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E&Y Experts Detail The Outlook For Financial Services

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A down equity market and demand for better corporate governance are just two factors that will shape financial services companies through 2003, experts explained during an Ernst & Young overview presented on Oct. 31.

The next area of regulatory scrutiny, now focused on investment research, may turn to the allocation of IPOs and high-net-worth clients, according to Robert Stein, chairman–global financial services with E&Y, New York.

Stein said that changes in corporate governance initiated by regulators can have a positive impact on the financial services industry as long as they do not create inefficiencies and stifle the willingness to take risks.

Efficiency will be needed by all sectors of the financial services industry to respond to market doldrums and to position for the next year, these E&Y representatives contended.

For life insurers, market declines will show up on the balance sheet, according to Peter Porrino, global and Americas director–insurance industry services with E&Y.

Deferred acquisition costs will impact financial results of some variable annuity and life writers as market declines are reflected in a decline in assets backing these contracts, he explained.

As the value of assets decline, costs are amortized more quickly so that liabilities match assets.

Porrino said that DAC costs could continue to be an issue through 2003 if equity markets do not rebound.

The markets are already impacting annuity sales, with premiums declining 20% in 2001 and with the likelihood that it will drop again in 2002 to a level not seen since 1997, Porrino said. “It is a huge issue for life companies that have cast their lot with variable products,” he added.

Life insurers are becoming more like asset managers, according to Porrino. Mortality risk, which he says has significant embedded “mortality gains,” are being reinsured, he said. The life reinsurance market will continue to experience growth, he added.

If the equity market continues its current downturn, guaranteed benefits will also continue to present problems for some variable writers, Porrino said.

For property-casualty insurers, the “same old story of fixing the hole in the balance sheet remains,” he added.

In actuality, Porrino explained, there are two holes: an “old hole” caused by asbestos and a “new hole” that resulted from “dramatic underpricing in the late 90s.”

On the property-casualty side of the business, surplus shortfalls, caused in part by losses in investments, will continue in 2002, according to Porrino.

If surplus shortfalls continue, so does the question of whether the property-casualty business is really experiencing a hard market.

Porrino said that it is but that the market can become harder. In order to achieve double-digit return on equity, the industrys combined ratio needs to be in the mid-90s, he said. It is moving toward that but not quite there yet, Porrino added.

According to information gathered by E&Y and Goldman Sachs, New York, since mid-1998 commercial line rates have gone from an 8% decline to a 20% increase in the first half of 2002. During that same time frame, flat rates in the personal lines area have increased by 10%.

Volatility in the equity markets is also accelerating consolidation in the asset management sector, Steven Buller, national and international director of asset management services for E&Y explained.

Acquisition activity will be greater among high-net-worth managers and trust companies not only because of the size of the assets under management but also because of the greater ability to leverage sales of other products, he said.

There is also going to be a retrenching of global investments and we are going to lose some of the smaller complexes through 2003, he Buller added.

Fund size has also shrunk with the current market drop. According to Buller, the average asset size for funds has declined to $561 million from $775 million.

Typically, a fund needs $100 million in net assets to break even, he said. Currently, 2,300 funds, or 28% of all funds, have less than $50 million in assets and 3,300 funds, or 40% of all funds, have less than $100 million in assets, Buller said.

Going forward, asset managers are going to rely more on advisors to reach the public, Buller added. Currently, he continued, financial planner, insurance and broker sales make up 85% of all fund sales, he said.

Reproduced from National Underwriter Life & Health/Financial Services Edition, November 11, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.