Although insurers have rebounded from the worst days of the financial crisis, their business as a whole continues to be challenged by a sluggish economic climate and poor industry fundamentals. Many factors are in play.
Downward revisions in global growth prospects and low levels of consumer confidence will negatively affect all business lines going forward, for instance. Many retail and small- and medium-enterprise buyers of insurance, in response to the tough economic times, will look for cheaper solutions, sometimes reducing coverage or even canceling policies. At the same time, both the frequency and the cost of claims for insurers will tend to rise as more consumers try to recoup the price of their coverage.
Core client behaviors have, in fact, already started to shift to some extent. Proprietary research by The Boston Consulting Group indicates that individual insurance customers have become increasingly price sensitive, often comparing premium quotes from different carriers and searching the market for better deals. Some retail customers are moving to scale down their coverage by cutting policy guarantees to the minimum and increasing deductibles. On the corporate side, clients have become more aware of the financial ratings and reputations of their providers and are developing internal know-how to help themselves balance the costs and benefits of transferring risks. We expect large corporate clients to make more use of their captive and excess reinsurance coverage.
Furthermore, from an investment standpoint, widespread market volatility and historically low interest rates are raising the stakes for insurers. Stock markets have been struggling for many months, long-term bond rates are remaining extremely low, and fears over weak sovereign debt are challenging the overall valuation of fixed-income portfolios. As for the regulatory climate, measures such as Solvency II are progressively influencing the capital allocations, return on equity, and profitability of insurance business lines, requiring companies to reduce their exposure to certain risks, reprice some guarantees, and adjust their financial policies toward less risky asset classes.
None of these dynamics is new per se. Yet the speed and cumulative effects of changes that are highly correlated, the structural aspects of the shifts, and the fact that so many market conditions are changing simultaneously have created a set of circumstances different from what we’ve seen in the past—disrupting strategic plans, putting pressure on balance sheets and profit-and-loss (P&L) statements, and deflating financial indicators for most insurers. Consider the following trends:
Credit Ratings. Most major insurers have been challenged by ratings agencies, and many have seen their debt offerings downgraded. On average, bond ratings of the largest insurance groups have been reduced by several notches over the past 12 months.
Stock Performance. Total shareholder return for insurers has suffered. From the beginning of 2008 through the end of 2011, TSR per annum for the Standard & Poor’s 500 Life & Health Insurance index was –12.2 percent, compared with –3.7 percent for the S&P 500 Property & Casualty Insurance index, and –1.6 percent for the overall S&P 500.
Market-to-Book Ratios. Many insurers have posted low market-to-book ratios, frequently well below 1, revealing a lack of investor confidence in the ability of insurance companies to maintain returns and create value for shareholders.
Under circumstances such as these, how can insurers step up performance in order to achieve healthy financial ratios and sustain long-term competitive positions in the future? The answer, since they cannot transform the evolution of the market, is that they must transform themselves. They must explore meaningful change across their entire organization—reviewing strategic business and operating models, target customer segments, product portfolios, distribution strategy, IT capability, cost structure, organizational leanness, and other elements of their overall business. The goal of insurers should be not only to adapt to difficult market conditions but also to make these conditions work to their company’s advantage. Doing this successfully will require a well-defined plan for change.