Last week's vote on the UK's membership of the EU sent insurance shares into a spin. Companies in continental Europe, the UK and Asia fell heavily as investors tried to digest the impact of the vote to leave.
The prospect of Brexit gives the industry an extra problem to cope with in the coming years, raising questions over London's status as a global centre for the industry.
But even before that, the broader insurance industry faced a range of challenges. Insurers are having to answer questions over how they do business, how they make money and what their industry will look like in 10, 20 or 30 years’ time.
These challenges fall broadly into two areas. The first is the environment within which they operate, with the global economy still struggling to recover fully from the 2008 financial crisis. The low growth that most developed economies are experiencing — which could be exacerbated by Brexit — is directly reflected in the insurance industry.
Property and casualty insurance typically grows in line with GDP, says Jon Hocking, an analyst at Morgan Stanley. “Any revenue increases will be mostly down to prices going up rather than policy numbers going up.”
Pricing is particularly tough in commercial insurance and reinsurance. Rates have been falling for years, partly because of a relatively low number of major catastrophes — which usually drive prices up — and partly because a lot of new capital has come into the industry, increasing capacity.
The situation is little better for life insurers. “Life insurance is structurally more challenged,” adds Mr Hocking. “Most products are savings products, many of which are linked to interest rates. When rates are low it is difficult to create products that are attractive to either shareholders or customers.”
Total value of M&A in insurance industry last year
In response, insurers are looking at two avenues for growth. The first is emerging markets. According to credit rating agency Moody’s, property and casualty insurance in emerging markets should grow by more than 5 per cent over the next year or so, compared with 1-2 per cent in Europe and 2-3 per cent in North America.
“There is structural growth in emerging markets, but accessing it is expensive and there is not much in the way of assets to buy,” says Mr Hocking. That has not stopped many large insurers from building operations in new regions. Axa, Prudential and Manulife have invested heavily in Asia, for example.
The problem that many of them face now is that, even in emerging markets, growth is not as strong as the insurers might have expected just a few years ago. Axa’s 2011-2015 strategic plan aimed for rapid growth in emerging markets, but it failed to meet its targets.
The other way insurers are trying to find growth is to buy it. Last year was a busy one for M&A activity in the sector, with more than 700 deals worth over $114bn, according to Dealogic. The largest included Ace’s acquisition of Chubb, and Tokio Marine’s acquisition of HCC.
“A lot of it was Chinese and Japanese companies investing in Europe,” says Simon Harris, head of insurance at Moody’s. “That will continue, although it may slow down.”
Many insurers, and their advisers, are expecting the wave of M&A to continue this year, although Mr Harris warns that it may not be the panacea that companies are hoping for. “Being a bigger insurer does not always save you from the problems you were facing. It may even be a distraction,” he says.
The other consequence of low economic growth is low interest rates, which make it tough for the insurers to enjoy the sorts of profits that they have traditionally earned from their investment books.
Even worse, some are struggling to find assets with returns that are high enough to match the promises they have made to their customers. “One of the challenges is investment guarantees on savings products,” says Gareth Mee, executive director at EY. “In Germany [the guarantees] are very explicit.”
To get around the problem, insurers are having to look further afield than the highly rated government bonds in which they have traditionally invested. “They are having to broaden their universe of assets,” says Mr Mee. “The asset mix is moving more towards what they do in the US, investing in infrastructure and real estate.”
The move into alternative assets has, however, been complicated in Europe by the arrival of the EU’s new Solvency II rules, which impose higher capital charges for some types of investment. Safe assets such as sovereign bonds carry no capital charges but produce very low returns. Higher yielding assets may be expensive to hold. So competition is growing for assets such as infrastructure debt that combine relatively attractive returns with low capital charges.
That may all seem daunting for the industry, but it is perhaps easier to cope with than the other set of challenges, which fall broadly under the heading of “technology”. While insurers are used to dealing with underwriting and interest rates, many of the latest technological developments have been tougher for the industry to grasp.
“Technology is fundamental to the industry,” says Mr Hocking. “The industry has been very slow to embrace digital. It was one of the first industries to use [information] technology in the 1970s and 1980s, and part of the challenge is that they’ve got very complex legacy IT infrastructure. Turning it all off and switching to a new system is tough to do.”
In the short term, the technology threat may come from a growing band of start ups that will nibble away at specific parts of the industry. From peer-to-peer insurers to robo-advisers and telematics specialists, the start-ups are making their presence felt.
But over the long term the threat is deeper. “On the property and casualty side there is a fundamental change to the business model coming,” says Mr Hocking. He says the use of data analysis to price products is becoming as effective as older actuarial methods. “With the internet of things there is also the chance to mitigate risk in real time. There is an opportunity here for the bigger insurers, but there is an argument that the whole industry shrinks. Those who aren’t at the leading edge will face outsize losses.”
For the optimists, technology is an opportunity rather than a threat. “It can mean interacting with customers more seamlessly,” says Mr Harris. Many insurers struggle to interact with their customers more than once a year, when the premium is due. But by using apps, telematics devices in cars or fitness trackers, so the theory goes, the insurers can start to become a more regular part of their customers’ lives and hence build a little more loyalty.
The growing threat of cyber attacks is also a chance for commercial insurers to find some growth against a backdrop of falling prices in other parts of the market. Cyber insurance tends to cover the practical impact of dealing with a data breach, such as the costs of investigating what has happened and notifying those who have been affected. The market is far more developed in the US than it is in Europe but changes to EU data protection rules, due in 2018, are expected to spur growing demand.
Despite that potential, however, there are questions over how far the insurance industry is willing to take on cyber risk. While some insurers, such as Allianz and Hiscox, are building cyber businesses, others are wary of exposing themselves to a phenomenon that they do not yet fully understand.
A recent survey for Airmic, which represents commercial insurance buyers in the UK, found that four-fifths of the organisation’s members did not think insurers were innovating enough to cope with new risks such as cyber and reputational damage.
However, as the industry’s business models evolve in the face of multiple challenges, it may be exactly those type of risks that provide the basis for future profits.