Global trends in insurance and risk management

1
Global trends in insurance and risk management

• Mike Cullen
• Managing Partner - Markets

2
Overview

• The main theme of this presentation is value
• Where is the value to the customer in insurance
  and risk management?
• Where is the value to the investor in financial
  services companies?

3
How the world used to be

• Customers
• Professional service firms
• Insurance brokers
• Insurers

4
Broker Consolidation
1990
2000
2005

• Marsh McLennan
• Alexander and Alexander
• Bain Clarkson
• Hudig Langeveldt
• CT Bowring
• Arthur J. Gallagher
• Hogg Robinson
• Alexander Howden
• Sedgwick
• Stewart Wrightson
• Willis Faber Dumas
• Johnson and Higgins
• Lowndes Lambert
• Fenchurch
• Jardines
• Lloyd Thomson
• CE Heath
• Nicolson Jenner Leslie
• Alwen Hough Johnson

• Marsh
• Aon
• Willis Corroon
• Arthur J. Gallagher
• HLF Insurance Holdings
• Jardine Lloyd Thompson
• Alwen Hough Johnson

?
More than half of the 1990 top 20 Insurance
Brokers no longer exist.
The future is oligopoly
5
Convergence of broking and professional services

• Massive consolidation of broking sector
• Where will broker growth and profit come from?
• Disintermediation
• Commoditisation of placing risks
• Self-insurance
• Diversification of brokers into risk management
  and general consulting
• ..but thats what we do

6
Convergence of broking and professional services

• What next?
• Broking becomes a cash cow for the remaining
  broking companies
• Ernst Young, Slaughter May, Marsh and Aon all
  operating in the same market
• A few giant financial service firms that do
  everything?

7
Advising customers

• Professional service firms and brokers are not
  the only ones seeking to provide advice to
  customers
• Is an insurer a product provider or a solutions
  composer?

8
Product provider or solutions composer?

• Private car insurance smooths the cost of
  repairs or keeps you mobile?
• Personal injury insurance rehabilitation and
  risk management

9
Personal Injury rehabilitation and risk
management

• Social inflation outstripping publics
  willingness to pay premium inflation
• Medical improvements help people live longer
• Judicial and legal developments
• Expectation of care at home rather than in
  hospital
• Government plans to recoup NHS costs from insurers

10
Personal Injury rehabilitation and risk
management

• Reactive and adversarial claims management
  proving to be inefficient and ineffective
• Introduces delay into the process of diagnosis
  and treatment
• Litigation exacerbates the delays and greatly
  increases the ultimate cost
• Move towards proactive and cooperative approach

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Proactive and cooperative approach to personal
injury

• Risk management advice to help reduce claim
  events
• Early expert diagnosis and treatment greatly
  reduces potential cost, eg whiplash claims
• Active management of claims helps claimants
  return to work earlier
• Treat third parties in the same way as
  policyholders

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Constituent parts of an insurer

• Customer relationship business
• Product innovation business
• Infrastructure business
• Asset management business
• Capital management business

13
Customer relationship business

• Potential for value where the customer wants
  advice and is willing and able to pay
• Commodity products and services will be sold on
  price through the most cost efficient sales
  channels

14
Product innovation business

• Sustainable advantage from product design?
• Increase value to segments of the insured
  population through risk adjusted pricing

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Risk adjusted pricing

• Reveals the cross-subsidisation between
  policyholders
• Niche players can take advantage to make
  short-term gains
• Increase the number of uninsured risks?
• Vigilante consumerism
• Impact on society and Government reaction?

16
Measures that matter to equity markets
17

• As industries evolve, trusted ways of creating
  value are also evolving
• managing physical and financial assets and
  managing earnings are no longer sufficient ways
  of growing value
• non-financial activities are key drivers for
  growing future value
• The FS sector is no exception
• Ernst Young study identifies the key
  non-financial drivers for the sector
• through interviews, survey and statistical
  analysis
• and concludes there is a huge potential for
  improvement
• by actively managing their critical non-financial
  activities

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Evidence Past performance is not a good
indicator of market value
SP 500 (10 yr. example)
4
Mkt. Value
3.5
3
2.5
2
Normalized Value
Earnings
1.5
Book Value
1
0.5
0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
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For financial services, continued success in
growing earnings...
Earnings Per Share
20
has done little to make it a high performance
industry
Price / Book
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Conclusion

• Market expectations
• past financial growth and past physical
  investment
• are increasingly unreliable indicators of the
  future
• then what are reliable indicators?

22
Much of the future value is in the performance of
non-financial activities

• such as strategy, management quality, corporate
  governance, human capital, innovation ..

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Why?

• Because reports on non-financial activities
• provide investors with information not contained
  in financial reports
• are often leading indicators of future
  performance
• At least 35 of market valuation is attributable
  to non-financial activities
• as shown by EY study Measures that Matter
  across a range of non-FS sectors
• and analysts forecasts are considerably more
  accurate when non-financial activities are
  incorporated

24
For FS companies

• Both analysts and executives say that
  non-financial activities are very important
• about 45 of market valuation is attributable to
  these activities

25
Discussion of the Results

• Obviously considerable overlap
• both stressed branding and the importance of the
  customer relationship
• Key points of difference
• investors stressed consolidation, ie. successful
  completion of strategies and the commoditisation
  of high quality products
• CEOs stressed convergence, ie. increasing
  breadth of reach and products
• investors wanted improved communication, CEOs
  did not!
• Our interpretation market perceives focused
  excellence to be better than broad mediocrity

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The Survey

• Scope
• covered 255 investors and 55 buy-side analysts
  across all market sectors
• including 40 FS companies
• Method
• provided with list of non-financial activities
• including the multi-sector study Measures that
  Matter
• asked to list in order of priority

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• Results of the Survey
• Non-financial activities for FS companies
• in order of priority

• Execution of strategy
• Quality of management
• Innovation
• Customer franchise reach strength of
  distribution
• Quality of strategy
• Customer franchise brand
• Human capital attract and retain talent
• Customer franchise quality of CRM

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The Results

• Our Interpretation
• develop a consistent vision, then focus on
  delivery of strategy
• credible management to ensure efficient delivery
• everything else follows ...
• This is consistent with interview findings
• In addition the survey covered relative
  performance across the sectors
• FS companies performed consistently badly
  compared to all other sectors surveyed
• in all non-financial activities
• which is consistent with poor market performance

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Back to the Investor Interviews

• We asked about comparative performance
• FS companies were perceived as poor in
• strategy execution and delivery
• quality and experience of management
• lack of meaningful vision for both product and
  service
• strength of customer relationships
• strength of investor relationships
• corporate governance
• with a small number of exceptions
• perceived to be strong across all activities,
  such as ABN AmRo, AMEX and MSDW

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The Outcome Main non-financial activities
Non-financial Category
Degree of Influence
Strategy
Very high
Human Capital
High
Medium
Management
Company Image ie. brand, customer
social responsibility
Medium

• all other non-financial categories were not
  statistically significant

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The Outcome Our Interpretation

• Results reinforce conclusions from interviews and
  survey
• successful implementation of strategy is critical
• human capital and credible management also
  important
• corporate image is also important

• Non-financial activities are significantly
  important contributors to stock value

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Overall Conclusions

• Non-financial activities are important for FS
  companies
• approximately 45 of market value is driven by
  non-financial activities
• strategy, human capital including management
  quality, and company image are the most important
  in driving company value on capital markets
• not all non-financial activities are effective
  differentiators
• FSI performs non-financial activities badly
• financial analysts give relatively low ratings on
  the non-financial activities of FS companies
• executives and investors disagree on some of the
  most important activities
• Statistics can identify highly-rated activities