INSURANCE

Corporate premiums for predictable risks will likely disappear

Four very different value propositions are emerging
Supplementing welfare, asset gatherers, or service providers?
FOR EUROPEAN
INSURANCE
160 THE McKINSEYQUARTERLY 1996 NUMBER 4
Patrick Wetzel
A
T FIRST SIGHT, IT MIGHT SEEM a relatively straightforward task to define
the size and scope of the European insurance market. Statistics show
that the property and casualty (P&C) market in Germany is worth
DMIOO billion, for example, and that Switzerland has Europe's highest life
premiums per capita.
But statistics mask industry trends that pose significant strategic questions for
every chief executive officer of an insurance company. The traditional delin-
eation between life and non-life insurance products is beginning to fade, as is
the distinction between the insurance and reinsurance businesses. At the
same lime, the very boundaries of the insurance industry are blurring. Life
investment companies, reinsurers, asset managers, investment bankers, and
private bankers all find themselves competing in the same arena for business
not always traditionally regarded as insurance.
To define insurance in terms of the types of cover available, such as motor,
death, invalidity, and fire, therefore no longer suffices. A difterent gauge,
capable of reflecting tlie industry's growing complexity, is required if CEOs are
to understand the trends in their industry and plan accordingly It is therefore
useful to examine the four value propositions around which todays European
insurance industry appears to be grouping.
Insurance as an instrument to cover unpredictable cash needs
For many customers, insurance policies are instruments for meeting unpre-
dictable cash needs: a premium paid in advance gives the insured the right to
get cash when a clearly defined event happens, be it fire, death, or a hurricane.
In many respects, insurance policies are similar to financial options traded
Patrick Weizel is a principal in McKinsey's Zurich office. Copyright 1996 McKinsey &
Company. Ail rights reserved.
THE McKJNSEY QUARTERLY 1996 NUMBER 4 161
NEW STRATEGIES FOR EUROPEAN INSURANCE
in today's derivatives markets, whereby a premium paid in advance gives
the investor the right to sell {or buy) certain assets at a fixed price sometime
in the future.
It is a similarity that a handful of the most sophisticated insurance companies
and multinationals are beginning to exploit to their advantage. Rather than
paying premiums to an insurer or reinsurer to cover their risks, these
companies are de facto buying an "insurance option" - an instrument that
guarantees cash as and when losses occur, regardless of any specific line of
business. If these new instruments become
-T-i . -I common currency, they will threaten ereat
There is an emerciim trend , , ^ , . . , . - ' , ^
, I " ^- I ,1 chunks ot traditional insurers revenue,
toward placing severe risk m the
market by issuing "risk bonds" , . .-, i r. i i
A r u " It works like this. Rather than msunng every
instead of buying insurance .- , . , ,-
aspect ot Its business, a multinational splits
its traditional insurance needs into predic-
table risk {risk that can be predicted statistically and for which it can plan,
such as a small fire or a strike) and severe risk. The predictable risk is no
longer insured, as the company will itself be able to provide the necessary cash.
Severe risk, however, such as a hurricane that destroys an entire plant and
could bankrupt a company, needs to be covered. Although this risk is still
largely placed with insurance or reinsurance companies, there is an emerging
trend toward placing it in the market. Instead of buying an insurance policy,
a company could issue "risk bonds." Normally, buyers of these bonds would
receive an annual premium, but in a year when unpredictable risk occurs,
they eould lose part of the principal of their investment. In effect, insurance
risk could start to be securitized just like credit risk.
Some multinational corporations are already going one step further and
wondering why they cannot combine their insurance risks with other risks,
such as currency risks, issuing a single instrument to cover losses from what-
ever source - be it a huge fire or a currency collapse. Reinsurance companies
such as Swiss Re and other global insurance companies, mostly via their
Bermuda subsidiaries, are starting to offer products in this area.
As the trend toward these new instruments grows, some big insurance companies
will end up acting more like bankers and capital providers than suppliers of
insurance cover. Investment bankers, on the other hand, are starting to apply
financial engineering tools to cover traditional insurance risks, and are in the
process of exploiting new alliances with insurance brokers and top reinsurers to
offer clients as wide a range of insurance services as possible.
For the insured, this trend is a clear, new value proposition. By replacing line-
by-line insurance coverage with a single instrument to cover all unpredictable
risk, the chief financial officer eliminates unnecessary premium payments
162 THE McKINSEY QUARTERLY 19% NUMBER 4
NEW STRATEGIES FOR EUROPEAN INSURANCE
and has greater control over cash flow. For conventional insurance players
active in commercial and corporate business as well as in reinsurance, the
trend could represent a significant threat to the structure of their portfolios.
Premiums traditionally paid by corporations for predictable risks will,
essentially, disappear from the statistics, as could traditional reinsurance
mechanisms, to be replaced by new, cash-oriented insurance instruments
which could also be oflered by investment bankers.
Two points highlight the magnitude of the changes ahead. Predictable risk
could easily represent 40 to 50 percent of the total premiums paid by corpo-
rations today, and 80 percent of UK companies already retain a significant
proportion of their own risks. Under these circumstances CEOs of middle-
size insurance companies, whose business has largely depended on predic-
table risk, will have to ask themselves how far they will be able to compete for
the more sophisticated business in markets dominated by investment bankers
and a few giant insurance piayers such as AUianz, Swiss Re, Munich Re,
Gerling, Zurich, and Generali.
They should also bear in mind that there is no apparent reason why the trend
toward all-inclusive insurance should not spread to other market segments,
such as the small commercial market or high net-worth individuals (HNIs).
HNIs, for example, might be interested in a product covering their unpredic-
table risks (accident, invalidity, or severe healthcare problems), while retaining
more predictable risks.
Mass market demand
If demand for insurance as a cash instrument in the corporate sector poses
a threat to insurers, there should be new opportunities in the mass market
in areas that are not yet a primary focus of the insurance business. Rather
than providing cash to cover for the unexpected, future insurance products
will provide cash to deal with the kinds of problems people commonly, if not
inevitably, bave to confront in the course of their lifetimes, such as unem-
ployment, old age, and sickness.
The degree to which traditional insurance companies already participate
in these markets depends largely on national regulation and the domestic
welfare system. In some countries - like France and Italy - the state gives
insurers little room to compete. In others, private insurance companies
are allowed to compete on a more or less marginal basis. In Germany, for
example, private health insurance plans can be offered to wealthier
individuals (earning more than DM73,000) as an alternative to national
health insurance products. Hamburger Volksflirsorge went one step further
into wbat was exclusive state territory, launching a private unemployment
insurance scheme intended to cover cash losses above the minimum
guaranteed by the public system.
THE McKINSEY QUARTERLY 1996 NUMBER 4 163
NEW STRATEGIES FOR EUROPEAN INSURANCE
As the burden of social costs continues to rise across Europe, it is difficult to
imagine that governments will not increasingly welcome the introduction of
similar kinds of private insurance products as substitutes for, or at least sup-
plements to, the basic cover offered through the welfare system. These new
products could include coverage for health, invalidity, accident, and long-term
care, as well as pensions in the form of a life policy They could be sold either to
individuals or households, or to corporations as fringe benefits for employees.
The historical (and legally enforced) separation between accident (P&C), life,
and health insurance business is therefore becoming an increasing burden
for insurers wanting to offer a comprehensive package of personal cover. In
the Netherlands and Switzerland, where semi-public health insurance already
exists, alliances between different types of insurers are already springing up.
Winterthur, for example, has integrated into its Swiss structure the fifth-
biggest national health insurer, KFW, and
created out of it a Wincare unit.
Banks are aggressively selling
persona] equity plans as tax- r i r^
oJ; , , . I-,- , ^ A privatization ol the European pension
elricient rivals to hie products... ^ , , , ,
system to Ihe same degree as already exists
in the US (with its 40I(k) regulation) could
conceivably generate more than 3,000 billion ecus in additional assets to
be managed, either by insurers or professional asset managers - such is
the magnitude of the potential opportunities emerging. Similarly, 500 billion
ecus in premiums could be generated by opening the healthcare market to
private insurers.
Insurance as an investment instrument
Beside being an instrument for meeting cash needs in return for premiums
paid in advance, insurance is also seen as an investment. Life insurers manage
10 to 15 percent of the world's financial assets, accumulated thanks to gen-
erous tax incentives from the state for those who take out life polices. Life
policies have become not only a means of absorbing risk, but of saving money.
Banks, on the other hand, have had to contend with modest, or even negative
growth of their traditional deposit accounts.
To try to restore some equilibrium, banks have been establishing their own
life insurance businesses or allying with life insurers, with considerable
success. "Bancassurance" now represents more than 20 percent of the
individual life market in the UK and half of the French market
In the most liberal European markets, such as ihe UK, banks have, however,
been able to win back still more of the revenue enjoyed by life insurers as a
result of the "neutralization" of historical tax advantages given to life
products. By giving some long-term investment products the same tax breaks
164 THE McKINSEY QUARTERLV 1996 NUMBER 4
NEW STRATEGIES FOR EUROPEAN INSURANCE
as those enjoyed by life insurance products, governments have not only put
traditional life insurance under severe performance pressure, but have also
blurred the distinction between life insurance and investment management.
In the UK. banks are aggressively selling personal equity plans (PEPs) as tax-
efficient rivals to life products.
insurers, however, have largely been slow to wake up to the fact that they are
now in direct competition for asset management money. Some have turned
their investment function into a profit center, or acquired asset manage-
ment expertise. The best-known examples are the acquisition of Kemper
($60 billion under management) by the Zurich Insurance Group, and the
acquisition of Barings by Dutch insurer ING. Other players have chosen
instead to outsource their investment function, as Scandia Life has done.
Scandia now offers unit-linked products of a selected number of chosen
funds, run by external asset managers and banks. But many insurers in
continental Europe are only now discovering unit-linked products that allow
clients to choose how to invest their savings.
Some banks have moved still further ahead. They offer not only their own
traditional life products, but also a new range of products, mostly mutual
funds, that replicate financially the attributes of typical life insurance
products: a guaranteed minimum return with the opportunity of additional
returns depending on the underlying asset chosen for the investment. The
difference, of course, is that there is no guaranteed lump sum payable on
death. The recently launched asymmetric
funds of SBC Warburg are examples of these i u i i
,. J ., . " ^ ...Insurers, however, are slowly
kinds ot products. , . ^ ^, r . *L u
^ waking up to the fact that they
, , ,. . are now in direct competition
In the medium term, every insurance com- < ^ J^
^ , , , ,, for asset management money
pany should probably plan lor a more even
playing field in which fiscal advantages given
to products with little real "insurance" content have been eliminated, and
they find themselves in direct competition with investment managers for
long-term savings. To survive, they will either have to wholeheartedly enter
the asset management business, or outsource the investment function. In the
case of the latter, insurers might continue to prosper as "asset gatherers,"
using their own sales channels to offer other financial products through a
third party. IDS in the US is already doing this.
For some life insurers in the high net-worth segment, an entry into private
banking might also be possible (as it has been for ING through Barings).
In Belgium, some large insurance companies such as Royale Beige or La
Patriotique have acquired small banks (or refocused a bank unit belonging to
their group) with the purpose of giving their brokers more muscle to compete
with the bancassurance channel in this field.
THE McKINSEY QUARTERLY 1996 NUMBER 4 165
NEW STRATEGIES FOR EUROPEAN INSURANCE
It is clear that the boundaries of the life insurance business are changing,
not only for the individual market but also for group business. Here it is
interesting to note that in many countries, group life insurers still offer undif-
ferentiated investment products. The idea of offering unit-linked products
for group life (as investment managers would do for pension money) is only
just dawning.
Insurance as a service to avoid distress in difficult situations
Despite their primarily product-oriented approach, insurers have traditionally
offered few product-related services. Until recently, they have been simply
payors, not service providers.
But as traditional lines of insurance become more like commodities, insurers
will have to start looking for new value propositions beside the purely cash
one (you pay now and I pay you cash when needed; or I invest your money for
you). A service offered either to prevent or limit distress in difficult situations
is one such proposition.
The first movers in this field have been not P&C insurers, but health insurers.
In Switzerland, health insurers have started to reinforce their role as payors
by offering clients a whole range of real seiTices: a selection of hospitals from
which to choose, a network of physicians, and in some cases direct delivery of
drugs and other medical supplies. This LJS-inspired approach, known as
managed care, has not only given health insurers a significant role in the
reshaping of the whole healthcare industry, it
T- , . , J U I lias also redefined the boundaries of the
hor lost or damaged belongines, , , , .
7 , I " health msurance business,
some insurers already replace
stolen or damaged goods rather _, ,w , .1
. ^^ , The same thmg is happenme m other msur-
than payine out cash ,. ^, '^. r r^- , -
^ ' '=' ance Imcs. Car msurers such as Direct Line
in the UK or Centraal Beheer in the Nether-
lands offer to take care of the whole repair procedure after an accident -
providing a replacement car, bringing the damaged car to the repair shop,
and repairing it. As the repair industry is fragmented and inefficient,
extensive restructuring can be expected. Some insurers are becoming major
parts wholesalers, negotiating for and buying parts directly from the
manufacturer. Others, such as Direct Line and Churchill (Winterthur), are
entering the car repair business and building repair centers. Direct Line
has recently built the biggest repair center in the UK, with capacity to
service more than 350 cars a day.
Home-owner insurers such as Germany's Gothaer Insurance are starting to
offer similar services to help customers deal with damage to their homes,
organizing immediate assistance and then providing a network of specialist
166 THE McKlNSEY QUARTERLY 1996 NUMBER 4
NEW STRATEGIES FOR EUROPEAN INSURANCE
repair services. In Belgium, several insurers have an agreement with Mondial
Assistance to offer home repair services.
In the case of lost or damaged belongings, some US insurance companies
already replace stolen or damaged goods rather than paying out cash - a
service that is not only convenient for customers, but more likely to
discourage fraudulent claims. One, USAA, has become one of the leading
direct retailers in the United States, able to negotiate professional
purchasing agreements with suppliers of consumer goods for items likely
to be stolen or damaged. The same trend is likely to emerge in Europe.
Indeed, replacement rather than cash payment already seems to be an
option offered by some UK insurers.
Risk-prevention services could also become a new source of income for
insurance companies interested in delivering better value propositions,
particularly to their commercial clients. The Gerling and Zurich groups
already provide a risk-consulting service, while P&C companies would seem
well-positioned to link their home-owner coverage with advice about home
security or even to fit burglar alarms.
First-mover advantage in the trend toward ofiering additional, insurance-
related services could be critical for success.
Insurance as an administrative service
One last role that insurers could play is that of transaction specialist. Clients
would use insurers not because they smooth their cash flows or invest their
money, but because they have the systems in place to deal with the
administrative tasks related to the insurance business: keeping track of
thousands of contracts, checking cover rules when claims are made, paying
the cash required in time.
Although this role might appear dull, it is a value proposition already oftered
by some, especially in the commercial and corporate sectors. Allianz, through
its APS-unit {Allianz Pension Services), offers a full service for the admin-
istration and handling of pensions, for instance. For insurance companies
losing volume because of greater retention of risks by their client base, offering
captive management services to customers could become an increasingly
important source of revenue.
Some corporations are starting to use their insurers as administrative partners
for whole employee compensation programs and related insurance cover
(pension schemes, accident, health, and life cover), ensuring that they have an
efficient, logistical system to track and comply with al! the administrative
and regulatory requirements linked to their insurance and pension plans.
THE McKINSEYQUARTERLY 1996 NUMBER 4 167
NEW STRATEGIES FOR EUROPEAN INSURANCE
What does all this mean?
What was once a clearly defined industry is changing its scope. The speed of
change may vary by country, depending on the regulatory environment, but
not the growing complexity of the market. For companies that would like to
stay in the old world of product lines and traditional sales channels, the
market will also be an increasingly difficult one. Significant chunks of
traditional business are set to be eaten away by new competitors from other
industries, or by competitors with new value propositions.
It means CEOs of traditional insurance companies have a lot to deal with.
Emerging technoiogies and new sales channels present operational
challenges, and pressure on costs and operational results will be severe. Yet
their first concern must be to act early at the strategic level, for two reasons.
First, they will take the right operational and investment measures only
if they have a clear vision of where to go. and second, strategic advantage
will go to those that are first into new areas because they will capture
the best partners and the most attractive customers. The opportunities
are there for early entrants who identify areas in which they can offer new,
clearly differentiated value propositions. The field is wide open - but only
for so long. Q
168 THE McKINSEY QUARTERLY 1996 NUMBER 4