Being a success story

Insurance doesn't actually have a particularly good reputation with investors. When you look at the return of equity from a number of sectors within the financial institutions area, and the average return on equity between 1988 and 2002, asset management companies like Foreign and Colonial achieve an average return on equity of 17.3%.

Investment banks achieve 16.8%, while going down to commercial banks they achieve an average return on equity of 14%

Then comes life insurance at 12.2% and finally non-life at 6.2%, and that compares with an average weighted cost of capital of 12%.

What these figures actually mean is that effectively most of these businesses lost money, particularly if they were insurance carriers, and the only thing which helped them to make money, was the investment of their capital in a rising stock market.

The Lloyd's chairman, Lord Levene, recently told an audience of insurance industry professionals that the property and casualty industry, since 1980, has collectively lost $437bn.

And do you know what the audience did? They just laughed, which I thought was rather extraordinary. The only time that the property and casualty industry has actually managed to make an underwriting profit was in 2004.

So what you see in the insurance industry is just a few successful companies, JLT being one, AIG, despite all its recent problems being another, Progressive in the US and Willis, since it came back to the market, are others.

But despite the appalling record, with only a few success stories, the extraordinary thing is that investors keep returning to insurance.

Before 31 December this year, between $10bn and $15bn of extra capital is going to be raised, primarily for the reinsurance and retrocessional reinsurance industry.

But, there are broader issues facing the industry. The first thing is increasing regulation, now we all know about increasing regulation and the regulators mean well, we know that, they're driven by, to an extent, political considerations.

But regulation comes at a price, first of all the hugely increased costs of having to comply. But just to highlight a number of features which have come in, have sort of been introduced and affect people working in the insurance business.

We've seen in this country endless pressure, particularly on IFAs and also on life assurers, in the mortgage endowment mis-selling scandal. We've seen Spitzer. The fall-out from that has real implications, particularly for brokers, both in terms of disclosure, but also in what they actually do. Do they represent their customers, do they, therefore, not take commission from insurers related to the profit from the books of business which they put to that particular insurer?

I happen to be a bit of doubter as to whether, particularly in the London market, it will be able to satisfy the regulator by the end of 2006. So what are they going to do about it, that is an uncertainty. And if you are actually looking to raise capital, just remember that all the rules, as result of EU regulation, have changed.

You cannot now go to the AIM market without issuing a prospectus. And if you're raising money privately, you need to be very careful.

A chief executive of one of the Lloyd's businesses told me the other day that the hurricanes last year, Charlie and the rest, were one in 100 year events. But now I find myself with Katrina, Rita and Wilma appearing over the horizon, and I have another one in a 100 year event.

So, when I started working in this business it was the last of a series of 100 years and we had a one in 100 year event in that period, and now I've moved into the next 100 years and I have the first of one in a 100 year event.

But it isn't like that. Disaster modelling is going to have to be redone, and a large part of this is climate change. Whatever anybody might say about climate change, and I can speak here in my capacity as a trustee of the National Trust, which is the largest landowner in Britain, we know that climate change is happening, we see it on our properties.

Climate change is a real issue, with rising temperatures and rising sea levels. It's a real issue for the insurance industry, and nobody can say that it isn't. And then of course terrorism, which is another factor.

Another ingredient within the increasing sort of risk is the increasing tendency for litigation. We are a much more litigious culture, and it's not just because of ambulance chasing lawyers. We are just more litigious and we place less value on the concept of 'my word is my bond'.

And then there is just change generally. First, the impact of technology, there are change distribution patterns affecting the insurance industry, the rise of e-insurance, the success of a company like Admiral and the risk of increasing broker disintermediation.

Technology could have a great impact on the efficiency of the insurance industry.

The other change is the customer. It's the flip side of the more litigious culture. There is less customer loyalty, customers are less sticky, they shop around, they can access quotes on the internet, they're bombarded with advertisements for the internet or for telephone insurance.

Another change is the rise of Asia, not just the opportunity from Asia, but also the labour costs. That you can outsource to Asia at a cost for one person, an intelligent graduate, hard working graduate, will cost one tenth of what they cost in Europe.

In conclusion, there are very few companies that have been success stories, particularly in the public markets.

Now fortunately most investors have short memories, and that's the great thing. They do have short memories. IT