through to mega-mergers from the old days. Also expect to see more transactions around newer re/insurers established with private equity funding over the last couple of years. Investors will be looking for exit strategies in the next two years, precipitating more corporate activity.
Whichever end of the industry spectrum the re/insurer decides to head, the key to future profitability will lay in aligning the business with future trends in the market environment. The following are key market trends to watch for in 2002.
First, retirement planning is a golden opportunity for life insurers as shrinking workforces, people living longer and PAYE systems malfunctioning drive a shift from public to private pension providers. Much of the world still looks to the state to fund the majority of the income for those individuals that have reached retirement. But this will change. The ability to exploit this golden opportunity will be a key differentiator between winners and losers.
In an attempt to survive, life insurers will continue the trend of `morphing' into retail financial services companies as they offer a greater variety of asset accumulation products and adjunct financial services. Reinsurers need to be aware of the likely changes this will bring in the types of business coming to market. The shift to long-term investment-type products will result in a corresponding move away from traditional life protection premiums although the US market has seen a significant surge in life insurance business since September 11. Reinsurers need to be aware of the potential softening in demand for life products and should look at opportunities to provide capital to the life insurers to aid them in broadening their risk base.
In addition, the so-called `death of inflation' will have massive implications for re/insurance companies. A world of unrelenting pressure on prices, plus falling bond yields and equity risk premiums, and potential deflation will greatly impact both reinsurers and insurance companies. Successful reinsurers will need to develop fee-based income streams based around pricing and risk assessment to supplement falls in investment income.
Finally, all these trends raise the key question: Who pays for insurance? The litany of natural and man-made disasters that have ushered in the new millennium has conspired to place new pressures on the insurance, and particularly the reinsurance industry. Can the reinsurance business survive as the size, predictability and global nature of risk continue to develop beyond rational expectations? Tough decisions will have to be made around policy exclusions, sector coverage, pricing risk and the adoption of new fee-generating skills. Most reinsurers will mutate and survive, but reinsurance markets are likely to look very different.
The reinsurance industry has gone through some difficult times in recent years. The future environment promises to be equally complex and volatile. Only those reinsurers that better optimise and even reconfigure their business models will survive and prosper. Regardless of business model, this will mean reinsurers need to focus on building straight-through processing of transactions for insurance customers. It will also mean packaging products with additional value-added services such as (online) real-time information on risks, research on the latest trends and issues facing key industrial sectors and tailored advisory services. Amongst many uncertainties one thing is sure; the future will not be very reassuring.
By Michael Laporta, Owen Ryan and Chris Gentle
Michael Laporta is Global Insurance Practice Lead at Deloitte Consulting, based in Stamford, US, Owen Ryan is US Managing Partner (Insurance), Deloitte & Touche, based in New York City, US, and Chris Gentle is Director (Europe), Deloitte Research, based in London, UK.
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