If the financial crisis proved one thing, it’s that stellar growth is no guarantee of a business’s viability. A more balanced outlook is required
Since the beginning of the financial crisis, there has been a worsening in the performance of insurers which, to a large extent, has been led by the severity of the decline in investment performance. This deterioration, together with high-profile shocks at some insurers, led to a widespread loss of investor confidence.
Previously focused on revenue growth and return on equity, insurance analysts have changed their track and openly place balance-sheet strength, robust risk management and operational efficiency at the top of their agendas. Such changes in investor demands are likely to remain in place until 2012 at the earliest, as a changing regulatory landscape is also expected to shift the goalposts for insurers. With the implementation of Solvency II in the EU, the historical focus on growth as a basis of measuring insurers’ performance has increasingly come into question.
The focus these days is on balance-sheet strength and financial viability, and against this background the role of the analysts in the insurance sector has become increasingly important. Some insurers have struggled to convince shareholders that their balance sheets are sound and that new business is not being written at the expense of disciplined underwriting. As a result, there is an increasing need to focus on balance-sheet efficiency, and risk management as a top priority in any insurance organisation.
Where insurers have been challenged by the financial crisis, this has, to a large part, been because they have failed to convince their shareholders of their financial viability. Thus, there is a need to clearly articulate the business operating model and strategy to external shareholders and analysts alike.
A Deloitte survey shows that shareholder priorities moved markedly between 2006 and 2009. Analysts were asked to rank the medium- to long-term (three years) performance criteria they used to judge insurance firms. In 2009, balance sheet and risk management scored 97%, while revenue growth scored just 43%. Compare this to 66% and 81% respectively in 2006.
The question is whether these new priorities are simply a knee-jerk response to the credit crisis. Analysts remain convinced that balance-sheet efficiency and risk management will remain a central focus until 2012. This is not only in Europe, where Solvency II will lead to more efficient capital models, but also where modifications to accounting rules to improve comparability and transparency, such as IFRS (International Financial Reporting Standards), will continue to focus analysts’ attention.
Against this background, the insurance industry needs to address balance-sheet efficiency and risk management as a priority.
This may require a transformation programme for the finance function, including management information solutions to improve the measurement of capital allocation, as well as reviewing the product base to understand its capital efficiency.
To conclude, a focus solely on growth as a key performance indicator may be unwise in the current business climate and for some time.
The main focus needs to be on balance-sheet strength, not on revenue growth. IT
Ian Clark is an insurance partner at Deloitte.