What goes around, comes around

In 1858, Janet's Repentance in Scenes of Clerical Life by George Eliot included the words: “History, we know, is apt to repeat itself.” Since then this adage has been continuously used and applied to many circumstances and industries.

Some people have never been convinced it is true. In 1957 Vera Brittain published Testament of Experience. It proclaimed: “History tends to defy the familiar aphorism; whether national or personal, it seldom repeats itself.”

In looking at the future for insurers, do you go with Eliot or Brittain? Are the big drivers for change over the past few years going to be repeated or will a raft of new factors and challenges shape the future?

Anyone studying the insurance industry over the past few decades could easily conclude that entirely new types of challenges are extremely rare. The difficulty seems to be that most insurers fail to recognise that history is indeed repeating itself.

In 1979 someone proclaimed: “We have seen an end to the merger and acquisition activity in the insurance industry.” The fact is that in the last two decades there has been an average of more than 30 mergers and acquisitions each year involving UK insurers.

“There is no scope for a new motor insurer to enter the market and challenge the big established players,” commented an industry expert in 1985 on the formation of Direct Line. So what about its two million-plus motor policies today?

In 1991 it was said: “Motor insurers have learned the lesson of underwriting losses, and the massive losses of the last few years will not be repeated.”

Well said, but in truth the losses were to be exceeded between 1997 and 1999.

Many more examples could be cited.

All suggest that many, or even most of challenges facing the insurance industry are already evident. They are not new but, in reality, variants of what has gone before. The key influences today for general insurers are largely the same as in 1990 or 1980. That is not to say that the insurance market in Britain is not changing rapidly, but the drivers for change have a remarkable similarity.

Important factors today, yesterday and tomorrow are take-overs, mergers and new entrants, competition, political, regulatory and consumer challenges, and technology

In regard to take-overs, the biggest are getting bigger. Market concentration is increasing. Old established names are disappearing. Size matters if you are to compete globally.

Merger and acquisition activity takes place all the time. The difference today is that the past four years have witnessed mega-mergers in addition to a whole series of smaller ones. In the decade to 1995, the average value of mergers and acquisitions involving UK insurers was under £2bn a year. Since 1996 the average has jumped to more than £6bn.

Of the top 50 companies it is likely that ten will not be separately listed in two years. UK general insurers are small by European standards and their market capitalisation makes them easy prey for an overseas predator or easy to accommodate in a merger.

Most of the consolidation over the past decade has been between UK insurance companies. However, given factors such as economic and monetary union, greater harmonisation within the single market and the need for insurance companies to build local presence, the number of cross-border mergers and acquisitions can be expected to increase considerably in the near future.

An example is Allianz. Allianz Cornhill needs to change significantly if it is to fulfil the European ambitions of the company. A major take-over is likely, with a resulting sort-out of the niche range of UK products and companies that form the group.

Royal & Sunalliance is very vulnerable. On September 25 its market capitalisation was just £6.8bn. This compares to £33.5bn for Lloyds TSB. It could be a tempting proposition for an overseas predator. The £8bn or so to take them over would be small change. The shares yield 5.3%, so they would enhance the earnings of the big European insurers.

Much cheaper and easier to swallow would be Independent Insurance. It has attracted take-over speculation for some time and even today its capitalisation is only £766m. As a well-run niche player, what is perhaps more significant is that the shares yield just 1.6%. This means it is probably less likely to be taken over.

However, in spite of the high number of mergers and acquisitions, the number of UK insurance companies is not, as yet, showing any signs of decline. It is easy to enter the market and so we have an increasing polarisation between large insurers and smaller niche players.

It will be interesting to see if the smaller companies start to take market share away from the big insurers. This seems highly likely as small and medium-sized companies take advantage of confusion and reorganisation following mergers and acqusitions activity.

Competition

Little needs be said about competition. It exists and can be fierce, but its effects can perhaps be overstated. In the past seven years, general insurers had an average trading profit of 7.7% of premiums, which represents a reasonable return on capital employed. It should be even better in the next couple of years.

Others have done even better out of the industry – enjoying returns that are likely to have been higher than from their main line of business and at virtually no risk. Tesco making over some shelf space to
sell financial products is a good example.

Anyone with a customer base can get an insurer or two as backers so they can enter financial services at little or no risk to them. This is driving some insurers towards being wholesalers rather than retailers of insurance. This trend is likely to continue. Some insurers have important lessons to learn about risk and reward.

Challenges

Insurers face important political, regulatory and consumer challenges in the next year or two. Many general insurance products have virtually become commodities, customers are becoming ever more choosy and demanding higher standards, and the image of the industry is generally weak which makes for added problems. The government is also expecting and demanding more of the industry.

Social and financial exclusion and welfare state reform are major areas of importance. There are potential commercial opportunities for insurers but also dangers if the industry is unable or unwilling to deliver what the government considers to be reasonable. There are no easy solutions, but the issues need to be much higher up the agenda for individual insurers and intermediaries and the industry collectively. Insurers should have regard to the battering that banks have taken.

The industry's weak image is a limitation. It means insurance is seen by the government as a way of gaining revenue and transferring responsibilities. This can result in retrospective costs, pricing insurance out of the market and affecting the commercial operation of the market. Recent examples are the recovery of NHS charges and the imposition and increases in the rate of insurance premium tax.

Regulation will remain an important issue. A change in regulator and a different regime will result in clear winners and losers in the industry.

If the General Insurance Standards Council (GISC) is not perceived as successful, it could damage the industry. Squabbles over membership and support would be damaging. Equally so would be the GISC saying or doing things that the industry does not believe are reasonable or within its remit.

Technology

Good use of technology and internet development are vital ingredients to success. Both require vision, excellent staff and partners and plenty of money. Some insurers have got their IT needs worked out and this is helping to improve customer service and drive down costs. This factor alone separates the successful from the likely failures.

Insurers have generally not inspired confidence with their internet ventures. Some of the lessons from their entry into direct writing have not been learned. There is a danger that the growth and profits from internet development will pass many insurers by.

Saturation point?

The one completely new challenge for insurers may be a decline in the size of the industry. In 1980 the UK premium income of general insurers was around £5bn. By 1990 it had grown to over £16bn. In 2000 it will be over £25bn. This is an impressive increase and greatly in excess of economic growth and inflation over the period.

In the 1980s, however, there was a three-fold increase in premiums, compared to a 50% increase in the 1990s. Has the industry reached saturation point with little or no real growth likely in the next decade?

In the commercial sector the trend to minimise insurance premiums has been well established for some time. There are early signs that this is happening in the personal insurance market in the UK. People instinctively continue premiums because they think it is a good idea even if, on reflection, they would be better bearing some of the risk themselves. This inertia may be breaking down. New policies with, for example, significant excesses and lower premiums are emerging for higher net worth people.

In addition, in the last few years the insurance industry has encouraged a degree of risk transfer from themselves to policyholders. It has encouraged risk improvement and discouraged claims. Premiums have been driven down as a result.

The trend away from insurance has been encouraged by Insurance Premium Tax (IPT). For example, you now buy a maintenance contract in Dixons rather than an insurance extended warranty policy. IPT adds directly to the cost of an insurance policy.

Self-insure and you pay no IPT. Retain more risk and reduce your insurance premium and you pay less IPT. If IPT increases further, significant volumes of premium income may be lost to the insurance industry.

The next decade may, therefore, see both individuals and businesses relying less on insurance for their protection. Instead they will invest in risk improvement, manage risk more themselves and rely on alternative risk management techniques.

This could be good news for insurance intermediaries if they can adapt and market services to encourage and meet changing needs. It may not be good news for insurers who could face a static or gradually declining market with greater competition for remaining business.