EU wins Nobel Prize but it's a tough time for European insurers

A lot has been said and written about the political and economic situation in Europe. Interesting news came from Oslo last week with the Nobel Committee awarding the Peace Nobel Prize to the European Union. While I reckon that some may be right to believe that the 70-year period of peaceful time we have been experiencing in Europe since the end of World War II could have been the fruit of the European Union construction, I have my doubts that what has been true in the past decades can be verified in the future. Being Swiss and therefore not part of the European Union, I think it would be worth providing my thoughts on the topic and what it means for insurers who are about to invest in Europe today and in the near future.

Obviously there is a “BEFORE” and an “AFTER” the financial crisis and I think it is important to analyse what has changed since 2008 and the collapse of US subprime bubble, the bailout of major financial institutions including banks and insurers and the downturn in the economy experienced immediately after that.

In terms of political stability we have to admit that the situation has been pretty shaky in certain EU member countries. Actually there is a rule that applies in a majority of them: governing politicians or political parties have lost power following the financial crisis. Examples include: Spain with the defeat of the Socialist party of prime minister Zapatero, Italy with the forced resignation of Silvio Berlusconi, France with the defeat of the UMP party and president Nicolas Sarkozy, Greece with the emergence of the fragile coalition following this year’s elections. This is without saying claims from regions asking for more independence like Catalonia in Spain or Flanders in Belgium.

With regard to the economic situation, some countries parts of the Euro-zone are cause of worries. With more than 25% unemployment, Spain and Greece top this list. But what is still more worrying is not the state of their economy but its dynamic. Indeed, not only the number of unemployed people is high in these countries but the increase in unemployment is very fast. For instance the unemployment rate in Greece has been increasing at a 1% pace over the past few months. More than a debt issue, the problem faced by countries such as Spain, Greece, Portugal, Italy and to certain extend France is a lack of competitiveness and with the recession looming I fear the situation could not improve.

It is in this tough environment that insurers are planning new investments in Europe. What we have already predicted in terms of investment in new core insurance systems in the life insurance sector seems to materialize. Uncertainty seems to hit less severely the general insurance sector (property and casualty) but the industry has still to generate underwriting profits in key lines of business for instance motor insurance in France and United Kingdom. I personally think that identifying and investing in innovative business models is key to grow and generate profit in the long term in this difficult market environment and I encourage insurance companies to challenge their traditional business model.

The State of Europe

I have frequently provided my personal view in this forum about the economic situation insurance companies have been facing since the emergence of the financial crisis back in the end of 2007. I published a post in November last year titled “Time is passing, uncertainty remains“, in which I exposed my view on 3 important lessons that manifestly are proving to become reality as time passes: nations are here to stay, democracy always wins, and we cannot solve a credit problem with more credit. But today I would like to get back to an interesting figure published yesterday demonstrating that the financial industry in Europe is in a deep transformation phase that could take more years before the industry gets back to a better shape. This figure is the recent estimation of the jobs lost in the City of London published by the Centre for Economics and Business Research (CEBR), who said that City roles were down by almost 100,000 since the recession so it means we are talking about one-in-three City jobs axed since recession (more from The Telegraph). This impressive number is among others the consequence of a fierce competition that is currently happening between the main international financial cities. On the UK life insurance side, we have seen big changes too as shown in the following chart, demonstrating that the life market has gone through difficult time over the past five years:

In France, the growing uncertainty surrounding financial markets has had an impact recently on how life insurance is perceived within the French population, explaining why life and pension product withdrawal (buyback of insurance policies) increased in 2011. Without saying that insurance ROEs have dropped across the board in comparison to the pre-crisis times penalizing the main bancassurance groups in 2011: In summary, uncertainty remains and getting back to the three key lessons explained in November 2011, I think the near future will remain tough for financial institutions and insurers. Indeed, the recent presidential elections in France and the parlamentary elections in Greece have demonstrated that: 1) There is a gap between what the European Union institutions think about the future of nations and what specific populations think is good for them. This is without saying that more integration between State members part of the EU forms part of the solution to the sovereign debt crisis but populations seem to be against this idea. 2) While austerity is needed, policy makers are now talking about growth programmes triggering confusion if not conflicts with the country producing the effort to keep the whole Euro-zone construction afloat (Germany) and without saying that austerity has not really been even tried as it is brilliantly demonstrated by Veronique de Rugy:

In the light of what I observe day by day I can only repeat what I have written last year. I think that we have reached a point where the magnitude of the Euro-zone problem is too big for policy makers ability to find a successful plan. To me the time has come to plan the end of the Euro-currency under its current form and the more we wait the more difficult it will be. For insurers, there is more uncertainty ahead and I would encourage them to prepare contingency plans as Zurich Financial Services is doing.

Ouroboros or the snake that is eating its own tail!

For those of you who don’t know it, China has its own rating agency. It is called Dagong Global Credit Rating Group. This week the Dagong Global Credit Rating Group reduced its credit rating for the U.S. to A+ from AA, citing a deteriorating intent and ability to repay debt obligations after the Federal Reserve announced more monetary easing. Of course the major US rating agencies still give the highest rating to the US. So, which view from the Chinese and the American view is the closest to reality? Maybe this is not the most important question right now. Actually what is more important to know is whether China still buys US government bonds? Actually it seems that China has been less inclined to buy US government bonds recently and so have been other Asian countries. So who is buying US government bonds right now then? The response is: The Fed! This is like a snake that is eating its own tail! and the animal is very hungry… Drawing by Theodoros Pelecanos, in alchemical tract titled Synosius (1478).

The Years Ahead

It’s been a while since my May 2009 post, whose title was: The consequences of printing money. What has changed since end of May 2009? Let’s try to review the two main ingredients that are influencing our economy: Government debts are increasing. Based in Switzerland – in the heart of Europe (geographically I mean since Switzerland is neither part of the European Union nor the Euro zone) – I was in the first raw to follow the Greek crisis. The lack of fiscal discipline and the absence of economic growth in Greece have contributed to put pressure on the Euro zone but eventually a new bail-out plan (at least a guarantee to launch one if needed) has been decided with the agreement of the German government. This test has demonstrated that the Euro currency system works well in good times but represents a weakness for Euro zone countries when some of their members are in a difficult financial situation as it is the case now not only for Greece but also for Spain, Portugal and some others. Stimulus packages have still to prove they work. The US counts on stimulus packages to boost its economy. Many policymakers thought the stimulus package decided following the 2008 financial crisis would help the US economy to get back rapidly to growth, which it temporarily did but it appears now that the overall economic situation in the US is deteriorating again. If we look at the industrialized world right now we can make the following statement: 1) European countries (at least the majority of them) and the US have serious concerns with relation to their debt level. Some European countries have decided to cut public spending like the UK, Greece and Spain. So far, there is not a clear trend to implement massive tax increase. 2) The US still continues its Quantitative Easing (QE) strategy. The Fed purchases the US government debt contributing to printing more money. Right now it seems that the debt level is not a priority for the US government. This situation leads me to ask myself important questions for the future: If there is no or very slow growth for a while how will governments improve their financial situation without increasing taxes? If they increase taxes will it contribute to kill any potential economic growth that is already predicted to be anemic? Is it possible to see a major government failure in the next 5 years? Government’s bail-outs of financial institutions have not solved the problem but just allowed them to gain some more time. But we should not forget that governments can print money but they cannot print jobs. There might be a no-exit path here unless governments address the chronic deficit and debt problems and together agree to restructure the international monetary system.

The least bad decision

As we have just entered the last quarter of the year, economists and business men are trying to anticipate what 2010 will be. So do policy makers and last week the Federal Reserve has published its Beige Book . For those of you, who are not familiar with the Beige Book, it is a report published 8 times a year gathering useful economic data from 12 regional districts in the United States, whose objective is to summarize the state of the US economy. The Beige Book is also an important tool upon which the Federal Reserve counts to make decisions around interest rates. The Beige Book October 2009 edition provides two important news: one good and one bad. Let’s start with the good one: the US economy seems to have reached its bottom at least it does not show signs of more degradation. However the bad news is: the US consumption is weak and when we know that consumption represents 70% of the US GDP, it means that the recovery will be slow. Overall there are two things to learn from the last edition of the Beige Book. First of all, American people seem to change their habits and behaviour. They tend to save more and I strongly believe that this change is good for the world economic system in the long run even though it is no in favour of a strong recovery in the short term. Indeed, the US people could not continue spending so much using debt. The second interesting aspect relates to how the Federal Reserve will then adapt its monetary policy going forward knowing that US consumers are spending less money. On the one hand low interest rates facilitate speculation and contribute to making the US$ weaker. To a certain extend this situation could generate a new bubble (I wonder whether it’s not already the case). On the other hand, hiking interest rates would slow down or even stop a recovery, which is already slow. In summary there is no two best alternatives to choose from. The US and world economy depend on choices between bad scenarios and the challenge will be to choose the least bad. But when we think where the world economy was last year, this is maybe not a bad situation to be in now.

Playing it Safe vs. Creative Thinking

I recently saw an interesting article that seems quite appropriate for the times we live in. This article was based on a report published recently by Robert Half International, a staffing service. Condensed versions and commentary on this report have been available via a number of search engines in recent weeks. These days we are bombarded with stories of gloom and doom. Stock market prices are dropping, wealth is eroding, jobs are becoming scarce, unemployment is rising, and the future seems more complicated than it has ever been. We are inclined in times of uncertainty to turn inwards, start playing safe, protecting what is there in the hope that time will heal all and that things will go back to the good old days. The article (in abbreviated form) advocates exactly the opposite when it comes to business practices. “Playing it safe” is put forward as being one of the top three mistakes managers make in times like this. As the article suggests, “being boring” is not a strategy for survival because losing your competitive edge is a likely result. This does not suggest that risks should not be considered, but rather that innovation and creativity are still ways to gain ground. The second main mistake is to discount or discourage innovative thinking at all levels in an organization. Innovative thinking, the article suggests, is more likely to help an organization survive; many ideas can be put into the pool to not only assist the organization but also encourage a sense of joint survival among all employees. Rewarding such behavioral thinking is an added encouragement. This concept can only thrive in an environment where managers actively encourage this and do not feel threatened. Managers should therefore actively participate in this process. Here in China, we are not unaffected by the issues that have been making page one news all over the world. We have seen many businesses close and unemployment levels rise. We too have recently seen a large injection of government capital into the economy to both boost and revitalize industries. Creative thinking and behavior at management levels to avoid the sometimes obvious mistakes could be another path on the way to revival and survival.

Dealing With Irrational Pessimism

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets… But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions…?

–Alan Greenspan, December 5, 1996

Quick, somebody, send Alan Greenspan a note. His quote during the dot-com run-up was prescient (even if his policies were not!), but I think we’re getting the answer. Now, we know.

Irrational exuberance was replaced with aw-shucks humility when the dot-coms sold off all their foosball tables. But then the traditional companies stepped in with some magic of their own. CDOs and other financial sleights of hand worked for a fashion, but then, according to Berkshire Hathaway’s Warren Buffett, they led us off a cliff. Now, we’re left with…irrational pessimism? Consumers and businesses are all sounding like Eeyore, the gloom and doom donkey.

So where to from here? I’ll leave the economic prognostication to someone else. But much of the current malaise seems to stem from consumer attitudes. So my prescription to start the healing process in the insurance industry is aimed directly at consumers, starting with readers of Celent’s insurance blog.

Here are three things I want you to do, starting today:

1) Buy some insurance that you intended to live without. You probably still have insurance on your car, your house, and your life, so those don’t count. But if you want to raise your coverages (especially against the backdrop of declining values!), that counts. Other good options: umbrella coverage on your home or auto policy, pet insurance, and long-term care insurance. Think of it as giving the industry its own stimulus check every time you pay the premium.

2) Call your agent and say encouraging things. Of course, buying something is about the nicest thing you could for your agent. But a little encouragement is always welcome. And we’re never going to pull out of this if we don’t have people selling our products.

3) Call the president of your carrier and demand better service. As the economy sags and people start looking for places to save, insurance is a tempting target. One reason is that people don’t get a warm, fuzzy feeling from their insurance experiences. Buying insurance, obtaining service, and making claims are all moments of truth where many insurers miss the mark. By putting pressure on service delivery, you will help your carrier retain current business and position itself to get more. Plus a side benefit: technology and service vendors in insurance will have healthier pipelines if the service imperative is emphasized.

Back to the future…

The major international equity indexes have lost ground this week, dropping by 3 to 4% in average. It appears that the recent numbers issued by companies have increased the global fear of a deepening recession. Despite a clear sign of confidence regarding its own future provided by Munich Re last week and notably its decision to keep its dividend per share stable, investors prefer giving more importance to the bad side of the coin for instance the disappointing Swiss Re numbers. The big giants have adopted different strategies and it seems that the German company is weathering the storm better. In the banking sector, the two biggest Swiss banks CREDIT SUISSE and UBS have announced billions of losses for 2008 but both companies see improvements ahead and expect good news already in Q1 2009.

Even though the overall environment doesn’t look great, I’ve got the feeling we are entering a phase of exacerbated pessimism in opposition to the irrational exuberance described by Alan Greenspan when he was talking at the Annual Dinner and Francis Boyer Lecture of The American Enterprise Institute for Public Policy Research in Washington in December 1996. Are financial markets so emotional that they exaggerate all kinds of perceptions in the highs as well as in the lows? According to me, there are clear signs of over-reaction or anticipation resulting in above-average volatility on the equity markets, which adds more uncertainty for the future of the insurance and the banking industry. That being said, the economical slowdown is a necessary cure to get back to basics. Then, we will enter into a sound prosperity for a while before diving in some kind of amnesia and enter a new exaggeration phase. The economy and especially the financial industry need bubbles to surf on but now it’s time to rest a bit before finding the next one…

The Potential Growth Segment of Rural China

Being a Celent insurance analyst based in China, I sometimes meet with Celent customers who visit Beijing and share my insights on China insurance market growth and technology development. Many customers are interested in the potential market size, the competitiveness of the market, and the progress of technology. But recently, when I meet Celent customers in Beijing, they ask me a new question: will the insurance industry in China continue its high growth? Consumer confidence is down because of the global financial crisis and the many countries in recession. Thus China’s exports are decreasing quickly, and because this influences other industries, we’re seeing China’s economic development slow down. Facing this, the Chinese government decided to stimulate internal investment and consumption. Since China has a population of 1.3 billion, it is a big market for its own products. At present, the rural areas in China are underdeveloped, and rural incomes are much lower. Some government policies are aimed to increase rural people’s income. So in the not too distant future, the rural area could be a large potential market for many industries, including insurance. The insurance premium from rural areas is very low. The market is dominated by a few large insurance companies and is still not highly competitive. The products being sold in rural areas are not specialized for rural people and thus couldn’t arouse their interest. The distribution channel is still dominated by sales agents. In June 2008, China insurance regulators started the micro-insurance experiment. To participate in the experiment, companies must develop simple products targeting low income people in rural areas, with payouts of RMB 10,000 Yuan to RMB 50,000 Yuan, low premiums, simple underwriting rules, and a simple claims process. The regulation also promotes the use of multichannel distribution and new technologies such as wireless solutions. By entering into the rural area, in the beginning, insurance companies may only get a very low premium from each client. However, as a mid-term to long-term investment, the rural area is a huge potential market for insurers, and future, rapid growth could still be expected.

The Rise of the Capable Insurer

I was talking about the financial crisis to an executive at a large life insurer recently. Given the steady stream of dismal financial news over the past two months, you might have expected it to turn into a “woe is me!” conversation. But in fact, the opposite occurred.

“We’re doing fine,” the exec told me, “and quite frankly we’re patting ourselves on the back for sticking with our investment strategies.” Their CFO had apparently resisted the pressure to chase high returns and is now being hailed internally as a quiet hero. As a result of his tenacity, the company is well positioned to invest in technology, service innovation, and perhaps even acquisitions of some less fortunate (less lucky? less well-run?) companies.

This is one example of an insurer doing things right, and doing things well. Somehow the bad news about our industry blares from the rooftops, while success stories like this get little notice. We’ve tried to elevate the success stories through our annual Model Carrier research, which offers a series of short case studies on effective use of technology. But it is difficult to battle the perception that insurers are laggards in terms of their business and technology strategies.

This theme of the capable insurer came up again last week at a Celent breakfast event in London. My colleague from Oliver Wyman, Andy Rear, used the term to frame a discussion around the strategies of insurers poised for success. His thesis—that capable insurers are emerging, particularly those that effectively manage customers, create rational service models, maintain operational agility, and recycle capital rapidly—really struck a chord with me.

There will always be winners and losers in the battle for premium dollars and customer loyalty. And we agree with Andy that the winners will have clearly defined strategies that make them more nimble and responsive to constant market changes. Getting there, as always, will be a challenge. But examples are emerging, so we know it can be done.