One Lesson I learned from a Value Destroying Industry

Insurance has become a value-destroying industry after decades of solid returns. This is not a problem caused by a few under-performers. Half of the global industry’s players do not earn their cost of equity. Half of global insurers trade below book value. Economic profitability goes down. Time to pause.

Insurance has been creating moderate investor value over many years. But as of 2015 multi-line insurers produce negative economic returns. It is an industry-wide phenomena. More of half of listed insurers had an ROE below their cost of equity over the past five years.

This is the not-so-reassuring (and not-so-new) conclusion of McKinsey's 2022 Global Insurance Report. It raises the key question about the long-term economic viability of the multi-line insurers.

Not surprisingly, investors have taken note as well. Worldwide, 60% of listed multi-line insurers have traded below their book value over the past five years. In Western Europe, insurers trade at a meager ROE of 9.2% end of 2021.

High costs of running the business

A key driver of the value destruction in insurance is the high cost of running the business. Despite relentless savings efforts, total expenses in the industry have gone up relative to total revenues - not down.

And despite P&C insurers improving their loss ratios three to five points from 2003 to 2019, increasing new business premiums by 10 to 15% and retaining up to 10% more of the profitable segments - all good news - costs have gone up by 20% for the Life & Savings industry and by 6% for P&C insurance carriers.

Over the same time horizon, other sectors such as automotive and telecom, successfully reduced their total expense ratios by 15%. Insurers dream of their version of Ford's Model T that went from 12.5 hours to 1.5 hours.

The costs of complexity - whether in the product portfolio, client experience, geographical footprint, lines of business, or position in the value chain - are simply too high. Today, multi-liners must invest heavily in multi-year programs to remove old technology stacks and get a claims closure down from one week to one day. In addition, rising regulatory pressures dampen the hard-earned efficiency gains.

Multi-liners: blessed or doomed

Fair enough, there are the upside effects of diversification that make multi-liners sustain successfully in economic downturns. In light of several "black swan moments" of the last three years, multi-liners have demonstrated remarkable resilience.

During pandemics, historic floods and unprecedented inflation they have proven disciplined risk management and delivered steady returns. So as a critical side note, McKinsey's report leverages data up and until E2021 for premium growth and profit increases, which is good. For demonstrating the industry's negative economic profit, data stops at 2019. Not good.

What Private Investors do and Insurers don't

Private investors have spotted the potential for improvement in the industry and are investing heavily in insurtechs. But disruptors in insurance take time. They require several rounds of financing and often last longer and cost more than expected.

Private equity firms are also entering insurance and annuities assets to secure permanent capital for their investment arms. There have been a number of transactions recently, also at AXA. However, this does not sufficiently addressed the uncomfortable question of business model changes to a multi-line insurer.

When Insurers become irrelevant

Some additional industry paranoia disclosed, global insurers do well fear to gradually become irrelevant when

• Retail P&C business transfers to mutuals, bancassurances, and direct players. Commercial P&C may be cannibalised by re-insurers and specialists.
• Life insurance goes to wealth and managers which digitalised faster and further, or private-equity firms.
• Health insurance becomes further intertwined with public healthcare systems even though it is one of the most difficult insurance lines to get substituted by non-insurers.

So should multi-line generalists become specialists? Should omni-channel strategies be reverted in dual direct and non-direct? Should incumbents let go end-to-end business model and move toward a disintermediation by insurtechs ? Or become an embedded service provider for large tech players with wider customer reach?

Relentless quest for industry growth

To create value and growth, AXA has taken important steps in capital management over the past few years, and continues to do so. AXA also reshaped its global footprint entirely with its activities in Central and Eastern Europe, Greece, the Gulf region, Malaysia, and Singapore. AXA has reallocated capital among its businesses and proven above market growth in preferred business lines.

At the same time, we have intense discussions internally on how important it is to invest and reinvest into organic growth. AXA has proven excellence in disciplined underwriting and consistently improved margins over time.

But in my mind, mid-term and long-term growth will need to come from other areas.

Three-plus-one areas of growth

Most often, primary insurers (along with their external consultants such as McKinsey) identify three key areas of growth.

• New risks. Data, cyber-security risks and machine-learning liabilities are new emerging risks which AXA is embracing actively. New mobility and electric vehicle risks are paramount for motor insurers which have been shaping the mobility ecosystem over the past few years. Climate is a vast field for new risk transfers and, most importantly, increasingly impact primary and re-insurers alike. Our ambition is for such risk to become or remain insurable. and this is by far no a given.
• New services. To address some of the protection challenges ahead, with increasing health inflation and longer lifetimes, AXA is developing a rich ecosystem of related and adjacent end user services. The Digital Health Platform (in cooperation with Microsoft) and Digital Commercial Platform are two prominent examples of such endeavours. Admittedly, it is still a long way to tech-based revenues to become a significant source of income, yet potential claims cost savings increasingly become an economically strong pro-argument.
• New business models. I do believe insurers do miss opportuntities to outsource more actively part of our insurance value chain to other players - even competitors. Having the courage to seriously consider B2B2C is critical for future growth, as value chain ownership may not last forever.

I personally believe there is a "plus one", one more growth opportunity and area for superior returns.

"Plus One": What McKinsey did not mention

There is one thing I learned from the value destroying industry. It takes no effort to think of the societal value an insurer generates. Insurers protect what matters in life.

Yet, the value of protection and prevention is often insufficiently priced in. As a consequence, when it comes to preventing harm from happening and to giving people peace of mind, the question about value creation is more complex.

The question to raise is: Can we create a new economic equation for the social value one insurer creates over the other? Are there opportunities of growth and prosperity by placing insurers in the middle of society.

What social value creation really means in insurance industry is still unchartered territory for many traditional players. Even though some player created economic equations that offer returns to insured, insurer and society alike, there is a need to join the discussion in light of increasing threats to accessibility and affordability of insurance.

Time to reframe investors' views on the insurer's life below book value.

Part 2 of this line of thought will follow soon.

Creating value, finding focus: Global Insurance Report 2022 | McKinsey

Mirjam Bamberger is member of the Management Committee of AXA's European Markets & Latin America. Until January 2022, she has been?CEO of AXA Luxembourg and CEO of AXA Wealth Europe. Prior to this she served in various roles as a board member of AXA Switzerland, having completed 15 years of international trajectory across US, Asia and Europe in High Tech and Financial Services.