A New World of Opportunity
We live in a world of continuing crisis and upheaval in the physical world, economics, politics and social infrastructure â€“ a world of threat and uncertainty. The insurance industry thrives on managing risk and uncertainty, but only if it can use its skills to price the uncertainty. The International Insurance Societyâ€™s 47th Annual Seminar in Toronto, June 19-22, 2011 provided many examples of opportunities for the insurance industry to leverage todayâ€™s uncertainties into new business opportunities. Most of the seminar content is available for review on the IIS website.
We live in a world of continuing crisis and upheaval in the physical world, economics, politics and social infrastructure – a world of threat and uncertainty. The insurance industry thrives on managing risk and uncertainty, but only if it can use its skills to price the uncertainty. The International Insurance Society’s 47th Annual Seminar in Toronto, June 19-22, 2011 provided many examples of opportunities for the insurance industry to leverage today’s uncertainties into new business opportunities. Most of the seminar content is available for review on the IIS website.
Global Crises and Upheavals
Global markets have gone through major ups and downs as part of a gradual recovery from the 2008 financial crisis and response to the current European sovereign debt crisis. Some have blamed governments for doing too little to stimulate economic growth through monetary and fiscal policy. Others have blamed governments for doing too much by sheltering financial institutions, running large deficits and imposing regulatory and tax barriers to private growth initiatives. All accept that government must provide some fundamental market stabilizing services (e.g., enforcing property rights, defense). Debate continues on what beyond these basics makes government a supporter, not an obstacle to economic growth. Political polarization around these positions suggests that we are not close to a consensus, adding political and social uncertainty.
Part of this debate has to do with the role of global markets and governance and that of national markets and governance. From the end of World War II to the early 1970s globalization developed gradually under the Bretton Woods formula that allowed nations to impose what they considered important protections of national interests. Since the early 1970s there has been a rapid reduction in barriers to global market freedom, accompanied by significant economic growth, but also significant dislocations for many. Developed countries lost manufacturing jobs to China and other emerging countries. Millions were lifted out of poverty in China as it expanded its manufacturing-for-export strategy, supported by a policy of controlling its currency value relative to others. This was accomplished in part by China’s investment in U.S. and other government and private debt. Resulting easy credit contributed to expansion of debt beyond that which could be sustained, publicly and privately, particularly in the event of a major asset devaluation. The bursting of the housing bubble exposed the imbalances and excessive leverage.
We know that open markets are an important engine of economic growth. We also know that they have a long history of boom and bust. There is a tendency during boom times to believe, hopefully, that this time will be different. Each bust stems from a different set of conditions, but repetition of the pattern seems inevitable.
Growth of globalization has been fed in part of political liberalization. The insurance industry resumed an active role in foreign markets prevalent prior to World War I through the opening of closed country markets from the late 1980s. Asia, Eastern Europe, Latin America and the Arab World have allowed foreign companies to participate in national markets. In many country markets, the insurance business had been little developed. Nations struggled to leverage foreign company participation to develop local markets, with appropriate regulatory regimes. Efforts were made to coordinate insurance regulatory policy through the International Association of Insurance Supervisors (mid-1990s), paralleled in banking by the Basel Committee and in securities by IOSCO. As in other economic areas, debate continues on the proper content of insurance regulation to balance support for and obstacles to market development.
Uncertainty in political influences on markets remains high as countries and regions continue to evolve. The European Union struggles with individual member behavior and the proper role of the whole versus national interests. The sudden changes in Arab countries will require time to form predictable political environments.
Economic crises and political unrest have led to social concerns. Globalization aided millions of poor people in less developed countries but also caused significant job losses in developed countries, contributing to stagnant wages for the U.S. middle class, for example. These stresses have strained the social fabric in many countries, e.g., Iceland, Ireland, Greece, Arab Spring nations. Internal conflicts in other countries have occurred in the form of political polarization.
On top of these concerns is long term problem of climate change. The science seems clear that human activity, particularly since the industrial revolution, has contributed higher levels of greenhouse gases that result in global warming. What is less clear is the future course of these effects, in terms of long term impact on weather and sea levels, and on short term impact on weather patterns (e.g., drought, flood). Some deny the phenomenon as a political hoax, adding to polarization.
It doesn’t sound like a great setting for business opportunities. Fortunately for the insurance business it is in the uncertainty business, providing coverage against a wide range of potential bad outcomes. The challenge is to measure the probabilities and distinguish measurable and immeasurable risks.
The IIS Annual Seminar in Toronto in June 2011 offers a long list of opportunities (See www.iisonline.org/seminars/archive/toronto-2011/).
In “That Used to Be Us: How America Fell,” Thomas L. Friedman outlined four major challenges faced by the U.S. today – globalization, IT developments, deficits and debt, and energy and climate change. These points provide a useful framework for identifying insurance industry opportunities worldwide.
Steve Catlin, CEO of Catlin Group, spoke at the seminar of the importance of insurance as an essential element of most daily activities. Commercial activity of all kinds, bank loans, public events, transportation and many other basic requirements of modern life require insurance to cover potential loss to property, loss of life or limb, or loss due to liability. China offers particular scope for growth in insurance to support economic development. Also, insurance recoveries have allowed rebuilding after major natural and man-made disasters. The opportunities are endless. The challenges are to continue to improve risk assessment and management, foster professionalism and improve recruiting and retention of talent. (See Catlin video)
With a third of his business in each of Asia, U.S. and Canada, Donald Guloien, President and CEO of ManuLife Financial, sees the life insurance industry as a major stabilizing force, particularly in times of great uncertainty. Long term investments and long term guarantees offer comfort that future financial resources will be available. Growth in Asian middle classes and the rapid aging of the world population offer significant scope for industry growth, faster than GDP growth in developed and developing markets. Challenges include maintaining stable financials in face of regulatory pressures for mark-to-market measurement volatility. (See Guloien video)
Bhargav Dasgupta, Managing Director and CEO of ICICI Lombard General Insurance Company of India, noted insurance growth at two times GDP growth due to low penetration and government support (e.g., subsidies, tax advantages). The challenge is to improve operating skills and service quality. Wide dispersion of policyholders requires innovation in distribution and use of technology to manage simple, low cost policies, with low cost sales and service (e.g., use of biometric smart cards for health insurance. (See Dasgupta’s presentation)
Representing Oracle, Chuck Johnston, Vice President of Global Strategy and Alliances, described the wide range of technology tools now available to the insurance industry to increase information flow and to lower costs. Data management, rules-based operating systems, business intelligence and support for modeling and analysis add to industry capabilities to assess and manage risks. Systems also help to identify new kinds of risk (e.g., eco), overcome language and cultural barriers, understand market requirements and keep up with local regulatory changes. The challenge is to apply these new tools and capabilities and to bring them to bear tempered by the extensive practical experience resident in the industry. (See Johnston’s Presentation)
Energy and Climate Change
Although it is generally accepted that carbon and greenhouse gases are accelerating global warming, and that these trends are impacting current weather patterns, the timing and extent of impacts are less well understood. Rowan Douglas, CEO of Global Analytics for Willis Re, noted that the insurance industry has much to offer both to help improve knowledge and to provide guidance for before, during and after disaster events. Good analysis of potential damages can help to identify cost effective preventive measures to minimize damage during an event. Early warning procedures can facilitate actions to reduce exposure to damage. Post-event actions and analysis can mitigate much of the damage and prepare for future events. Public and private partnerships are needed to assure efficient preparation. The industry’s ability to weather recent large events has demonstrated improvements in risk assessment, capital adequacy and preparedness. (See Douglas video)
Retirement Savings and Income – Deficits and Debt
As aging increases the size of retired populations versus working populations, reliance on public pay-as-you-go pension plans continues to decline, along with a shift from employer-based defined benefit to defined contribution plans. Responsibilities previously assumed by governments and employers are shifting to individuals, for pre-retirement saving and post-retirement income generation and management. Yet, a large part of public expenditure, now and in the future, will continue to go for retirement income and health coverage, aggravating the deficit and debt problem.
Paul Kitson, consultant with Towers Watson, described these trends in the U.K. market and noted a continuing development of new products to meet the changing demand. He also noted the development of financial hedging and other tools to manage future guarantees in today’s volatile markets. (See Kitson video)
Having weathered the financial crisis well in Canada, Donald Stewart, CEO of Sun Life Financial, noted Canadian efforts to broaden access to pension plans when employer group plans are not available. A key to future success is education of individual pre- and post-retirees so that they are able and encouraged to make good choices about adequate savings and effective management of retirement income. (See Stewart video)
Principal Financial’s Chairman, President and CEO, Larry Zimpleman, described U.S. progress toward greater coverage of employees in retirement programs through automatic enrollment and improvement in funding vehicles. Nevertheless, many Americans have much less retirement savings than they need. Companies are broadening their savings vehicles and offering in-workplace education to encourage gap filling. There remains plenty of room for growth in retirement savings and income markets. (See Zimpleman video)
Industry Structure and M&A
Gregory Locraft, Executive Director of Morgan Stanley, described the current market for M&A in insurance. Low valuations and economic weakness make it difficult for potential sellers to get desired price levels and provide little equity currency for buyers. Growth and investment opportunities are problematic in today’s market. Share buybacks can be attractive now.
Pressures to capitalize on size and scope advantages are likely to support continuation of industry consolidation trends. Combinations should consider strategic fit, closeness to core strengths, profit accretion potential and the practical ability to combine organizations. (See Locraft video)
Telling the Insurance Story
As noted by Ludger Arnoldussen, Member, Board of Management of Munich Re, insurance is a complex business that is not easy to describe even to banking-oriented stabilization regulators. Accounting numbers are often not very useful. Recent efforts to make accounting and regulatory measures more business relevant may bring them closer to economic reality but remain difficult to follow. Movement toward an agreed global standard of measurement is valuable particularly for those attempting to work in multiple country markets. Effort must continue to find better ways to make the values and challenges of the industry more transparent. (See Arnoldussen video)
A perennial key issue in the industry is the state of industry regulation. In addition to regulatory policy, industry fortunes are heavily influenced by general economic conditions, financial market stability and political directions.
Canada’s Finance Minister, Jim Flaherty, outlined many of the reasons that Canada weathered the recent financial crisis well. Legal and social constraints in mortgage and financial markets limited the leverage that had built up in the Canadian markets. Partly a result of its recent success, Canadian financial officials have been active in international efforts to improve global financial market stability. The Canadians support efforts to bring global regulatory frameworks within a consistent set of principles. (See Flaherty video)
Julie Dickson, Canada’s Superintendent of Financial Institutions, provided a view of what is needed in insurance to minimize crisis potential. Strong, independent risk officers, robust stress testing, strong governance in companies, and well articulated risk appetite and tolerances were cited. Canada supports the International Association of Insurance Supervisors (IAIS), the global standard setter for insurance regulation, in its efforts to develop capital models, group supervision and global accounting standards to improve standards and avoid regulatory arbitrage. Key to success in any regulatory environment is the capability and quality of supervision supported by accounting, actuarial and management professionals. (See Dickson video)
In his recent book, Boomerang, Michael Lewis described the recent history of rapid successes and then rapid declines in Iceland, Greece and Ireland. In each case, historical cultural norms were reshaped to form an economic bubble, supported by global financial markets. As the economic activity became unsupportable, the implosion left each country in a position of having to rethink cultural norms and social structure. Similar cultural strains were cited in Europe’s tentative moves toward fiscal union and America’s political polarization.
In Reckless Endangerment, Gretchen Morgenstern related the various strands of financial market excesses and government policy that drove the failure of the housing and mortgage markets in the U.S. Similar kinds of cultural breakdown are cited as contributors to this story.
At the Madrid Seminar in June 2010, Ikuo Uno, Chairman of Nippon Life in Japan, described Japan’s “lost decade”. He warned against putting too much faith in the ability of markets to self-correct and for economic models to capture all relevant trends. In addition to reestablishing an appropriate balance between free market opportunity and government controls, Uno cited the importance of having company managements that exercise constraint with a focus on long term stability over short term gains. Integrity and prudence is needed. Adam Smith advocated free markets and limited government constraint but also assumed a natural order of individual initiative coming together for the common good. Aristotle suggested a golden mean of balanced interests. Uno’s message was to not ignore the moral dimension in business. (See Uno video)
So, much to worry about, but also much opportunity to pursue. History provides many lessons about how such opportunities might be pursued effectively. But, new twists can be expected both as new pitfalls and new success levers.
Part of the solution is to build into insurance institutions and practices an effective framework of sustainability. The Insurance Working Group of the United Nations Environment Programme Finance Initiative (UNEP FI) will present such a frame work – the Principles for Sustainable Insurance – at the 2012 UN Conference on Sustainable Development (Rio+20 Conference) which will overlap the 2012 IIS Annual Seminar in Rio. The PSI offer a global best practices framework to facilitate the systematic consideration of environmental social and governance risks and opportunities in core insurance company business strategies and operations, including risk management, risk underwriting, product and service development, claims management, sales & marketing, and investment management. A United Nations-backed global initiative of insurers will be formed to drive adoption and implementation of the PSI.
Plan on attending the IIS Rio Annual Seminar, June 17-20, 2012 to join in the continuing growth and sustainability discussion.
1. How have the economic crisis and aftermath affected insurance lines, e.g., higher claims, decline in sales, growth in sales, new products?
2. How has the experience in financial services affected the direction of insurance regulation? Is insurance regulation affected by mistaken assumptions about industry needs and norms, e,g., excessive restriction on the use of needed hedging facilities?
3. How will the recent experience change risk management practices in the industry?
4. Will problems in the derivatives markets reduce or change the use of capital markets for insurance activities?
5. What new market opportunities are created by the recent crisis?