Academic journal article The McKinsey Quarterly

Facing Up to the Losses

Academic journal article The McKinsey Quarterly

Facing Up to the Losses

Article excerpt

An analysis of the European insurance industry on the verge of a structural shake-up

On July 1, 1994, the third EC insurance directive will further deregulate the European insurance industry, providing another brutal increase in competition that will put in jeopardy the fortunes of the majority of Europe's traditional insurance providers. Indeed, dramatically changing patterns of competition have already begun to anticipate the painful effects of deregulation: the industry is on the verge of a structural shake-up, and the losses will be heavy. The strong likelihood is that many traditional multi-line insurers will break down under the pressures -- financial and managerial -- of a genuinely free market. But there are basic changes these companies can -- and must -- make now to steer their way through the coming period of deep structural change.

WITH ITS ASSETS of more than US$2.2 trillion growing faster than GDP, the European insurance industry has long been a well protected and very profitable financial machine. It has also been extremely fragmented: more than 2,000 companies; a wide variety of sales methods, financial reporting methods, and tax regimes; and huge cross-border variations in market penetration and in the premiums charged for comparable coverage. (The average per capita premium in Greece, for example, is US$115: in the United Kingdom, US$1,907.) As a result, when the protection offered by national laws disappears, the degree of upheaval in insurance will be considerably greater than in most other regulated industries.

Based on government-approved premiums and conditions, European insurers' decades-old formula for success -- "go for volume" -- is not merely obsolete. It is a recipe for disaster. As in the United States' airline, transportation, and financial services industries in the late 1970s and 1980s, far-reaching deregulation will lead to extreme difficulties for -- and even the demise of -- many traditional carriers. When economic ground rules change, poorly-managed companies will no longer be able to survive, let alone prosper. Only the fittest will stand a chance.

An industry in transition

The balance sheets of many of Europe's major insurance and reinsurance groups are already beginning to show the signs of increasing pressure on profits: underwriting results in 1991 and 1992 were sharply down. This is not, as it was in the past, merely the reflection of a temporary dip in the underwriting cycle. t marks the onset of an unstoppable transition.

In the more deregulated environments of the United Kingdom, the Netherlands, and France, industry profitability has plummeted, in some cases to levels only one-third those of such markets as Germany and Switzerland (Exhibit 1) -- markets that are still heavily regulated and obviously on the brink of a drastic decline in profitability.

The economic logic for the impending collapse in profits across the region rests on:

* Overcapacity of 30 percent or more in sales and administration. The capital resources built up during the long era of high growth rates and stable profits are now making possible much more aggressive competition. Products are rapidly degenerating into commodities, as prices and margins decline in the general search for volume to fill capacity.

* A rush of specialized insurers into the market with simplified and, in some cases, 40 to 50 percent leaner cost structures is grabbing share away from established multi-line insurers -- and fundamentally changing the whole industry's cost curve.

* More discerning customers are beginning to see insurance as a major financial burden and are actively seeking more favorable terms and conditions. As households and industrial corporations alike opt for self-insurance much more frequently, the total volume of premiums in the market will fall by 20 to 25 percent from today's levels.

* Financing the enormous investments now required in systems and marketing will force insurers to ratchet up profitability levels or liquidate hidden reserves. …

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