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Managing Change on a Global Scale Market Facts, Fall 2002)

Managing Change on a Global Scale Market Facts, Fall 2002)

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Published by: adillawa on Jul 25, 2010
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on a Global Scale
By Sax Riley
Chairman, Lloyd’s of London



any aspects of the insurance business have changed over the years. Although much has changed, the fundamental facets of the insurance offer haven’t. The basics of risk have not changed, and the way we underwrite them hasn’t changed very much, either. Today, we still exchange uncertainty for certainty. The skill of underwriting, our core competence, is much the same as it was when Lloyd’s of London started in this game over 300 years ago. What has changed — and continues to change — is the entire environment in which we operate. This article focuses on three specific areas, each of which presents both challenges and opportunities for the insurance industry in one way or another. They are a shift in the risk climate, an explosion of globalization, and a rocky financial landscape.


LIMRA’s MarketFacts Quarterly • Fa l l 20 02

THE CHANGING NATURE OF RISK In the past, people came to us with their concerns about the cost of fires, sinking ships, thefts, and the other conventional insurable perils we all know about. We were able to ease their concerns by exchanging the unknown cost of those perils for a known premium cost. These conventional risks remain. Some of them, like fire, we now have pretty much under control. We haven’t stopped them, but for both insurers and our clients they have become much more manageable. Other traditional perils, such as earthquake and weather risks, are giving increased cause for concern. Today, 40 of the world’s fastest-growing cities are in earthquake zones. Half of the world population lives in coastal regions, many of which are exposed to rising sea levels, flooding, and cyclones. In addition, businesspeople are coming to us about a whole new tier of risks that were not on the corporate risk agenda 10 years ago. We increasingly rely on modern communications and technology. Any involvement with the Internet alters the risk profile of a company dramatically. However, more and more

business is being done in this way, and with it comes risk of various kinds. Internet technology does two things. First, it presents old risks and amplifies them in a new context. Consider, for example, exposure to fraud, potential third-party liabilities, and copyright and jurisdictional issues; all of these were present in our businesses before we went online, but now they are reemphasized in a new form. Second, technology carries a range of new risks, such as the threat of viruses, hacking, and business interruption due to system failure. A survey conducted this year in the United States by the Computer Security Institute asked companies about their experiences with computer crime and security. Nine out of 10 organizations reported computer security breaches over the past 12 months. Eighty percent were able to identify financial loss as a result of misuse. Of those who were able to quantify the size of the loss, the average value was nearly $500,000, with the most serious losses occurring through theft of information and financial fraud. In tandem with the development of technology and communications, we have witnessed the rise of the global brand. Globalization as we understand it has been underway for centuries; however, the past 20 years have seen a spectacular growth in its visibility. Pivotal events in recent decades — oil crises, currency crises, and the like — have led to a sudden acceleration in its social and political prominence. They have also triggered the rise of the global capital markets that make market confidence an increasingly important part of today’s equation. Today men and women from Africa to America are increasingly conscious of the brand of their clothing or their bottle of beer. These brands are immensely valuable. In research that Lloyd’s commissioned recently, 65 percent of executives surveyed in


LIMRA’s MarketFacts Quarterly • Fa l l 20 02

the food and beverage industry said their brand was their and it may be provided on the basis of much more limited company’ most valuable asset. Once again, a changing social underwriting information than would be demanded by an international carrier. trend is driving a very real change in business values. Typically, globalization cuts costs. Products are manufacAs with any asset, various perils place brands at risk. In January a U.S. court ordered a huge Swiss pharmaceutical tured where labor and production costs are lowest. It might company to pay a U.S. company $505 million over the vio- therefore seem counterintuitive, but international competilation of a licensing agreement for biological testing tech- tion can actually increase the cost of insurance. To nology. Such licensing and patent infringement cases are fairly understand why, it is necessary to understand what it is that the insurance policy fundamentally represents: a lease on common today. Other losses can be even higher-profile. Product recall cases capital. By paying an insurance premium, the insured is renting can be particularly undesirable, costing companies not only the insurer’s capital for the duration of the policy. The in terms of the physical reclamation of potentially damaged level of alternative demand for access to that capital will goods, but also in terms of business interruption, lost sales, and determine the size of the premium. In the case of a domestic insurer, the only alternative demand will also be domestic, damage to the corporate reputation. So, although we understand and manage many traditional but the level of international demand will drive an internaperils better than ever before, corporations today face a number tional insurer’s pricing. Globalization is also profoundly of other concerns that did not exist a affecting the fabric and structure of decade ago, whether natural or manour industry. As the world economy made. The good news is that special goes global, we have seen a steady coverage is available if you need it. If increase in cross-border insurance we are to be successful in managing business. Today, it accounts for over 21st-century risk , we must work to2 percent of the world’s nonlife gether as an industry to anticipate and is also profoundly market. The UK’s unique historical respond with new approaches and position as a center of world trade solutions. and commerce is ref lected in that the even today its insurance market plays GLOBALIZATION In mid-April there a significant part in the provision of were demonstrations in Washington, cross-border insurance. D.C., at the meeting of the G7, IMF, and fabric and structure Additionally, we have seen a wave World Bank. We have become used to of consolidation. The reinsurance such antiglobalization demonstrations industry is a case in point. At the around the world. This is not mentioned of our . beginning of the 1990s the world’s in order to debate the pros and cons of five largest reinsurers accounted globalization, but simply to illustrate for 21 percent of the reinsurance that there are pros and cons. Globalization presents both challenges and opportunities for the market, but10 years later they represented 38 percent of the total. Together, the top 20 reinsurers increased their share from insurance industry as well. A major advantage is that globalization provides access to 39 percent to57 percent over that period. Globalization also has implications for insurance regulathe products, skills, and experience of service providers across the world. No longer is the consumer constrained by what is tion. Host country regulators cannot hope to be familiar, locally available from often second- or third-rate suppliers. in detail, with every insurer or reinsurer around the world. This is good news for the consumer, but threatens the Reliance on home country regulation becomes a necessity if domestic supplier with potentially damaging competition. the host country regulators are to allow their market the The argument is, of course, that competition forces domestic advantages of free access to offshore reinsurers’ balance suppliers to raise their performance to match the higher global sheets, for example. Organizations such as the International standard, so that in the long run, globalization will be good for Association of Insurance Supervisors and the Organisation for Economic Co-operation and Development are now them, too. Protectionism is not always bad for the consumer, either. actively promoting greater co-operation between regulatory While a locally available product may not be world-class, authorities, greater information sharing, and the setting of a protected local supplier might be willing to make a product international minimum standards for regulatory practice. And, available when an international supplier might not. While of course, with another round of World Trade Organization local coverage may be more limited in scope, it may be cheaper discussions now underway, more countries will be entering




Fa l l 20 02 • L I M R A ’ s M a r k e t F a c t s Q u a r t e r l y


parts to the equation. First, for those of us who are completely sold on the benefits of globalization, rule compelling levels of number one is don’t underwrite for market share. You do not have to be big to be effective. Interestingly, we did an analysis of all the syndicates in the value without Lloyd’s Market over the period 1995 through 1999. We divided the making an businesses into quartiles based on THE CHANGING FINANCIAL profitability performance. The top ENVIRONMENT The beginning of underwriting quality — the good performers — this article mentioned that losses shrank their businesses in real terms. have soared over recent decades. In The bottom quartile — the poor perfact, economic losses rose from . formers — grew their businesses. $69 billion in the1960s to $536 bilThe same pattern applies elsewhere. lion in the 1990s. The cost to the insurance industry climbed even more rapidly — from $6.6 bil- The belief that global market share is a valid business goal lion to nearly $100 billion — over the same period. We need by itself is a dangerous one. Rule number two is that terms and conditions are to return to the concept of making a profit on our core just as important as rates, if not more so. The past 10 years activity: underwriting. Perennial optimism and irrational exuberance on the stock have seen extensions of coverage that have had just as much markets have been replaced by sober reality. Industry cash economic effect as the reduction in rates. Indeed, they may flow has deteriorated and interest rates are low. All of this have been more harmful, because these extensions have eaten means that investment income cannot be an alibi for under- away at the discipline of identifying, anatomizing, segmenting, writing. You can’t deliver compelling levels of shareholder and pricing risk. The tragedy of September 1 2001, has provided more 1, value without making an underwriting profit. Indeed, some of the best analysis to date suggests that the new start-ups evidence to support this view. There have been various in Bermuda will have to operate at combined ratios of around efforts by politicians to intervene in the market to correct what they see as a market failure. They see it as failure to 80 percent to satisfy their required rate of return. Continuing on the mathematical theme, there are three provide coverage, rather than seeing the true failure, which the arena of liberalized trade in financial services. So, this work must continue and deserves our support to achieve an increasingly harmonized environment that is fair and liberal, yet rigorous and disciplined. But globalization does not necessarily lead to greater profits. Bigger is not always better.

You can’t





LIMRA’s MarketFacts Quarterly • Fa l l 20 02

is to identify and price coverage properly over the long term. The third and final rule is to make a gross underwriting profit. Don’t rely on reinsurance to bail you out. Again, looking at those in the industry that deliver outstanding shareholder value, the best businesses make it work at the gross level. These are not difficult concepts. They are not unfamiliar. And yet we all know how many, or rather how few, organizations turn them into reality. Many conversations with policyholders have revealed a real desire for pricing and coverage stability, heading to stability of relationships and improved financial planning. Relative stability at levels of rating and coverage that deliver an economic return is of interest to policyholders, underwriters, and brokers. Post-September 1 2001, we have finally seen the start of 1, a return — long overdue — to the notion of making a gross underwriting profit. Intelligent insurers are forgetting the notion of market share and simply focusing on gross underwriting results. In turn, this is having an effect on the products being offered. Where packages had become the norm, now they are being divided. What we are experiencing is a return to the fundamentals of analyzing and pricing specific exposures. CONCLUSION A shifting risk profile, a global trading platform, a difficult financial environment — such are

the challenges and opportunities we need to address at the start of the 21st century. However, whatever shifts around us, the greatest challenge is to remain true to the core perception integral to your brand. The Lloyd’s brand carries a couple of important perceptions: that we will insure things others can’t or won’t, and that we will pay losses no matter what. The key to success is not necessarily copying Lloyd’s. But it holds true for all insurers, and indeed all businesses, that staying true to the core perceptions of their brand is a key component of success. You can spend millions on advertising, but if your products and actions don’t live up to the qualities that people associate with your name, it will not stand up to the test of time. Here is a lighter but equally resonant thought on change. Lewis Grizzard, the U.S. author, wrote that life is like a dogsled team. If you aren’t the lead dog, the scenery never changes. That is perceptive, and unarguable. Being a leader of change isn’t always easy, it is never cheap, and it is often unsuccessful. But for those of us who see change everywhere, in our markets, in our business environment, in our shareholders’ demands, across the spectrum — we can either lead, or simply react. For those who just react, the scenery truly never changes. But for those who lead, take the brave steps, make managing change a core competence, and steel themselves for fundamental changes of self-image, then exciting, bold new landscapes lie ahead.

onfe re nces 2003

New Five in One!

LIMRA International’s 2003 Distribution Conference
Marriott Rivercenter San Antonio, Texas

• Agency-Building Program • Brokerage & Independent Program (combined) • Multiple-Line Exclusive Agent Program • Financial Management Program
Save the dates: February 26– 2003 28,
For the latest information visit our Web site at http://www.limra.com/events

Fa l l 20 02 • L I M R A ’ s M a r k e t F a c t s Q u a r t e r l y


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