XL’s CEO Mike McGavick doesn’t mince words when it comes to looking at the big, and not very pretty, picture of the state of the re/insurance industry. Address emerging risks, innovate, create new products and provide potential insurance buyers with the coverage they want and need, or risk becoming increasingly irrelevant – that’s his basic message.
He laid out that scenario at the European Insurance Forum in Dublin last May, and he repeated it even more forcefully at the recently concluded Reinsurance Rendezvous in Monte Carlo. “Insurance and reinsurance is declining in relevance to the society as a whole in the property casualty space,” McGavick said. “We either reverse this trend, and therefore see our value in the economy grow, or we fail to reclaim our space, our relevance, and we will see continued decline.”
He explained that “over time we are making less and less of a difference to the economy.” If that trend isn’t reversed, it will mean that the re/insurance industry will attract less capital, which “is a reality, and something must be done to reverse it.”
He backed up that assertion by pointing out that between 2002 and 2011 “global GDP grew by about 3.8 percent a year…but our growth over that period was 2.5 percent.” Premiums in property/casualty during the period went from around $1.1 trillion to $2 trillion. “We have gone from being 3.4 percent of global economic activity to 2.8 percent.”
To illustrate his hypothesis McGavick pointed to the technology sector, which he said “is changing everything,” and the energy sector “that part of the economy that powers everything that we do.” He also called attention to the problems of interruptions in the supply chain as an illustration of a sector, which “really has no insurance solutions.”
Perhaps the biggest change in the use of technology has been the exponential growth in “smart phones.” There were around 1.15 billion in use in 2010, but by 2020 it’s estimated there will be 4.3 billion smart phones in use – a growth “from around 27 percent of all phones in use to over 80 percent,” McGavick said.
He then described a presentation by Marc Andreessen, the co-founder of Netscape, who explained that his current project “is to find companies whose mission it is to destroy entire sectors of industrial activity, and put it on this [smart phone] device.”
The implications of that changeover are immense – “your watch, your camera, your phone book” and other examples were cited by McGavick. He also noted that the market capitalization of the five largest companies comprises three technology companies, Apple, Microsoft and IBM, and two energy companies, ExxonMobil and China Petroleum. At over $700 billion Apple is currently the largest in terms of capitalization, while the combined capital of the U.S. P&C industry is considerably less at $176 billion.
McGavick did note that the P&C industry has had some success in distributing cyber coverage; however, he also said “we still believe that there are some 70-plus percent that could be or should be buying this product, but don’t.” Either it’s “not sufficiently meaningful for the protection of the balance sheet or it just isn’t a product that they have been made aware of.”
The energy sector, which, McGavick pointed out, is the best “predictor of the well-being of the human race.” Its cost and availability provide essential “metrics” that comprise vital statistics. However, citing the Gulf oil spill as an example, he described the P&C industry as being “barely present in that event,” mainly because BP was self insured. “They looked at the balance sheet they had; they looked at our entire sector’s balance sheet, and said, frankly you can’t really help.” Basically the energy sector’s capitalization, at over $800 billion, is five times larger than the P&C insurance sector.
“When we get too small, we can become irrelevant,” McGavick said, indicating that “buyers of insurance are becoming less important in larger organizations as their purpose is no longer seen as essential for the protection of the balance sheet.” However, he added that balance sheet protection isn’t the only service the P&C industry can provide to its clients, including the energy sector.
McGavick pointed out that the knowledge and experience the industry has acquired concerning “activities repeated across many companies, not just one,” is valuable in its own right, especially in assuring safety procedures. “The fact is we can make a difference; they [companies] may realize that we can add great value by having someone looking over their shoulder and giving them insights from many experiences, as opposed to relying totally on their own.”
Turning to CBI [contingent business interruption], McGavick described the “just in time supply chains” as going back almost 20 years, and “yet people were astonished when the tsunami struck Japan, and all of a sudden these interdependencies were laid bare.” The current protection mechanism is antiquated, relying on “multiple routes,” and hoping that some supplies get through. But when parts – he cited a $90 flow sensor – become unavailable, it can shut down an entire operation – in this case auto production lines.
As another example McGavick noted that following the floods in Thailand the price of computer chips rose by 10 percent. But the P&C industry’s response hasn’t been to offer solutions. It’s mainly been to impose sub-limits or to exclude it entirely.
However, he warned: “We cannot exclude our way to prosperity, and we cannot sub-limit our way to relevance.” In order to maintain its return on capital the industry needs to show that it can “make a difference” for its clients and give them “something that really matters.”
He pointed to his own company as an example of what the industry could do to increase its relevance. XL is “using analytics” in every sector; it is “investing in cyber liability” and other aspects of technology, as well as going into “partnership with brokers and clients to go through what is not covered, and what can we do about it. We’re investing in teams,” which are designed to work side by side to find the “spaces and gaps between them so that new coverages can be introduced.”
If the industry is to become more relevant, it needs to change its ways. McGavick said the industry’s practice of relying on “vast data sets,” which may take as long as 10 years to build up, ignores the fact that during that time “entire industries may come and go. That approach will not work, and we will decline in relevance.” Taking advantage of the vast amounts of data that are already there would help solve the problem immediately.
However, he cautioned that balance sheet considerations must be analyzed “on every new bet.” That’s not an excuse to do nothing, only a caution to proceed carefully as the industry cannot solve all of its problems at once, but should address the ones where solutions are available first.
His third suggestion would seem somewhat self evident. Rather than employing an insurer’s most talented people in lines that are the most profitable (and by definition stable), they should be assigned to dealing with business which is the most challenging. “We’re investing in that right now,” he said.
For his closing remarks McGavick issued a warning about Solvency II and other regulatory measures that could require the industry retain more capital. “In the end if Solvency II is allowed to come to life in such a way as to require even more capital to be held against risks, despite the fact that in the recent crisis we performed extraordinarily well, meaning we were just stress tested and passed with flying colors,” it will have adverse consequences.
“They [regulators] will drive our industry to produce less return,” which in turn “will result in fewer companies” on which the world is more dependent. “That is the opposite of creating an innovative environment. We will not become more relevant. We will hunker down – be safer – be larger and fewer companies,” which will be more heavily regulated. “That is not the way to become more relevant,” and “it is our fight to engage and make sure that this is clearly understood. We must struggle to reclaim our relevance.”