Academic journal article The McKinsey Quarterly

New Strategies for European Insurance

Academic journal article The McKinsey Quarterly

New Strategies for European Insurance

Article excerpt

Corporate premiums for predictable risks will likely disappear Four very different value propositions are emerging Supplementing welfare, asset gatherers, or service providers?

At first sight, it might seem a relatively straightforward task to define the size and scope of the European insurance market. Statistics show that the property and casualty (P&C) market in Germany is worth DM100 billion, for example, and that Switzerland has Europe's highest life premiums per capita.

But statistics mask industry trends that pose significant strategic questions for every chief executive officer of an insurance company. The traditional delineation between life and non-life insurance products is beginning to fade, as is the distinction between the insurance and reinsurance businesses. At the same time, the very boundaries of the insurance industry are blurring. Life investment companies, reinsurers, asset managers, investment bankers, and private bankers all find themselves competing in the same arena for business not always traditionally regarded as insurance.

To define insurance in terms of the types of cover available, such as motor, death, invalidity, and fire, therefore no longer suffices. A different gauge, capable of reflecting the industry's growing complexity, is required if CEOs are to understand the trends in their industry and plan accordingly. It is therefore useful to examine the four value propositions around which today's European insurance industry appears to be grouping.

Insurance as an instrument to cover unpredictable cash needs

For many customers, insurance policies are instruments for meeting unpredictable cash needs: a premium paid in advance gives the insured the right to get cash when a clearly defined event happens, be it fire, death, or a hurricane. In many respects, insurance policies are similar to financial options traded in today's derivatives markets, whereby a premium paid in advance gives the investor the right to sell (or buy) certain assets at a fixed price sometime in the future.

It is a similarity that a handful of the most sophisticated insurance companies and multinationals are beginning to exploit to their advantage. Rather than paying premiums to an insurer or reinsurer to cover their risks, these companies are de facto buying an "insurance option" - an instrument that guarantees cash as and when losses occur, regardless of any specific line of business. If these new instruments become common currency, they will threaten great chunks of traditional insurers' revenue.

It works like this. Rather than insuring every aspect of its business, a multinational splits its traditional insurance needs into predictable risk (risk that can be predicted statistically and for which it can plan, such as a small fire or a strike) and severe risk. The predictable risk is no longer insured, as the company will itself be able to provide the necessary cash. Severe risk, however, such as a hurricane that destroys an entire plant and could bankrupt a company, needs to be covered. Although this risk is still largely placed with insurance or reinsurance companies, there is an emerging trend toward placing it in the market. Instead of buying an insurance policy, a company could issue "risk bonds." Normally, buyers of these bonds would receive an annual premium, but in a year when unpredictable risk occurs, they could lose part of the principal of their investment. In effect, insurance risk could start to be securitized just like credit risk.

Some multinational corporations are already going one step further and wondering why they cannot combine their insurance risks with other risks, such as currency risks, issuing a single instrument to cover losses from whatever source - be it a huge fire or a currency collapse. Reinsurance companies such as Swiss Re and other global insurance companies, mostly via their Bermuda subsidiaries, are starting to offer products in this area. …

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