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7/30/2019 New Strategies for European Insurance_Mc_Kinsey_2013

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160 THE McKINSEY QUARTERLY 1996 NUMBER 4

INSURANCE

Corporate premiums for predictable risks will likely disappear

Four very diferent value propositions are emerging

Supplementing welfare, asset gatherers, or service providers?

NEW

STRATEGIESFOR EUROPEANINSURANCE

UNITED ARTISTS (COURTESY KOBAL)


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THE McKINSEY QUARTERLY 1996 NUMBER 4 161

AT FIRST SIGHT , IT MIGHT SEEM a relatively straightforward task to dene

the size and scope of the European insurance market. Statistics showthat the property and casualty ( P&C ) market in Germany is worth

DM 100 billion, for example, and that Switzerland has Europes highest lifepremiums per capita.

But statistics mask industry trends that pose signicant strategic questions forevery chief executive ocer of an insurance company. The traditional delin-eation between life and non-life insurance products is beginning to fade, as isthe distinction between the insurance and reinsurance businesses. At the

same time, the very boundaries of the insurance industry are blurring. Lifeinvestment companies, reinsurers, asset managers, investment bankers, andprivate bankers all nd themselves competing in the same arena for businessnot always traditionally regarded as insurance.

To dene insurance in terms of the types of cover available, such as motor,death, invalidity, and re, therefore no longer suces. A diferent gauge,capable of reecting the industrys growing complexity, is required if CEO s areto understand the trends in their industry and plan accordingly. It is therefore

useful to examine the four value propositions around which todays Europeaninsurance 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 toget cash when a clearly dened event happens, be it re, death, or a hurricane.In many respects, insurance policies are similar to nancial options traded

Patrick Wetzel is a principal in McKinseys Zurich oce. Copyright 1996 McKinsey &Company. All rights reserved.

Patrick Wetzel


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in todays derivatives markets, whereby a premium paid in advance givesthe investor the right to sell (or buy) certain assets at a xed price sometimein the future.

It is a similarity that a handful of the most sophisticated insurance companiesand multinationals are beginning to exploit to their advantage. Rather thanpaying premiums to an insurer or reinsurer to cover their risks, thesecompanies are de facto buying an insurance option an instrument thatguarantees cash as and when losses occur, regardless of any specic line of

business. If these new instruments becomecommon currency, they will threaten greatchunks of traditional insurers revenue.

It works like this. Rather than insuring everyaspect of its business, a multinational splitsits traditional insurance needs into predic-

table risk (risk that can be predicted statistically and for which it can plan,such as a small re or a strike) and severe risk. The predictable risk is no

longer insured, as the company will itself be able toprovide the necessary cash.Severe risk, however, such as a hurricane that destroys an entire plant andcould bankrupt a company, needs to be covered. Although this risk is stilllargely placed with insurance or reinsurance companies, there is an emergingtrend toward placing it in the market. Instead of buying an insurance policy,a company could issue risk bonds. Normally, buyers of these bonds wouldreceive an annual premium, but in a year when unpredictable risk occurs,they could lose part of the principal of their investment. In efect, insurancerisk could start to be securitized just like credit risk.

Some multinational corporations are already going one step further andwondering 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 re or a currency collapse. Reinsurance companiessuch as Swiss Re and other global insurance companies, mostly via theirBermuda subsidiaries, are starting to ofer products in this area.

Asthetrendtowardthesenewinstrumentsgrows,somebiginsurancecompanieswill end up acting more like bankers and capital providers than suppliers of insurance cover. Investment bankers, on the other hand, are starting to applynancial engineering tools to cover traditional insurance risks, and are in theprocessofexploitingnewallianceswithinsurancebrokersandtopreinsurerstooferclientsaswidearangeofinsuranceservicesaspossible.

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 unpredictablerisk, the chief nancial ocer eliminates unnecessary premium payments

NEW STRATEGIES FOR EUROPEAN INSURANCE


There is an emerging trendtoward placing severe risk in themarket by issuing risk bonds

instead of buying insurance


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and has greater control over cash ow. For conventional insurance playersactive in commercial and corporate business as well as in reinsurance, thetrend could represent a signicant threat to the structure of their portfolios.Premiums traditionally paid by corporations for predictable risks will,essentially, disappear from the statistics, as could traditional reinsurancemechanisms, to be replaced by new, cash-oriented insurance instrumentswhich could also be ofered 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 signicantproportion of their own risks. Under these circumstances CEO s 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 forthe more sophisticated business in markets dominated by investment bankersand a few giant insurance players such as Allianz, Swiss Re, Munich Re,Gerling, Zurich, and Generali.

They should also bear in mind that there is no apparent reason why the trendtoward all-inclusive insurance should not spread to other market segments,such as the small commercial market or high net-worth individuals ( HNI s).HNI s, for example, might be interested in a product covering their unpredic-table risks (accident, invalidity, or severe healthcare problems), while retainingmore predictable risks.

Mass market demandIf demand for insurance as a cash instrument in the corporate sector poses

a threat to insurers, there should be new opportunities in the mass marketin areas that are not yet a primary focus of the insurance business. Ratherthan providing cash to cover for the unexpected, future insurance productswill provide cash to deal with the kinds of problems people commonly, if notinevitably, have to confront in the course of their lifetimes, such as unem-ployment, old age, and sickness.

The degree to which traditional insurance companies already participatein these markets depends largely on national regulation and the domesticwelfare system. In some countries like France and Italy the state givesinsurers little room to compete. In others, private insurance companiesare allowed to compete on a more or less marginal basis. In Germany, forexample, private health insurance plans can be ofered to wealthierindividuals (earning more than DM 73,000) as an alternative to nationalhealth insurance products. Hamburger Volksfrsorge went one step furtherinto what was exclusive state territory, launching a private unemploymentinsurance scheme intended to cover cash losses above the minimumguaranteed by the public system.




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As the burden of social costs continues to rise across Europe, it is dicult toimagine 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 ofered through the welfare system. These newproducts could include coverage forhealth, invalidity, accident, and long-termcare, aswell aspensions in the form ofa life policy. They couldbe soldeither toindividuals or households, or to corporations as fringe benets for employees.

The historical (and legally enforced) separation between accident ( P&C ), life,

and health insurance business is therefore becoming an increasing burdenfor insurers wanting to ofer a comprehensive package of personal cover. Inthe Netherlands and Switzerland, where semi-public health insurance alreadyexists, alliances between diferent types of insurers are already springing up.Winterthur, for example, has integrated into its Swiss structure the th-

biggest national health insurer, KFW, andcreated out of it a Wincare unit.

A privatization of the European pension

system to the same degree as already existsin the US (with its 401(k) regulation) could

conceivably generate more than 3,000 billion ecus in additional assets tobe managed, either by insurers or professional asset managers such isthe magnitude of the potential opportunities emerging. Similarly, 500 billionecus in premiums could be generated by opening the healthcare market toprivate insurers.

Insurance as an investment instrumentBeside being an instrument for meeting cash needs in return for premiumspaid in advance, insurance is also seen as an investment. Life insurers manage10 to 15 percent of the worlds nancial assets, accumulated thanks to gen-erous tax incentives from the state for those who take out life polices. Lifepolicies 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 negativegrowth of their traditional deposit accounts.

To try to restore some equilibrium, banks have been establishing their ownlife insurance businesses or allying with life insurers, with considerablesuccess. Bancassurance now represents more than 20 percent of theindividual life market in the UK and half of the French market.

In the most liberal European markets, such as the UK, banks have, however,been able to win back still more of the revenue enjoyed by life insurers as aresult of the neutralization of historical tax advantages given to lifeproducts. By giving some long-term investment products the same tax breaks



Banks are aggressively sellingpersonal equity plans as tax-

ecient rivals to life products


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as those enjoyed by life insurance products, governments have not only puttraditional life insurance under severe performance pressure, but have alsoblurred the distinction between life insurance and investment management.In the UK, banks are aggressively selling personal equity plans ( PEP s) as tax-ecient rivals to life products.

Insurers, however, have largely been slow to wake up to the fact that they arenow in direct competition for asset management money. Some have turnedtheir investment function into a prot 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 theacquisition of Barings by Dutch insurer ING . Other players have choseninstead to outsource their investment function, as Scandia Life has done.Scandia now ofers unit-linked products of a selected number of chosenfunds, run by external asset managers and banks. But many insurers incontinental Europe are only now discovering unit-linked products that allowclients to choose how to invest their savings.

Some banks have moved still further ahead. They ofer not only their owntraditional life products, but also a new range of products, mostly mutualfunds, that replicate nancially the attributes of typical life insuranceproducts: a guaranteed minimum return with the opportunity of additionalreturns depending on the underlying asset chosen for the investment. Thediference, of course, is that there is no guaranteed lump sum payable ondeath. The recently launched asymmetricfunds of SBC Warburg are examples of thesekinds of products.

In the medium term, every insurance com-pany should probably plan for a more evenplaying eld in which scal advantages givento products with little real insurance content have been eliminated, andthey nd themselves in direct competition with investment managers forlong-term savings. To survive, they will either have to wholeheartedly enterthe asset management business, or outsource the investment function. In thecase of the latter, insurers might continue to prosper as asset gatherers,using their own sales channels to ofer other nancial products through athird party. IDS in the US is already doing this.

For some life insurers in the high net-worth segment, an entry into privatebanking might also be possible (as it has been for ING through Barings).In Belgium, some large insurance companies such as Royale Belge or LaPatriotique have acquired small banks (or refocused a bank unit belonging totheir group) with the purpose of giving their brokers more muscle to competewith the bancassurance channel in this eld.



Insurers, however, are slowly

waking up to the fact that theyare now in direct competitionfor asset management money


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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 isinteresting to note that in many countries, group life insurers still ofer undif-ferentiated investment products. The idea of ofering unit-linked productsfor group life (as investment managers would do for pension money) is only

just dawning.

Insurance as a service to avoid distress in dicult situations

Despite their primarily product-oriented approach, insurers have traditionallyofered few product-related services. Until recently, they have been simplypayors, not service providers.

But as traditional lines of insurance become more like commodities, insurerswill have to start looking for new value propositions beside the purely cashone (you pay now and I pay you cash when needed; or I invest your money foryou). A service ofered either to prevent or limit distress in dicult situationsis one such proposition.

The rst movers in this eld have been not P&C insurers, but health insurers.In Switzerland, health insurers have started to reinforce their role as payorsby ofering clients a whole range of real services: a selection of hospitals fromwhich to choose, a network of physicians, and in some cases direct delivery of drugs and other medical supplies. This US-inspired approach, known asmanaged care, has not only given health insurers a signicant role in the

reshaping of the whole healthcare industry, ithas also redened the boundaries of the

health insurance business.

The same thing is happening in other insur-ance lines. Car insurers such as Direct Linein the UK or Centraal Beheer in the Nether-

lands ofer to take care of the whole repair procedure ater an accident providing a replacement car, bringing the damaged car to the repair shop,and repairing it. As the repair industry is fragmented and inecient,extensive restructuring can be expected. Some insurers are becoming majorparts wholesalers, negotiating for and buying parts directly from themanufacturer. Others, such as Direct Line and Churchill (Winterthur), areentering the car repair business and building repair centers. Direct Linehas recently built the biggest repair center in the UK, with capacity toservice more than 350 cars a day.

Home-owner insurers such as Germanys Gothaer Insurance are starting toofer similar services to help customers deal with damage to their homes,organizing immediate assistance and then providing a network of specialist



For lost or damaged belongings,some insurers already replacestolen or damaged goods rather

than paying out cash


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repair services. In Belgium, several insurers have an agreement with MondialAssistance to ofer home repair services.

In the case of lost or damaged belongings, some US insurance companiesalready replace stolen or damaged goods rather than paying out cash aservice that is not only convenient for customers, but more likely todiscourage fraudulent claims. One, USAA , has become one of the leadingdirect retailers in the United States, able to negotiate professionalpurchasing 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 anoption ofered by some UK insurers.

Risk-prevention services could also become a new source of income forinsurance companies interested in delivering better value propositions,particularly to their commercial clients. The Gerling and Zurich groupsalready provide a risk-consulting service, while P&C companies would seemwell-positioned to link their home-owner coverage with advice about home

security or even to t burglar alarms.

First-mover advantage in the trend toward ofering 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. Clientswould use insurers not because they smooth their cash ows or invest their

money, but because they have the systems in place to deal with theadministrative tasks related to the insurance business: keeping track of thousands of contracts, checking cover rules when claims are made, payingthe cash required in time.

Although this role might appear dull, it is a value proposition already oferedby some, especially in the commercial and corporate sectors. Allianz, throughits APS -unit (Allianz Pension Services), ofers a full service for the admin-istration and handling of pensions, for instance. For insurance companieslosing volume because ofgreater retentionof risks by theirclient base, oferingcaptive management services to customers could become an increasinglyimportant source of revenue.

Some corporations are starting to use their insurers as administrative partnersfor whole employee compensation programs and related insurance cover(pension schemes, accident, health, and life cover), ensuring that they have anecient, logistical system to track and comply with all the administrativeand regulatory requirements linked to their insurance and pension plans.




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What does all this mean?

What was once a clearly dened industry is changing its scope. The speed of change may vary by country, depending on the regulatory environment, butnot the growing complexity of the market. For companies that would like tostay in the old world of product lines and traditional sales channels, themarket will also be an increasingly dicult one. Signicant chunks of traditional business are set to be eaten away by new competitors from otherindustries, or by competitors with new value propositions.

It means CEO s of traditional insurance companies have a lot to deal with.Emerging technologies and new sales channels present operationalchallenges, and pressure on costs and operational results will be severe. Yettheir rst concern must be to act early at the strategic level, for two reasons.First, they will take the right operational and investment measures onlyif they have a clear vision of where to go, and second, strategic advantagewill go to those that are rst into new areas because they will capturethe best partners and the most attractive customers. The opportunitiesare there for early entrants who identify areas in which they can ofer new,

clearly diferentiated value propositions. The eld is wide open but onlyfor so long.

