Slide 1

Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 Lecture for Nottingham University Business School Current trends and challenges in the global insurance industry Kurt Karl Swiss Re Economic Research & Consulting New York, February 11, 2002 Slide 2 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 2 Agenda Long-term trends Profitability and the cycleProfitability Liberalization / Consolidation / ConvergenceLiberalization Reinsurance marketsReinsurance Slide 3 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 3 Global premium volume growth is accelerating, after years of slow growth Source: sigma No. 6/2001 Slide 4 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 4 The average premium growth in emerging markets is nearly twice as high as in the industrialised countries Average: 8.6% Average: 4.7% Real growth rates in % Source: sigma No. 6/2001 Slide 5 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 5 Global premium income 2000: the industrialised countries dominate Source: sigma No. 6/2001 Slide 6 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 6 Motor has the highest share in the European Non-Life market Western Europe 2000 Slide 7 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 7 Non-life insurance: Premium growth is recovering from the soft market Real growth rate in % Source: sigma No. 6/2001 Slide 8 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 8 Life premium growth: another boom year Real growth rate in % Source: sigma No. 6/2001 Richard MacMinn: Is much of this growth due to demographic changes? Will changes in state provision or support of pensions alter this pattern? Richard MacMinn: Is much of this growth due to demographic changes? Will changes in state provision or support of pensions alter this pattern? Slide 9 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 9 The twelve most important countries of the global market by business share 2000 Source: sigma No. 6/2001 Slide 10 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 10 Non-life insurance penetration: higher income levels boost insurance demand Premiums in % of GDP GDP per capita in USD Source: sigma No. 6/2001 Richard MacMinn: How well positioned is the industry to manage the growth in coverage that must be expected in the emerging markets? Richard MacMinn: How well positioned is the industry to manage the growth in coverage that must be expected in the emerging markets? Slide 11 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 11 Life insurance penetration: income, taxes and social security systems make the difference Premiums in % of GDP Source: sigma No. 6/2001 GDP per capita in USD Slide 12 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 12 Conclusions Growth in insurance premiums has begun to accelerate after a long soft market. Life premiums are increasing more rapidly than non-life premiums. Premiums in emerging markets generally rising more rapidly than in industrialized countries. Insurance premiums rise more rapidly than income. Hence, premiums as % of GDP rises as per capita income grows. Life is more income elastic than non-life insurance, particularly above USD 10,000 per capita. Richard MacMinn: How price elastic is the demand in some of the emerging markets? Richard MacMinn: How price elastic is the demand in some of the emerging markets? Slide 13 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 13 Agenda Long-term trends Profitability and the cycle Liberalization / Consolidation / Convergence Reinsurance markets Slide 14 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 14 The main questions What are the main drivers of profitability in non-life insurance? How important is investment activity as a driver of profit, capital funds (leverage), and volatility? What patterns are there to the insurance cycle, in length and between countries? What underwriting result is necessary to achieve an average economy-wide ROE? Slide 15 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 15 Insurance companies generally lose money on underwriting Combined ratio = 100 x (losses + expenses)/ net premiums, 100 x (UWL + UWE)/NP Combined ratio is typically > 100 Negative underwriting results (= NPE - UWE - UWL) Particularly true for long-tailed lines (e.g. liability) Insurance companies make virtually all profits from investing premiums before making actual loss payments Profitability Slide 16 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 16 Insurance pricing cycle is determined by flow of capital into and out of the industry Surplus (assets less accounting liabilities for unearned premiums and unpaid claims) rises and falls for variety of reasons Large losses Capital flows out Prices rise in the insurance industry Capital flows in Bull stock market, asset values rise, surplus rises Profitability Slide 17 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 17 Net investment result in % of net premiums Source: Economic Research & Consulting Investment results have grown increasingly important for profitability. Slide 18 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 18 Source: Economic Research & Consulting in % of net premiums Rising reserve ratios... Slide 19 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 19 Source: Economic Research & Consulting in % of net premiums... have increased asset leverage. Slide 20 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 20 forecasts Source: DRI-WEFA Consumer price inflation, % Stable inflation outlook after a decade of decline... Slide 21 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 21 forecasts Source: DRI-WEFA Long-term interest rates, %... drives down long-term interest rates. Slide 22 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 22 Source: Swiss Re Economic Research & Consulting Expenses in % of net premiums No general trend towards lower expense ratios Slide 23 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 23 Source: A.M.Best Underwriting result in % of net premiums US: Underwriting results show a strong cyclical pattern. Slide 24 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 24 Sources: A.M.Best, Swiss Re Economic Research & Consulting in % Asset-induced changes in surplus: US 1968-2000 Capital Constraints Cycle in the U.S. Slide 25 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 25 in USD billion, at 2000 prices Source: Swiss Re Economic Research & Consulting ? 9/11 losses compared to global cat losses Slide 26 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 26 hard market reinsurance Fresh capital in % of surplus Sources: A.M.Best, Swiss Re Economic Research & Consulting Figure 2 Fresh paid-in capital comes into the market after major catastrophes Slide 27 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 27 Source: Swiss Re Economic Research & Consulting Operating result in % of net premiums Underwriting cycles correlated across major markets. Slide 28 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 28 Conclusions High investment returns of the 90s lead to a soft market and more asset leverage. The future investment outlook is uncertain. Underwriting results follow a cyclical pattern with an average length of about six years. These cycles are increasingly synchronized across countries and to some extent across lines of business. Insurance prices are improving, but more needs to be done. Combined ratios need to improve by at least 7-14% to return to average profitability. Slide 29 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 29 Agenda Long-term trends Profitability and the cycle Liberalization / Consolidation / Convergence Reinsurance markets Slide 30 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 30 Liberalization is a worldwide trend: recent major changes that affect insurance markets DeregulationConvergenceCapital market and opening upenvironment of borders USAbolition of the GlassGlass Steagall ActAct EuropeThird DirectiveIntroduction of 1994the Euro 1999Euro JapanBig bangBig bangBig bangBig bang 1996-20011996-20011996-2001 AsiaWTOWTO Slide 31 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 31 Deregulation and liberalization: A competitive mapping of the global insurance markets Market access (de facto) Insurance regulation (de facto) Hong Kong USA European Union Singapore Japan IndiaChina Poland Argentina Taiwan Philippines price & formsolvency easy difficult Malaysia Mexico Russia Czech Rep. Thailand Slide 32 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 32 Types of mergers and acquisitions Within one country Between insurers Across Sectors Across Countries CNA - Continental (95) Travelers - Aetna (96) Axa-UAP (96) Commercial Union - General Accident (98) CGU - Norwich Union (00) Credit Suisse - Winterthur (97) Travelers - Citicorp (98) Lloyds TSB - Scottish Widows (99) Allianz - Dresdner (01) Munich Re-HypoVereinsbank (01) Allianz - AGF (98) Zurich - BAT (98) Aegon - Transamerica (99) ING - Aetna (00) Swiss Re - Lincoln Re (01) ING - Barings (95) Zurich - Scudder (97) AXA - Sanford Bernstein (00) Allianz - Pimco (00) Slide 33 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 33 Value proposition and potential rationalizations for the four types of M&As: Within one country Between insurersAcross sectors Economies of scale linked to costs are the main motive. Cutting distribution networks and administrative functions (rationalization), including information technology and risk management areas. Economies of scope through cross-selling are key motives. Risk and revenue diversification. Optimum use of complementary distribution networks. Rationalizations with administrative functions may offer economies of scale. Domestic insurance M&AsDomestic conglomeration Slide 34 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 34 Value proposition and potential rationalizations for the four types of M&As: Across countries Between insurersAcross sectors International insurance M&AsInternational conglomeration Size is the main motive. Diversification Matching the size of clients and following clients. Possible rationalization within administrative functions. Higher growth potential in foreign markets. Saturation of brand name in home market. Economies of scope through cross-selling together with size are the two main motives. Risk and revenue diversification. M&A offers few rationalizations because institutions are in different countries and subject to different regulations and practices. Slide 35 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 35 Risks associated with the four types M&As: Within one country Between insurersAcross sectors Domestic insurance M&AsDomestic conglomeration Integrating technology may prove to be more expensive than expected Managers may become overly focused on internal issues and lose market share Managers may be unable to focus on or understand integration issues Possible personnel friction due to differing staff rules and pay scales. Problems with integrating fiscal and accounting systems due to differing reporting requirements. Reputation risks for separate core target markets, in the medium and long term. Slide 36 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 36 Risks associated with the four types M&As: Across countries Between insurersAcross sectors International insurance M&AsInternational conglomeration Integrating technology may prove to be more expensive than expected Managers may become overly focused on internal issues and lose market share Foreign exchange risks. Maximum risk. All risks relating to domestic conglomeration and international insurance M&As. Reputation risks in the medium and long term. Slide 37 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 37 Differences and similarities of financial intermediaries Insurers Commercial/ retail banks Risk management and underwriting Structured finance (offers insurance as capital supplement to equity and debt) Capital and asset management Investment banks/ securities firms Liquidity Credit monitoring Payment services Distribution Strong capital base Retail network Wholesale business Financial innovation Strong distribution Research and analysis Value propositions / comparative advantages Slide 38 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 38 Insurers Commercial/ retail banks Risk retention capacity (event risks and natural catastrophe) Comparative advantage in risk diversification Increasing appetite for capital market risks (financial, credit, etc) Risk financing on the rise Address previously uninsurable risks Investment banks/ securities firms Takes on credit, market and interest rate risks Risk transformation e.g. securitization Accustomed to financial market risks Risk transformation e.g. securitization Risk appetite Differences and similarities of financial intermediaries Slide 39 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 39 Main value for clients Asset risks Provide liquidity Liquidity shortage = bank runs Credit risk Liquidity Main concern Comparison of banks and insurers BanksInsurers Liability risks Protect against hazard risk Catastrophic loss occurrence Equity risk Credit risk via bond portfolio and ART Solvency Slide 40 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 40 Asset shares, US Depository institutions 60% Insurers 17% Securities 1% Pension Funds 18% Mutual Funds 4% Depository institutions 32% Insurers 15% Securities 5% Pension Funds 25% Mutual Funds 23% The share of US financial intermediary assets held by depository institutions has slid dramatically over the past two decades. 1980 total assets = USD 8.3 trillion2001/Q1 total assets = USD 26.9 trillion Note: 1980 asset total is adjusted for inflation. Source: US Federal Reserve Flow of Funds Accounts Slide 41 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 41 Asset shares, UK and Japan Relative shares of financial intermediary assets in UK and Japan, 1989-2000, in percent Depository institutions Insurance and pension funds Other institutions 64.755.0 25.327.1 10.017.9 55.247.9 16.420.6 28.531.5 UK Japan Source: Bank of Japan Flows of Funds Account, UK National Statistics. 19892000 Slide 42 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 42 Credit risks, various commodity price risks Protect margins by extending insurability Interest rate, exchange rate risks Auto insurance Fire insurance Transport insurance Product liability Terrorism Product recall Loss of data Prototype failures Political and regulatory risks Liquid markets for traditional insurance risks and financial risks Currently not or inadequately covered insurance and financial risks (illiquid markets) Currently not covered other risks Business risks margins Negative publicity Warranties etc. Slide 43 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 43 ART gallery Alternative risk transfer ART Alternative solutions Alternative risk carriers Alternative channels Finite risk Multi-year/multi- line Multi-trigger Insurance linked securities Committed capital Risk exchanges Captives Banks/Investment banks Slide 44 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 44 Traditional players face unprecedented challenges. But they will stay afloat if they: Is the traditional insurance company an endangered species? leverage technology to improve customer service, increase business process efficiency and utilize on-line sales channels, remain open-minded about new product innovations, consider outsourcing strategy for non-core activities, and maintain and further strengthen their brand recognition. Conclusion Slide 45 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 45 Agenda Long-term trends Profitability and the cycle Liberalization / Consolidation / Convergence Reinsurance markets Slide 46 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 46 Global reinsurance business: An industry fact-sheet Reinsurance clients not only comprise non-life and life insurers but also large corporations, major pension funds and capital markets. Reinsurance is a wholesale business. The leading global reinsurers provide their clients with (1) risk underwriting capacity and pricing/reinsurance structuring expertise, (2) protection against large complex risks and natural catastrophe volatility and loss and (3) risk management/risk mitigation services, as well as financial and asset management (e.g. through integrated solutions and products tailored to captives). Slide 47 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 47 Global reinsurance business: An industry fact-sheet Reinsurance is a global business because it relies on global risk diversification. Global reinsurance premiums amount to $127 billion ($98 billion in non-life, $29 billion in life) with North America and Western Europe accounting for the lions share (80%). Total insurance industry was $2.4 trillion in 2000, ($0.9 trillion non- life, $1.5 trillion life) In 2000, for every $100 in premium income, the top 10 global reinsurers incurred losses and expenses of more than $110. Slide 48 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 Global reinsurers value proposition Direct insurerReinsurer Risk capital before R/I Risk capita l after R/I before R/I after R/I An insurer buying reinsurance can release a certain amount of risk capital which is larger than the additional capital the reinsurer needs in order to absorb the buyers risks. This overall improvement in capital productivity is the economic value added of reinsurance. It is based on global reinsurers superior geographical and lines-of-business diversification. Slide 49 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 Reinsurance in the 21 st century: Managing clients capital and risk IPOs Capital raising M&A Merchant banking Run-off management Und erwr iting serv ices Risk tran sfer Ri sk fin an ci ng Risk trans fer via redis tribut ion (to capit al mark et inves tors) Fina nce & advis ory/ equit y inves tmen ts Asset mana geme nt Based on global risk expertise Based on geographically & product-wise balanced risk portfolio Derivatives Securitization of insurance risks (e.g. earthquake) Finite reinsurance Multi-year solutions Diversification over time Combining reinsurance with asset-liability expertise and worldwide asset management capabilities Slide 50 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 50 Reinsurance value for the customer: A wide spectrum of services Risk awareness enhancement Risk portfolio analysis Risk dialogue (e.g. on insurability) Policy design and wording Risk management Loss prevention Advice on pricing Risk assessment and risk management Optimizing risk carrying economics Reducing results volatility (diversification) Minimize cost of risk-adjusted capital Supporting business and financial strategy Risk underwriting capacity Balance-sheet management Bottom-line optimization Regulatory, accounting, tax Structuring reinsurance programs Risk transfer, absorption or financing Claims containment/ claims management Containing claims cost Contractual/legal aspects Claims adjustment support Feedback to underwriting Slide 51 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 51 Global diversification reduces cost of capital of primary insurers Insurers of last resort provide liquidity to insurance industry Provide services, including underwriting support Globally regulated by rating agencies maintaining a AAA rating is essential for a global reinsurer Value proposition of reinsurance Slide 52 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 52 Development trends in risk transfer & finance 19501995 capital markets traditional insurance retention, self-insurance reinsurance globally reinsurable risks individually diversifiable risks locally insurable risks globally diversifiable risks Slide 53 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 53 The future of reinsurance Value added achieved through technology and knowledge management Complex risk analysis Rapid change of risk and financial markets Advisory services Slide 54 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 54 Cat bond deal: 2000 pages Traditional reinsurance contract: 30 pages Traditional reinsurance is efficientand here to stay Slide 55 Swiss Re, Economic Research & ConsultingLecture, Nottingham, February 2002 55 The global reinsurance companies can provide risk transfer and risk financing in a win-win transaction Global re-insurers will play a pioneering role in extending the boundaries of (re-)insurance Reinsurance companies are providing increasingly sophisticated solutions with financial features Global re-insurers will continue to demonstrate the value of their risk management skills Traditional reinsurance is not expected to disappear Conclusion