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Daring to be different
www.pwc.com/insurance
Reinsurers need to stand out in the face of continued market uncertainty and limited growth prospects in traditional reinsurance. But they have a real opportunity to focus on repositioning the economic value of risk transfer.
September 2011
Reinsurers need to stand out in the faceof continued market uncertainty andlimited growth prospects in traditionalreinsurance. But they have a realopportunity to focus on repositioningthe economic value of risk transfer.
PwC Daring to be different 1
Daring to be different
For the reinsurance industry, 2011is proving to be another year ofunfulfilled hopes and promises. Aftera challenging 2010, with earthquakes inChile and New Zealand and an increasein the frequency and severity ofman-made disasters, the substantialcatastrophe losses in Q1 2011 wipedout a meaningful portion of theindustry’s excess capital. But theselosses, and arguments that the greaterfrequency and severity of disasterswarrant a review of risk analytics andredefinition of risk-adequate pricing,have failed to trigger a directionalchange in the market. Overall, the rateenvironment remains lacklustre.
At the same time, existing capitalframeworks are being challenged byforthcoming new regulation underSolvency II. On the asset side of thebusiness, with the meaning of ‘risk-free’being redefined through the seismicshifts in sovereign credit ratings andwith interest rates at exceptionallylow levels, it is difficult to generateadequate returns. Meanwhile, greaterdiversification by reinsurers, urged bythe credit ratings agencies in the wakeof Hurricane Katrina (2005), has failedto deliver the expected benefits.Indeed, efforts to diversify by writingcatastrophe business in a wider rangeof countries, served merely to increaseexposure to recent losses in Japan andNew Zealand.
Reinsurance industry fundamentals continueto disappoint...
2 PwC Daring to be different
Customer behaviours
• Social networking
• Customerexpectations
• Risk awareness
• Health
Demographic shifts
• Rise of themiddle class
• New familystructure
• Dependency ratio
• Aging
Stakeholder trust
Talent drain
Corporate socialresponsibility
Social Technological Economic Environment Political
Information andanalytics
Devices and sensors
Software andapplications
Medical advances
Urbanization
New growthopportunities
Fiscal pressure
Inflation/deflation
Risk sharingand transfer
Social securityand benefits
Distributor shift
Partnerships
Climate changeand catastrophes
Sustainability
Pollution
Regulatory reform
Geo-political risk
Rise of state-directed capitalism
Terrorism
Tax treatment
Sharia compliance(Takaful)
Figure 1: STEEP Drivers
1 Datamonitor, “Swiss Re Strategy, SWOT and Corporate Finance Report” (2011).
Source: PwC
Looking beyond the immediate marketenvironment reinsurers also need toconsider what factors will drive theirfuture strategies and how these driverscould alter their business model. Todevelop a set of future scenarios, PwChas conducted extensive research(What the future holds: Insurance2020, June 2011), which assesses theimpact of global social, technological,environmental, economic and political(STEEP) factors across four majorsectors (personal, commercial,reinsurance and life, annuity,retirement).
From our analysis, it is clear that, facedwith limited growth potential in thetraditional risk transfer market, thereinsurance industry’s positioning inthe risk transfer value chain as well asits geographic and product focus are setto change significantly:
• Volumes of risk transfer business aredeveloping and being transactedoutside the established markets of
the Americas, Bermuda and the EU.Increasingly the focus of the industrywill need to be on the developingmarkets, where the emergence ofnew sources of institutional andpersonal risk will fuel local growth.As commercial and personalaffluence increase, so too does theneed for risk protection, risk andwealth management, creatingsubstantial volumes of growth ininsurance and reinsurance demand.For example, the proportionof world GDP spent on insurancepremiums is expected to increasefrom 5.6% (2006) to 9% by 2015,creating a significant opportunityfor reinsurance.1 With growingurbanisation in emerging markets,the probability of a greaterfrequency, complexity andmagnitude of commercialcatastrophe events could alsoincrease with the growth indeveloping nations.
...and material challenges to the business model are on the horizon
• In 2009, the US still dominatedglobal trade flows, despite theexplosion of trade with China overthe last 10 years. China will overtakethe US and dominate global trade in2030 and financial flows will followsimilar trends. Figure 2 shows thedifference twenty years will make astrade evolves.
• With the primary insurance industrygrappling with the same challenges,attention will shift to reviewingbusiness models and focusing onactivities where differentiation andvalue can be created, which will leadto a break up of traditional insurancemodels. This will offer reinsurers asubstantial opportunity to shift awayfrom a three-party model, whichcomprises insurer, distributor andreinsurer, to a two-party model,which cuts out the insurer, therebyultimately increasing theeffectiveness of risk transfer.
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Figure 2: Size of bilateral trade flow ($USm)...
...in 2009
n Under 50,000 n 50,001–100,000 n 100,001–200,000 n 200,001–350,000 n 350,001+
Source: PwC
9%The proportion of world GDPspent on insurance premiums isexpected to increase from 5.6%(2006) to 9% by 2015, creatinga significant opportunity forreinsurance.
...in 2030
4 PwC Daring to be different
• While the developing and emergingeconomies will offer substantialgrowth potential, the developedmarkets will also presentopportunities outside the traditionalrisk transfer market. With adynamically changing riskenvironment, individuals,corporations, institutions andsovereign organizations are lookingfor risk management solutions,which mitigate material risks(new risk classes and risk profileaggregations that can materiallydestroy wealth or disrupt financialstability). This offers the reinsuranceindustry the opportunity to leverageits wealth of risk insight andtechnical expertise to create risk
management solutions that matterin a future world and help movethe industry away from a heavilycommoditised risk transfer market.
• The speed at which the capitalmarkets have been able to supplycapital to reinsurance has beentransformed in the last decade interms of both traditional directequity investments and through thedevelopment of insurance-linkedsecurities and derivatives of theseproducts. This development willcontinue to have profoundimplications for the shape of theindustry. Furthermore, the abilityto turn information into smartinsight and the proliferation of cloudtechnology will reduce the barriersto entry in the industry, increasetransparency and lead to a valuechain transformation facilitatinga direct connection between theinsurance risk and capital markets.
• At the International InsuranceSociety, PwC asked delegates fortheir views on the extent to whichthe industry expects sophisticatedinformation analytics to develop.Figure 3 shows that 63% opted formore ‘data driven’ scenarios.
Insurers are met withincreased data overload,quality and privacy issues.
Coupled with legacy ITissues they struggle tounderstand how to makethe information usable fordecision-making revertingback to ‘gut-driven’decision making
Insurers continue to manageinformation overload andever increasingsophistication of analyticaltechniques requiringcontinuous investment tokeep pace with thecompetition
Sophisticated informationanalytics becomes thekey determinant ofcompetitive differentiationand underwriting talentmagnifies the differentiation
Sophisticated informationanalytics and new sourcesof information (from mobiledevices and sensors)becomes the keydeterminant of competitivedifferentiation andunderwriting talent magnifiesthe differentiation
Sophisticated informationanalytics progresses to apoint where no more usefulinformation can be extractedand all key decision-makinghas been automated,and shifts competition topreventative andproductivity gains
Figure 3:
Source: PwC presentation at the International Insurance Society Annual Seminar June 2011 including audience feedback from 150 delegates
‘Gut-driven’Decision Making
‘Data-driven’Decision Making?
1 2 3 4 5
49%25%10%2%
14%
Anand RaoPartner, PwC (US)
“Reinsurers should use information and analyticsto better understand existing risks as well as toidentify new emerging sources of risk. In addition,alternative risk transfer mechanisms and capitalmarket instruments should be explored to allowmore efficient capital management.”
PwC Daring to be different 5
Putting this into a capital marketscontext, the ‘good news’ is that riskswhich are uncorrelated both to otherasset classes and to fluctuations inmacroeconomic variables are ofconsiderable interest to investors.This is particularly true in the currentenvironment, which is characterisedby a high degree of macro uncertaintydue to sovereign debt concerns andtheir potential impact on GDP growth.
A wide range of investors is active in thesector. For example, US private-equitygroups Apollo and CVC Capital betweenthem bought Brit Insurance at theend of 2010, while hedge funds haveinvested in side cars, catastrophe bondsand longevity bonds.
Three Bermuda-based reinsurers –Validus, Lancashire Holdings andAlterra Capital Holdings – have set upsidecars in 2011 with capital suppliedin part by third party investors. Newregistrations in Bermuda, particularlySPVs, are running at record levels.
CAT bond issuance, meanwhile,reached $1bn in the first quarter of2011, compared with $650m in thesame quarter last year.2 SovereignWealth Funds (SWF), too, areconsidering increasing their exposureto insurance risk through insurance-related securities, while in August 2011China’s SWF revealed that it holds a3 per cent stake in Munich Re.
Capital marketscontinue to display ahealthy appetite forexposure to‘un-correlated’ riskssuch as reinsurance...
However, the ‘bad news’ is thatvirtually all the mainstream listedreinsurers currently trade at materialdiscounts to tangible book valueand have proved disappointinginvestments over the last couple ofyears. While many financial servicescompanies trade at discounts to book,the gap is easier to explain for banks,which are a play on economic healthand often have materially higherexposure to peripheral Europeansovereign credit risk, than forreinsurers, which offer uncorrelatedrisks ranging from catastrophe tolongevity protection.
The discount in part reflects thefact that reinsurers are perceived byinvestors to be financial equities andtheir performance fluctuates withthe fortunes of the broader financialservices sector. But this raises thequestion of why investors do notdraw more of a distinction betweenreinsurers and other financial servicescompanies?
While easy to blame the capitalmarkets for failing to understand the
industry, a large part of the answercan be found in the absence ofinvestor confidence in the diversifiedreinsurance business model. Insteadof serving to reinforce the distinctiveinvestment attractions of thereinsurance sector, the searchfor diversification is often viewedby investors as underminingaccountability and as a justificationfor growth and ‘mission creep’ overreturning cash to shareholders. In thisrespect, what might be viewed as the‘traditional’ reinsurance industryfaces a continuous challenge todevelop clear and differentiatedstrategies where ‘diversification’ isnot an end in itself, but demonstrablyproduces tangible benefits which arefully aligned with investor interests.(The need to differentiate is examinedin greater detail in the recent PwCpublication ‘Standing out is in yourhands’, July 2011).
...but, despite this investor appetite, capitalmarket valuations of listed reinsurers continue todisappoint
2 ‘Strong Investor Demand Drives Catastrophe Bond Issuance of USD 1 Billion in the First Quarter of 2011’, Willis media release, April 2011.
James QuinEuropean Insurance Market Reporting leader, PwC (UK)
“The ‘uncorrelated risk’ argument for investing inreinsurance ought to be very attractive in the currentenvironment, but the fact that virtually alltraditional reinsurers are trading at materialdiscounts to tangible book value shows that thebenefits of being ‘diversified’ are far from obvious tothe capital markets. Reinsurers need to askthemselves why investors own their stock – or perhapsmore pertinently, why do investors not own theirstock?”
6 PwC Daring to be different
The main drivers of value, such asdistinctiveness, specialism, effectivenessand orientation with stakeholderinterests have been discarded. Instead,strategies have been built ondiversification as an excuse to beeverything to everybody and the resultis a commoditised and opaque industry.
But the risk environment is changingdramatically, focusing minds on thelonger-term material risks identifiedthrough analysis of STEEP factors.Looking ahead, reinsurers mustrecognise that their customer basewill be undergoing substantialtransformation and will look and actdifferently from today’s client base.As reinsurers pursue growth inemerging markets, for example, theirproduct lines and business models mustkeep pace with the different needsof this new customer base. (See PwC’s‘What the future holds: Insurance2020’, June 2011 for further detail).In developed markets, where growthof traditional products may be static oreven in decline, reinsurers need to tapinto this capital pool by providing newsolutions for non-commoditised riskssuch as new technologies, changes inglobal supply flows and longevity.
Those companies, which do not havea response for the future, which havenot translated the emerging challengesand opportunities into a valueaccretive strategy, or those who failto communicate the underlying valuedrivers effectively to the markets,will lose their capital access andultimately be marginalised.
The time seems rightfor a thoroughreconsideration offuture strategies, valuechain positioning andvalue communication
Arthur WightmanPartner, PwC (Bermuda)
“Reinsurers need proactively to address capitalmarket concerns about the sector, by clearlydemonstrating their value creation propositionand seeking to provide straightforward andmultiple access points to suit varying investorstrategies.”
Reinsurers need to look beyond“managing the cycle” to anticipatelonger-term challenges. You need todefine the future scenarios, which bestreflect what you can believe and thenstart positioning your business againstthem, considering both evolutionaryand radical approaches.
Define a clear and clean businessmodel, which clearly aligns futurestakeholder demand with yourorganisation’s capabilities andcapacities: ask yourselves the question‘why do investors own our stock?’ anddecide who and what you want to be.Diversification can no longer be usedas a default position that supplies arationale for the company’s existence.Instead, reinsurers need to move fromthe zone of competitive disadvantage,where the majority currently reside,into the zone of competitiveadvantage (See Figure 4).
The reinsurers that will emerge withrenewed investor interest will bethose that move away from theundifferentiated centre by developingfurther and utilising their superior riskinsight, operational infrastructure,
client relationships and understandingof investor risk appetite to promotetheir growth prospects.
The focus should be on how robustand sustainable value canconvincingly be created – how adifferentiating position can be createdin this evolving future risk transfermarket. Emphasis is also needed oneffective internal steering andexternal value communicationstrategies, which need to support therationale for your strategy, businessand operating models.
How should reinsurance leadership teamsconsider responding?
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Figure 4: Assessment of strategies of select wholesale insurers
Skill
Scale
Risk transformationRisk partnership
Zone of competitive advantage Zone of undifferentiated competition Zone of competitive disadvantage
Source: PwC review and analysis of the strategies of 33 insurers. From PwC’s ‘Standing out is in your hands’ July 2011.
Achim BauerInsurance Strategy Leader, Partner, PwC (UK)
“Too often, diversification is merely the justification for growth for growth’s sakeand companies have failed to address the need to change. Those companies thatdifferentiate their strategy by focusing on strong leadership, anticipating futuretrends and assessing demand in the evolving global risk landscape will ultimatelyemerge as the industry’s winners.”
As part of our advice and support for reinsurance companies, we have beenbuilding up a wealth of data and analysis on why some firms are performing betterthan others and how organisations can maximise their value potential.
Our proprietary research and analysis into the future of insurance can help yourstrategic thinking around positioning for growth and help you consider thedifferent possible approaches to implementing a well-planned and executablestrategy that is specific to your unique goals.
If you would like to discuss any of the issues raised in this paper or know moreabout how your business can develop a clearer and more differentiated strategy forvalue growth, please contact one of the authors listed here:
Achim BauerInsurance Strategy leader, Partner, PwC (UK)+44 (0)20 7212 1405 [email protected]
Anand RaoPartner, PwC (US)+1 617 530 4691 [email protected]
Arthur WightmanPartner, PwC (Bermuda)+1 (441) 299 7127 [email protected]
James QuinEuropean Insurance Market Reporting leader, PwC (UK)+44 (0) 20 7212 [email protected]
How can PwC help?
8 PwC Daring to be different
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon theinformation contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy orcompleteness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers does not accept or assume any liability,responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for anydecision based on it.
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