Insurance - Business issues
A series of natural disasters have hit the headlines over recent years. According to the UN, hurricanes, floods, earthquakes and tsunamis caused $109 billion of economic damage in 2010 - three times more than in 20091.
These catastrophes have also, naturally, hit the insurance industry. Few Lloyd’s of London insurers reported profits for the first half of 2011.
The industry has remained robust and proactive in the face of such adversity with an innovative approach to product development and a sustained commitment to dealing with the effects of climate change.
On the product innovation front, an example is Catastrophe Bonds (cat bonds) - a form of insurance securitisation that allows risk to be spread to investors rather than insurers. Cat bonds provide protection for the insurer’s balance sheet if a payout needs to be made and also give policyholders confidence that they are protected. If a catastrophe occurs, bondholders lose their money – because it is paid to policyholders.
Disasters such as Hurricane Irene triggered a flurry in the trading of these securities, reflecting their growing usefulness across international insurance markets2.
INNOVATION IN P&C: ONLINE OPPORTUNITIES
The volume of quotes for P&C insurance generated online continues to grow exponentially. Intense competition may be driving incomes down – but it is also making insurers more creative in the way they tailor policies and use the Internet as a channel to market3.
Insurance companies have also shown similar proactivity in addressing the risk of global climate change which may exacerbate or cause such natural catastrophes. High profile initiatives have included the formation of ClimateWise in 2007 and the role of senior insurance industry figures in liaising with Governments around the world4.
Whilst it may have been buffeted by natural disasters, the insurance industry has at least remained relatively sheltered from the other storm currently sweeping the world: the global financial crisis.
Although part of the financial services sector, insurance has remained relatively demarcated from international financial institutions and markets.
In P&C insurance whilst falling incomes amongst consumers may represent a threat to revenues, insurers in this sector had already developed a focus on data warehousing and business intelligence. Analysis and profiling is helping them to optimise risk management and automate compliance as well as offering consumers more personalised policy options in order to gain a competitive edge.
Of course, insurance companies invest in equities, bonds and capital markets and the giant American International Group (AIG) suffered its own massive losses that necessitated a Government bailout.
But across the industry as a whole, exposure to the type of asset-backed securities that turned toxic with the failure of the American sub-prime market has been limited compared to that faced, for example, by the banks.
There are nonetheless other shared financial services challenges which insurance companies have not and will not be able to avoid.
Principal among which is the burden of regulation.
The Solvency II Directive for insurance and reinsurance companies is scheduled to come into force on December 31st 2012. Complying with this and a raft of similar legislation will necessitate additional investment in areas such as technology and will certainly tie up management time that could otherwise be put to productive use. Failure to comply also represents a heavy risk in both financial terms and loss of reputation.
In addition, insurance companies may experience severe downward pressures on their future growth and profitability caused by the increased capital holdings which new legislation obliges them to put in place.
