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Insurance Industry


Major Industry Trends

The insurance sector is highly cyclical. Enormous sums can be lost when a series of weather-related catastrophes go against the sector. On the plus side, catastrophes—or even serious weather damage—serve to remind people that they can’t do without insurance. So the industry is able to make up its losses during the course of the next few years as insurance companies recover by raising their premiums. That increased pricing power in turn brings large amounts of new money into the sector, which initiates a new round of price competition and a fading of insurance company profits as premiums diminish under competitive pressure. The cycle is repeated over and over, which some have argued ultimately means that the sector is not really bearing risk, since—with a one- or two-year time lag—losses are foisted off on to clients and the market in general through higher premiums. These switches are labeled a “hard cycle,” when insurance companies can get a “fair price,” and a “soft cycle,” when price competition drives down premiums.

In a briefing to the market at the end of 2013 Swiss Re, the world’s second largest reinsurer, was optimistic that 2014 held out real promise of growth for the global insurance sector. The brightest signal for the sector, it said, stems from the fact that global growth should continue to strengthen through 2014: “This will support on-going premium growth in the non-life primary market, particularly in emerging markets, with reinsurance premiums following suit.” The reinsurance sector uses its capital and access to the capital markets to underwrite positions which major insurance companies want to move off their books. As such, it provides a vital additional source of funding for the insurance sector.

Swiss Re expects premiums in the life market around the world to grow by some 4% year on year in both 2014 and 2015, with this growth coming mostly from emerging markets. Latin America, for example, saw premiums grow by 18% year on year in 2012 and by a further 10% (estimated) through 2013. Although the Middle East and Africa have seen some turbulent times through 2013, the stable countries in the region are seeing premiums grow at around 5%, albeit from a low base. However, Swiss Re expects premium growth in advanced markets to contract somewhat. New capital from alternative sources continues to flow into the insurance sector, putting pressure on prices and margins, particularly in the US catastrophe business, it says.

The insurance sector faced a heavy bill in 2013—though less than the preceding year, when the global insurance payout totaled some US$81 billion. According to a press release by Swiss Re about its forthcoming “sigma” publication, “Natural catastrophes and man-made disasters in 2013” (for link, see Websites at end of article), events of these two types together caused an economic cost of some US$130 billion in 2013. Of that, the insurance sector faced US$44 billion worth of loss payouts. Some US$38 billion of the payout was due to natural disasters, while US$6 billion was paid out for manmade disasters. The major headline event was undoubtedly Typhoon Haiyan/Yolanda hitting the Philippines with some of the strongest winds ever recorded, along with a 4-meter tidal surge. The typhoon caused 7,000 deaths, the single largest loss of life attributable to a natural disaster in 2013.

Europe did not escape unscathed in 2013. In June, flooding affected large areas of central and eastern Europe, causing economic losses totaling some US$18 billion, with insured losses amounting to US$4 billion. The June flooding was the second most expensive ever recorded by Swiss Re, although it runs a distant second to the Thailand floods of 2011, which led to insured claims of more than US$16 billion. In addition to floods, Swiss Re notes, parts of Europe were hit by hail and windstorms. Hailstorm Andreas, for example, wreaked havoc in Germany and France in July 2013, resulting in insured losses of US$3 billion.

Apart from the weather and its impacts, the insurance sector faces some major trends and challenges. These are summed up in a recent report by accountants PricewaterhouseCoopers (PwC) as demographic shifts, the rise of emerging markets, and changing customer behavior largely driven by social networking and technology changes. These trends affect all three major business areas (personal, commercial, and life, annuity, and retirement) for the insurance sector. The whole sector is going to have to face the fact that growth in the major advanced economies is likely to be slow, particularly by comparison with emerging markets. What insurers operating in emerging markets need to do is to find ways of reshaping some mainstream advanced market insurance products for their own particular markets.

At the same time, social trends are changing and are shaking up traditional business patterns in the insurance industry—very much to the benefit of the customer, PwC says. Instead of going through brokers, for example, customers are showing an increasing preference for dealing directly with insurance providers if the right Internet-based or telephone channels are available. This is driving a switch to insurance products being bought by customers rather than being sold by brokers and agents. The shift to mobile and online shared social networking sites is another factor that has to be coped with. “Leading insurers will get better at targeting customers and customising product and service attributes to meet their specific needs,” PwC says.

As consumers become ever more comfortable with social media such as Facebook and Twitter, social networks are likely to foster some dramatic changes. For a start, customers are increasingly likely to use their social network as a way of testing a particular insurer’s credibility, so insurance companies have to find ways of marketing to social networking sites in order to promote their own reputation and avoid or neutralize harm.

At the same time, improvements in technology will enable the leading insurers to get better at targeting customers and customizing their product for each and every one of their client base. Eventually, the online social networks could turn into pooling mechanisms for self-insurance, PwC says. This will change the role of insurers at a primary level from product manufacturers to administration service providers.

A cluster of technological developments has helped the insurance sector to achieve much greater efficiencies in the last few years. PwC identifies the key developments as: the growth in smart phones and tablets, which provide constant access to the Internet; the massive increases in computing power and storage available to companies, which makes it possible to analyze huge amounts of data to spot trends; and the growth in active sensors and devices connected to the Internet. On this last point, on top of the fact that commercial insurers are already looking to connected devices and sensors to develop risk and loss management systems, life and health insurers are increasingly targeting “smart” devices as well. The medical service and treatment model is evolving toward the customization of health care. Personalized medicine and highly customized health care offer the sector a way of containing costs as longevity continues to improve. There are some profound ethical issues here that the sector will have to grapple with as there is an obvious perceived unfairness in any movement toward using people’s genome profile to assess their risk profile from an insurance standpoint. Disadvantaging whole groups of people on the basis of their genetic makeup is a profoundly repugnant notion to liberal democratic societies, so the sector will need to exercise extreme caution in negotiating this minefield, despite the fact that there are clear parallels, from a statistical risk perspective, between finding a strong genetic link with, say, a disposition to breast cancer and building on a flood plain versus building on a hill.

Interestingly, despite the sense that we are seeing an increase in major natural catastrophes, possibly associated with global warming, the risk that insurers themselves most prioritize is the risk posed to their business models by regulatory changes. Without doubt, this reflects the global industry’s dissatisfaction with Solvency II, the major form of regulation being faced by the sector as regulators seek to prevent another meltdown such as the US$188 billion loss suffered by American International Group (AIG), which had to be bailed out by the US taxpayer and was one of the first casualties of the 2008 financial crash.

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Market Analysis

There are at least three serious risks which the insurance sector is grappling with and which will shape the industry and determine its fortunes over the next decade. These are, in no particular order: climate change and the risk of increasing numbers of extreme weather events; longevity risk; and regulatory risk. All are serious, and any one of them is capable of sinking an unwary insurance company.

Longevity

In a report announced in August 2013 (and published in December of that year) the Joint Forum, which represents the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSC), and the International Association of Insurance Supervisors (IAIS), pointed out that aging populations pose serious social, political, policy, and regulatory and supervisory challenges in many countries, particularly in the West. Longevity risk—the risk of paying out on pensions and annuities for longer than anticipated—is significant and needs to be taken seriously, the Joint Forum warns.

The sums involved are staggering. Estimates of the total global amount of annuity- and pension-related longevity risk exposure range from US$15 trillion to US$25 trillion, and pension funds the world over are keen to transfer this risk—wherever economically possible—to the insurance sector. This represents a huge business opportunity, but also a huge risk that needs to be properly managed, the Forum warns. Regulators need to be vigilant against allowing regulatory arbitrage. They—and senior insurance company management—need to understand the risk exposure involved in taking on longevity swap contracts, and policymakers need to be clear about where such risks are best placed and who is best equipped to handle them.

Regulation

PwC points out that Solvency II negotiations were under way at the end of 2013 and that there appears to be a strong political will to achieve a conclusion to the deliberations relatively soon. Agreement is emerging on how to calibrate long-term guarantees offered by the sector and to factor these into the capital adequacy requirements laid down by Solvency II. The European Insurance and Occupational Pensions Authority (EIOPA) has released guidelines for regulatory supervisors to follow with effect from January 2014, despite some existing uncertainties in the capital adequacy regime. National supervisors can be expected to start enforcing the governance, disclosure, and risk management procedures in Solvency II from early in 2014. So the year ahead looks to be a fraught and busy one for the sector as it struggles to bring its IT infrastructure and processes into line with the spirit of the regulations.

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Further reading on the Insurance industry

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