Reg Morton considers insurance developments in the last decade of the current millennium and looks to what lies ahead in the early years of the new millennium.
“Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to” said the CatAlice's Adventures in Wonderland
In recent years the insurance industry has experienced unprecedented levels of merger and acquisition activity, and there is no reason to assume that things will slow down in the foreseeable future - unless, of course, Nostradamus proves to have been a few months out in his reckoning, and the feared Y2K disaster stops everything and everyone in its/their tracks (query whether the millennium bug could be, for insurers, the fabled “quadruple whammy” where (a) insured suffers loss as a result of problems in-house (b) failures of insured's clients and suppliers leads to insured loss (c) insurer has its own in-house problems to contend with and (d) reinsurer disappears or disclaims responsibility!).
The development of new insurance products and selling practices is also accelerating, with phrases like “alternative risk transfer” and “e-commerce” very much in vogue. While one hopes that readers of this issue will all be breathing sighs of relief about having completed their Y2K health checks, now is not the time for anyone to be resting on their laurels. Instead, the strategists will be trying to work out how best to maintain or enhance their position in the market over the coming years, in the face of the challenges ahead.
Consider the following developments in the last decade of the current millennium:
• Consolidation of the insurance providers. Some policyholders, particularly in personal lines business, could be forgiven for becoming paranoid about the constant name changes of their underwriters.
• Likewise, the merger and re-merger of the major brokers/risk managers. A few large multinationals with great purchasing power now dominate the market.• Demutualisation. What started off with building societies has now spread to life offices and to the P&I clubs.
• Direct selling of more and more insurance products. Telephone selling is now firmly established and branded selling, through major consumer outlets such as Tesco's, is on the increase. Selling via the internet and on digital television channels is a certain bet to take over the lead in the fairly near future.
• Lloyd's has resurrected itself with the injection of corporate capital, to the extent that the influence of individual Names is rapidly waning. While the increasingly small band of sophisticated individual Names will no doubt continue underwriting through Lloyd's, it seems likely that eventuall
y they will all do so through pooled corporate vehicles, whereupon the spectre of unlimited liability will have disappeared completely from the Lloyd's market.• The constant movement in the underlying regulatory environment. A steady stream of European Directives continues to develop the harmonisation of insurance practices throughout the European Community. Meanwhile, the UK insurance industry is about to experience the fruits of yet another revamp of our financial services regulatory system, in the shape of the Financial Services Authority and the new legislation promised for the middle of the year 2000.
• Against the background of all of the above, the underwriting cycle in many sectors is scraping the bottom, despite repeated attempts to talk it up. There have been preliminary signs of a possible recovery in recent months, but it is difficult to foresee an early substantial upturn with so much spare underwriting capacity in world markets, a capacity made ever greater by the use of alternative risk transfer products such as securitised catastrophe bonds.
In the passage quoted at the beginning of this article, Alice continued by explaining that she did not much care where she was going, so long as she got “somewhere”. The Cat advised her that she was sure to do that, if only she walked for long enough. Those involved in the insurance industry would be most unwise to adopt a similar attitude. In the real world, the need is now greater than ever to assess the implications of recent developments and to evaluate the threats and opportunities which lie ahead.
So far as premium rates are concerned, it may be that only a series of catastrophes will be enough to counter the effects of current market overcapacity. Even then, many insurers will find themselves unable to take advantage in the short term. The bargaining strength of assureds has led, naturally enough, to underwriters seeking to retain market share and quality clients by offering long-term policies for two or three years, or even longer. Insurers who have followed this practice will take time to catch up with the benefits of any general upturn in premium rates (especially if their policies do not contain loss review clauses).When a profits squeeze cannot be cured by increasing income, the obvious available alternative is to cut costs. It is this factor, more than any other, which has prompted the mergers and acquisitions of recent years, as companies seek to achieve economies of scale. At the top end of the market, the scope for such takeover and merger activity in the future seems greatest in relation to the insurance providers. One can anticipate a continuing stream of such deals as the big insurance companies become more and more globally orientated. In contrast, the large insurance brokers are likely to find that monopolies legislation constrains them from increasing their market share by acquisition, so they may need to concentrate on organic growth. Further down the scale, however, the desire/necessity to consolidate back offices and reduce costs will drive the smaller and medium sized companies into corporate deals.
The search for economies of scale is by no means the whole explanation for all of this activity. The strategic thinkers in the market are looking ahead to what most agree will be the main challenge for the early years of the new millennium, namely the technological revolution which goes under the name of e-commerce. Although the development and set-up costs will be daunting, the result will be a massive overhaul of the industry's marketing, selling and servicing processes. While this is something that the market as a whole will need to get to grips with, the prize available to the big brokers and underwriters will be the ability to stay ahead of the game (and put further distance between themselves and the rest) by investing in the relevant technology. It is axiomatic that the large organisations will be best placed to come up with the required funds - with considerable help from the capital markets - and thereafter to reap the benefits.
The advantage of ready access to the capital markets can easily be appreciated and it is to be expected that this will encourage more and more mutuals to abandon their status - although the continuing pressure from members of the carpetbagging industry would doubtless be enough, in itself, to achieve this result eventually. One can look ahead to a time in the not too distant future when the UK building society and life assurance industries have become totally demutualised.The P&I clubs are considerably more likely to retain their existence as mutual organisations, operating in a well-defined sector of the market, although they too will cast envious eyes at those who can turn to the capital markets to finance technological development. The 10 year exemption from European anti-trust rules recently granted to the International Group Agreement, which lasts up until April 2009, has certainly taken the pressure off for the time being. The main challenge for the P&I mutuals in the near term will be to withstand the competition presented by the growth in the fixed premium marine insurance market. Many predict that this will result in further downward pressure on rates, which in turn could lead to casualties in the market, or at least encourage more of the players to merge or demutualise.
What else lies ahead in the early years of the new millennium? How about the following shopping list:
• The distinctions between Lloyd's and the corporate insurance market become increasingly blurred, although Lloyd's access to its worldwide network of insurance licences ensures its continuing separate existence.
• E-commerce forces brokers to focus on their role as risk management consultants and to abandon some of their traditional functions (for example, claims processing) in favour of specialist companies. In the risk management consultancy field, there will be an interesting battle for position between the brokers and the large accountants.
• Talking of battles, the rationalisation of investors' compensation schemes will spawn endless debate and argument. While banks and building societies will not be keen to help pick up the pieces of failed insurers (and vice versa), the logic for moving towards a single scheme, covering all the players in the financial services industry, becomes more and more compelling the closer one gets to the “true” harmonisation of standards.
The overall conclusion must be that the considerable corporate activity of the last decade is well set to continue throughout the next. There are many more years over which corporate insurance lawyers will be able to demonstrate that talk is not necessarily cheap!
Reg Morton is a partner in Ince & Co, a leading insurance and reinsurance law firm. Mr Morton specialises in corporate and regulatory advice for the insurance market and his clients include Lloyd's agencies, insurance brokers and insurance companies.