Companies that seek longevity in the insurance industry should not focus solely on increasing profits. That’s the assessment of Robert P. Hartwig, president and economist for the Insurance Information Institute. In his evaluation of centenarian insurance companies and species for lessons on what it takes to survive, Hartwig said both species and companies that live to be 100 learn to adapt to changes in their environment and constantly reinvent themselves.
Hartwig noted that about 61,000 businesses failed last year — the highest number in more than a decade. On the other hand, businesses that have stood the test of time tend to:
- Be highly focused and remain true to their core business. They avoid businesses they don’t understand.
- Embrace some concept of mutuality. For example, some of the world’s oldest firms are family owned, such as breweries and other artisan operations. Others may have a cooperative arrangement, such as in the agricultural industry.
- Exhibit altruistic behavior in which perpetuation of the species or business is evident. A strong willingness to work for the common good and to perpetuate the business is a proven survival trait, he said.
- Grow slowly. “You’d be hard-pressed to find a century-old company that’s also ranked in the fastest growing category,” Hartwig said. He noted that centenarian insurers’ surplus expanded less quickly relative to other insurers. And these insurers’ premium to surplus ratio tended to be lower than the overall industry. (Premiums are a rough measure of risk accepted. Surplus is funds beyond reserves to pay for unexpected losses. So the larger the surplus is in relation to premiums — the lower the ratio of premium to surplus — the greater the capacity to handle the risk it has accepted, he explained.)
- Be on the smaller side, compared to the competition. Size does matter when it comes to longevity, Hartwig said. This is also true among living species such as bacteria and insects, for example.
- Not be the most profitable. “The object of continuous profit maximization is not consistent with longevity,” he said, but a “will to survive” is still necessary.
Nearly 13 percent of property/casualty insurance companies today are 100-plus years old. That means these companies have been through two World Wars and the Great Depression. And the world’s oldest insurance companies are more likely to be mutual companies, Hartwig said. About 62 percent of 100-year-old companies are mutual insurers, while stock insurers account for about 36 percent of the total.
The National Association of Mutual Insurance Companies said 650 of its members have made it to the 100-year or older mark.
Why Do Insurers Fail?
In examining why companies live to be 100 or older, Hartwig said it might be helpful to understand why insurers fail. Looking back over 40 years of data, it’s obvious that the number of property/casualty insurance company failures had not been constant. In particular, the past three years, in which there has been a global financial crisis, many companies have failed.
However, the number of P/C insurers that have failed is near an all-time record low, Hartwig said. “Somehow our friends in the banking industry are having a failure rate near an all-time record high [which means] there’s something different between you vis a vis them. And it’s a good difference.”
Hartwig said an insurer’s combined ratio is a measure of underwriting stress, so the higher the combined ratio, the worse the company’s underwriting performance is and larger the underwriting losses. This clearly indicates that P/C company failure rates are highly correlated with parts of the underwriting cycle when the combined ratio is high, he said. “This should not be all that surprising. When we start to see large-scale underwriting losses, some companies are going to fail.”
But what’s important to note, Hartwig said, is that history has shown that a financial crisis is not what causes property/casualty insurers to fail. Instead, failures tend to occur at the tail-end of a soft market, when combined ratio begins to rise.
“Gee … are we approaching a period like this soon? Will we have another one of these shakeouts in the P/C world? Failures in the P/C industry tend to be caused by our own internal cycle — that is the leading cause of death of insurance companies,” he said.
5 Deadly Mistakes
There are “five deadly sins” property/casualty insurance companies can make, that contribute to company failure, Hartwig said. First, underpricing/under-reserving is the leading cause of death, contributing to about 38 percent of company failures.
“The leading cause of death is suicide, because this is something you can control,” Hartwig said, noting that his data underscores the importance of discipline. “What we need to do in the industry is improve our record of pricing and reserving that allows us to better ride out the underwriting cycle.”
Second, excessive growth too quickly, either organic or through mergers and acquisitions, can be fatal, he said.
Too much underpriced catastrophe exposure, too little reinsurance and insufficient diversification also can lead to failure, he added. Excessive catastrophe exposure accounted for approximately 8 percent of P/C company failures, according to his analysis.
Companies whose investments are too risky, too illiquid or insufficiently understood also have a high chance of failure, representing about 7 percent of failures.
And, problems with affiliates — when non-core operations cause problems for the parent company as in the “grand example” of AIG in which the financial services wing caused problems for the parent company as a whole — have contributed to approximately 8 percent of P/C company failures, he said.
On the other hand, strong leadership can contribute to a company’s longevity. In centenarian companies, management tends to act as a steward of the enterprise. The objective is not to get rich, but rather to pass a healthy firm safely and securely to the next generation of management and their policyholders, Hartwig said, noting that this is perhaps why so many mutual insurance companies have lived to be 100. The CEO should not be an “imperial,” but rather should be a listener and consensus builder, he added.
Management financial incentives also should be in line with the goal of providing the projection purchased. In centenarian companies, there is typically no third-party like shareholders to compensate, and the CEO’s total compensation is generally a smaller multiple relative to the average employee.
These long-lived companies grow more slowly, but nevertheless are still nimble and adapt over time. “I guarantee that every one of the 100-year companies operating today uses telephones,” Hartwig said jokingly. He noted that even smaller companies have to be as knowledgeable about industry trends, opportunities and threats as their larger competitors.
In the next decade, he said keeping up with underwriting technology will be essential. “Whether it’s credit, predictive modeling or telematics, these are things most centenarian companies were not first-adapters of, but did apply successfully and will be moving into in not to distant future,” Hartwig said. He predicted the next wave of technology will include integration of real-time information such as vehicle and driver information, which will be essential to pricing products accurately. Because this technology is interactive, it will allow consumers to adjust their behaviors. “That will be good for them, good for you, good for public policy and public safety,” he said.
Meanwhile, management needs to be “disciplined enough to stick to the business that they know, but also adapt to changing business conditions and seize opportunities ad necessary,” he added. “Sticking to your knitting has certainly been a character of success.”
Importantly, long-lived companies have a strong customer-focus and relationship-driven nature. “It’s palpable, you see it, you feel it, you see it in the relationship with the customers and agents,” Hartwig said. “This means that customers are the No. 1 priority, as is the agency form of distribution, with 21st century enhancements.”
Hartwig said while the Internet has grown in importance, he doesn’t think the industry is evolving into separate forms of distribution. Rather, he said he sees a diffusion of distribution, where the average customer doesn’t see a distinction between purchasing insurance through an agent or Internet. “It’s all one package of distribution: the agent they can use as a resource, and then there’s online, and there’s company resources — and the customer want all of them,” he said.
Management of companies that have survived for centuries don’t fight regulation, but rather they want efficient but local form of regulation, instead of a national charter, he said.
Although Hartwig said, “There’s no shortage of things to worry about in the decade ahead,” a major key to staying alive for at least the next 10 years is to maintain adequate reserves and pricing. “The industry is not in a position to absorb underwriting losses like we used to. The majority of years of centenarian companies primarily made the bulk of their money on underwriting profits,” he emphasized.
This article is based on a presentation Hartwig gave at the National Association of Mutual Insurance Companies Annual Convention. Click to download the full presentation of “How to Live to Be 100 in the Property/Casualty Insurance Industry.”
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