Setting sail for sustainable growth
Dutch Insurance Outlook 2018
The insurance industry has experienced some turbulent years, and more challenges will need to be conquered in the near future. In order to achieve sustainable growth, Dutch insurers will need to prepare for and adapt to an increasingly saturating market, changing employee -and customer needs, new regulations and innovative technologies.
Stormy weather in the Dutch insurance industry
From a regulatory perspective, insurers have just finished implementing Solvency II, and are making final adjustments to that. IFRS 17, the new accounting standard for insurance contracts, was published earlier this year and will come into effect for financial periods starting 1 January 2021. New procedures are being implemented to comply with the ban on paying commissions for selling complex financial products.
According to Verzekeraars in Beeld, a market survey performed by Kantar TNS, consumer trust in insurers is at 7.10, on a scale of 1 to 10, while insurance companies are still dealing with the aftermath of the policy miss-selling affair (‘woekerpolisaffaire’) in the Netherlands1. Interest rates remain low and are taking their toll: traditional life and pensions business has come to an almost complete standstill, life insurers face increasing competition from banks in customer wealth accumulation, which was traditionally the life insurers’ playing field. Non-life insurers are fiercely competing with each other and also face external competition, for example from car manufacturers who include lifelong insurance coverage with the vehicles sold.
In this Insurance Outlook we explore options for insurers to achieve profitability and growth in a sustainable way. A complicating factor is that, despite the fact that from a Solvency II perspective most insurers seem to be adequately capitalised, capital is definitely not plentiful. Capital requirements (locked-in capital) are increasing following risk-based regulations, and insurers need to hold even higher margins before being able to provide dividend payments. There is limited return on locked-in capital so the right balance between available and required capital is a challenge. Additional capital for new risky initiatives remains limited.
To use an analogy with the insurer as a ship; sailing that ship to new territories requires strategic choices along the three dimensions of profitability, growth, and capital. In this Insurance Outlook, we provide a nautical chart of the waters, we try to forecast the weather, we discuss ways of improving the ship, and we provide tactics for winning races, using state-of-the-art tools and techniques.
The nautical chart | The market
The Dutch insurance market is mature, so how feasible is profitable growth in this market? For most insurance products, the market is both saturated and highly competitive. The life market is still shrinking, due to tax reforms and low interest rates. Click the first figure on the right to view. For non-life business, the regulator has indicated that insurers should focus on sound combined ratios and on changing the business model where required. The traditional distribution model has come under pressure, as insurance products are increasingly sold online and the role of the independent broker is shifting from sales to service. Technology is both disrupting and enabling.
Numbers disclosed by Insurance Europe indicate that, compared to other countries, the amount people spend per capita on insurance is relatively high in the Netherlands: the Netherlands is ranked second2. For a large part this is due to our healthcare system, but, also for other insurance types, the expenditure remains significant, and gross written premium spend in the Netherlands is within the top ten.
Gross written premiums for life and non-life have been showing a decreasing trend for many years. In the property and casualty (‘P&C’) market, on the other hand, we see a stabilisation, driven by increased premiums in motor (due to pressure from the regulator) and in the fire portfolio. At the same time, combined ratios are still high, and rising, influenced by a negative trend in bodily injury claims and higher claim costs due to fire and hail damages. Both trends (of decreasing premiums and of increasing claim expenses) put pressure on cost reduction in order to remain competitive and profitable, click the second figure on the right to view.
The other ships | The competition
Historically, the insurance industry is not generally known for its innovative power. The market denominators have been the same for years. Besides health insurance, the Dutch market used to have the ‘big six’ insurers. Together these companies had more than 80 percent of the markets for non-life and life, according to the Verbond van Verzekeraars3. The market was expecting consolidation, but it took quite some time before we saw the first big acquisition in the Dutch market. Recently, an old and strong brand (Delta Lloyd) was acquired by another, bigger brand (NN). This acquisition enables NN to grow, and if synergies materialise, this may release capital and increase profits, leading to profitable growth for NN. More recently, ASR acquired Generali’s Dutch operations.
But, this may not be the last acquisition in the Dutch market. The five biggest players are all multiline insurers: they offer both life and non-life business, using multiple distribution channels. Strategic consolidation can lead to growth, but the question is whether those huge conglomerates should offer the whole breadth of products, or whether focus might lead to a better risk return profile. Why would it be inconceivable for a big insurer to sell their life business? Yes, closed book life business remains sufficiently profitable to keep it on the balance sheet, but selling this run-off business could release capital that can be used to strengthen other strategic business lines. In a time when capital is not infinite, decisions like these are becoming more important, especially when shareholders increasingly interfere with company strategy. Only time will tell, but maybe more than before in these fast changing times, the insurer should formulate a solid strategy, monitor the market closely, and be prepared to act quickly on market developments.
Despite the upcoming withdrawal of Generali from the Dutch market, pockets of the market remain attractive to specific foreign insurers. Examples of growing foreign insurers and investors are Anbang (Vivat), RGA (Leidsche), Chesnara (Waard and Legal & General) and Eli Global (Conservatrix).
Growth comes from better or new capabilities that so-called InsurTechs could provide. We see that InsurTechs are increasingly entering the insurance market. These start-ups generally focus only on parts of the value chain. Many interesting initiatives have been introduced in the insurance company domain, such as product solutions, services, or process optimisation. Is the business model of InsurTechs to become the ‘insurer of the future’, or are these companies solely founded to be sold for a high price to traditional insurers? Irrespective of the ambition of these start-ups, their efforts are both a risk and an opportunity for the existing players.
The crew | The employees
Over time, ships have evolved considerably using newly invented technologies. In the time of the Romans, trade galleys used manpower to row the boat against the wind. This required many people and a lot of food for those people, with little room left for merchandise. Nowadays, cargo ships only have a limited number of people on board, making use of engines and automation, leaving more room for cargo.
Not that long ago it was still common for an employee to work for one company for many years. This employee was educated and trained internally, had his career mapped out and was a proud advocate of the brand. Recently, various reorganisations were initiated in the insurance industry, leading, among other things, to the release of personnel. Consequently, the number of people working for insurers has decreased by almost 20% from 2011 to 20154. All major insurers went through some kind of reorganisation or have outsourced parts of their business to low salary environments. These change programmes also led to new ways of working. A very visible change insurers have gone through in the last five years is the so-called ‘new way of working’: providing flexible working, building open offices, encouraging working from home, and having remote meetings.
But not only companies change. Employees are changing too: young people want project-based work, and want to keep learning and to keep developing themselves. This is in line with the agile way of working currently being introduced at many insurers. The agile way of working was initially implemented in IT departments, but is gaining popularity in other departments, including finance and risk. The decrease in personnel and the new way of working led to a reduction in the number of insurance offices, shorter time-to-market. The corresponding cost savings are helping to improve profitability.
Another development is the recent implementation of Solvency II, and the fine-tuning of the risk management framework following that implementation. The effectiveness of risk frameworks has come under scrutiny and governance structures are in the spotlight. Companies are making their control frameworks more effective, rationalising controls were possible, and striking a balance between efficiency and being ‘in control’. The responsibilities of the three lines of defence are also defined more clearly, and any overlapping responsibilities eliminated. Business units should take full ownership of the risks in their area, while the risk management function should focus on its risk control role through oversight and by challenging the business. If implemented correctly, fewer risk managers are required, resulting in a reduction of costs.
The fans and spectators | The clients and customers
In the consumer market we see several trends. Consumers of insurance products tend to be more focused on the real benefits of insurance for the individual, rather than blindly insuring their risks through a standard format. Consumers are increasingly willing to share information, especially if discounts are offered in return. On the other hand, consumers are more aware of data protection issues. The use of digital platforms for buying insurance policies is increasing, although for complex products, personal advice is still appreciated. New online peer-to-peer platforms, such as self-organised hospitality platforms, integrate individual and commercial insurance needs. This offers opportunities, but could also potentially result in unclear expectations and misinterpretation.
Consumer appetite for insurance products in general is changing, along with the services they expect from an insurer and the way in which they want to be contacted. Consumer categories can be identified so that the insurer can contact them using the most appropriate communication channel. Products are becoming more tailor-made, jeopardising solidarity principles: specific groups of high-risk consumers may find it increasingly difficult to get insurance.
As digital touchpoints increase and the opportunities of having personal contact reduce, the quality of the personal contact becomes more important. Therefore it is important to balance the value insurers derive from the customers with the value insurers provide to the customer. Insurers need to differentiate their service treatment. As part of the total contact strategy, chatbots can play a role.
Clients do not compare the service performance of insurers with that of other insurers. Clients compare the service performance of insurers with the services received from well-known e-commerce organisations. Therefore, they no longer tolerate a lengthy underwriting process but expect a split-second quote and acceptance. In order to facilitate this, unnecessary steps should be removed from the process, systems should be updated, data should be connected, and technological improvements should be implemented in order to help to meet customer expectations.
The law of the sea | Compliance, rules, and regulations
Compliance, rules, and regulations still have a huge influence on insurers. The three dominant regulations and standards currently affecting the insurance industry are:
Complying with regulations can be very costly, but non-compliance can also come at a high price, in the shape of capital add-ons (Solvency II), or share price drops and penalties (IFRS 17, GDPR).
Solvency II is the current capital regime drawn up by EIOPA and applies to nearly all European insurance companies. Solvency II disclosures include the capital position of the insurer. Compliance with Solvency II is costly. Even though Solvency II is already in force, many refinements still needs to be made in areas like risk management, data quality, governance, model improvement, and validation. Risk management in particular can be improved; instead of being purely compliance driven, it can also be used to power an organisation’s strategic choices and help drive performance. Investors and analysts use Solvency II disclosures in their assessment of the insurer’s financial position, and solvency position is one of the main drivers for mergers and acquisitions.
After many years of drafting, the International Accounting Standards Board (IASB) published the final version of IFRS 17 in May 2017. The IASB’s objective was to develop a common, high-quality standard that will address recognition, measurement, presentation, and disclosure requirements for insurance contracts. The new standard requires insurance liabilities to be measured at a current fulfilment value and provides a more uniform measurement and presentation approach. IFRS 17 is expected to become effective for annual reporting periods beginning on or after 1 January 2021 (pending EU endorsement) and is applicable to insurers listed in the EU. IFRS 17 introduces a new way of presenting the performance of the insurer and requires separation between onerous and non-onerous portfolios, explicitly showing the distinction between profitable and loss-making contracts. The implementation of IFRS 17 is expected to be just as burdensome and costly as the implementation of Solvency II. During the implementation phase of IFRS 17, insurers need to already think about how to structure their portfolios in order to present profits in a balanced way. Too little profit may scare off investors, too much profit might chase customers away.
General Data Protection Regulations (GDPR) is the legislative act that sets out the minimum standards on data protection in Europe. It protects individuals’ privacy and strengthens the individual’s rights to control his own data. Slowly, the market seems to understand the tremendous impact GDPR will have: Not only because of the introduction of the Data Protection Officer, but also because of the huge sanctions for violating the articles of GDPR. The maximum fines depend on the violation category. For less serious violations, the maximum penalty is the higher of 10 million euros or 2 percent of total annual worldwide turnover of the preceding year. For more serious violations, this increases to 20 million euros or 4 percent of turnover5. However, implementing GDPR should not be just about avoiding sanctions: insurers can implement GDPR in a smart way, achieving synergies, and ensuring the investment is well spent.
The common denominator of Solvency II, IFRS 17, and GDPR is the importance of data. Implementation requires the gathering, storing, and securing of enormous amounts of data. Given the overarching role of data, a holistic view on these regulations could prevent inefficiencies, and provide upside potential through better and more secure use of data. The implementation projects should be scoped in such a way that they ensure compliance and simultaneously add value.
Tooling and navigation | Technology and data-driven insights
Many insurers have considered themselves to be data driven organisations for some time, since data and analytics have been at the heart of insurance business. However, the extent to which data and analytics are used is limited to a few core processes such as reserving and pricing. Increasingly, insurers recognise the value of data analytics: to enhance risk assessment in underwriting, to reduce the cost of claims, to identify new sources of profitability, to identify favourable customer segments, and to improve the customer experience, to name a few examples.
Technology has always played an important role in the insurance industry, and its importance will only increase. Several insurers are considering investing in new digital platforms to facilitate connectivity and benefit from new technologies such as blockchain, artificial intelligence (AI), automation, and robotics—things which will become household terms in the insurance industry. Innovation capabilities, new technologies, improving hardware, the cloud, big data storage, and analysis will enable insurers to grow their business. These are exciting times!
To remain competitive, the insurance company will have to reinvent itself. Many capabilities can be automated or strengthened in partnerships within the insurance ecosystem. Fundamental questions arise: How big does the company want to be? What has to be kept in-house and where can partnerships be leveraged? What activities should the business units perform, and what can be centralised? Thorough analyses may be required to answer these questions.
Sustainable growth | Winning the race
The competitive sailor’s goal is to win the race. To win, the sailor has to have the fastest boat, shed excess weight, gain knowledge of the best winds along the track, and formulate a strategy for beating the competition. For an insurance company, it is not so different. The insurer needs to improve margins by focusing on high profit activities and by cutting costs where possible, identify pockets of growth in the market, and optimise the deployment of available capital.
The first and obvious way to create profitable growth is by improving margins. But improving the margin is not about increasing profits at all cost. It is about the long-term, sustainable, and positive development of that margin. The insurer has several key ways to improve margin; for example by cutting costs, creating more efficiencies, improving claim management, or pricing and underwriting in a smart way.
Many cost-cutting measures have been implemented over the past years, but more opportunities still remain. Outsourcing to low-cost countries has increasingly been reversed, with Robotic Process Automation (RPA) implemented instead—robots are found to be cheaper, they are closer to home, and the insurer has more control over them. Data processes are increasingly automated, enabling professionals to focus more on the higher value tasks, such as analysis and strategy.
Insurers are rolling out the agile way of working. The resulting self-steering teams have a different type of hierarchy: fewer managers, shorter meetings, and higher efficiency. Employees increasingly want to work on a project basis, get hired on flexible terms and focus on learning and development. By hiring these flexible workers during the peak season, insurance companies can reduce the permanent workforce.
Another way to improve the margin is by improving the client portfolio or by selling products to more profitable market segments. Dynamic pricing is increasingly used to determine the fair price of products, given the client’s risk characteristics. By adapting prices quickly to the specific client, balanced subsidies are set in risk pools and the total amount spent on underwriting and claims payments is reduced. Claim costs can also be reduced by automating claims processes; by using the client’s mobile devices to record damages, for example,or by using data analytics to detect fraud. By also applying data analysis to the providers of repair services, such as body shops for example, the costs of claims can be significantly reduced. Existing third-party contracts may need to be renegotiated, and certain capabilities or services may need to be outsourced.
There are many interesting ways to improve margins. In this Outlook, we highlight three, which we believe are of great importance for the current insurance market: RPA, dynamic pricing, and Agile HR.
Pockets of growth
Although the Dutch insurance market has shrunk over the past years, growth is still possible. Growth can be realised in the areas of portfolio management, underwriting, and sales. New technologies, societal developments and climate change create new risks that customers wish to insure. Customers increasingly want to take out insurance for defined periods (‘pay-as-you-go’): when passing the border, when leaving the house, or when driving along a specific road. The dividing line between private and commercial coverage disappears, following developments such as self-driving cars, the sharing economy, and online peer-to-peer platforms, such as self-organised hospitality platforms. Such usage-based insurance has definite growth potential.
Digitalisation also creates new hazards. The May 2017 worldwide cyber-attack using ransomware affected hospitals, electricity companies, and other organisations, revealing the potential for upheaval in society after such an attack. Cyber insurance products have been developed and insurers are gaining more experience in this field, making it an increasingly attractive product.
The evolving Dutch pension system is another business area that offers potential growth for insurers, provided they broaden their scope from a product to a customer focus. The population is aging, and legislation is likely to be overhauled at some point in the coming years. There will most probably be a shift from collective and one-size fits all schemes with much solidarity, towards more individualised solutions. This gives rise to opportunities for new products, especially in the so-called third and fourth pillars (individual pensions and savings).
A technology that is in its infancy, but that may change the insurance sector profoundly, is blockchain. Blockchain has the potential to drastically bring down onboarding costs, by recording and encrypting customer data, and sharing this information across insurers. But it can also prove to be a growth enabler, by facilitating peer-to-peer insurance, by connecting an Internet of things environment or by radically transforming the policy and claim processes.
Another driver for growth is selling more products to existing clients using cross-selling or upselling. This is achieved by applying new data-driven techniques and by using advanced data analytics. These techniques can help insurers to find more successful combinations of insurance products or insurance covers to meet the client’s needs. If the insurer is able to identify strategic client segments and to define client values across products, this will help grow the portfolio. Technology can also be used to decrease the perceived distance between insurer and customer. High-quality interaction, digital or analogue, can identify clients’ needs and enable the offering of a better, suitable product.
Finally, acquiring other market players remains an important way of growing the business inorganically. The trend of consolidation in the insurance market is not likely to abate any time soon.
Five potential growth areas and enablers are highlighted in this Insurance Outlook: blockchain, cross- and upselling customer contact, data analytics, the retirement market, and cyber insurance.
The final area relevant in generating profitable growth is optimising the cost of capital. Capital is required to meet regulatory solvency capital demands, leaving little capital available for investing in further growth. Many opportunities for growth, such as acquiring a business or investing in technology, require large investments and do not always increase margins. Therefore, it is crucial to have a solid capital management strategy. Possible elements of such a strategy are divestments, product selections, asset allocations, portfolio management, mergers, and acquisitions.
Currently, capital strategies are often linked to the optimal asset allocation, with the aim of reducing the dominant market risk of an insurer. The capital optimisation strategy often does not take growth or profitable opportunities into account. But underwriting risk models make it possible to distinguish between more or less capital intensive products. The practice of designing a holistic capital optimisation strategy, where both assets and liabilities are taken into account, is not yet commonly seen but can yield great benefits.
Additionally, the outcome of the sophisticated economic capital models for Solvency II can be refined, parameters can be recalibrated and aggregation models adjusted in such a way that locked-in capital can be released. In a risk-adjusted return framework, both economic profits and required capital are drivers. Once Solvency II and IFRS 17 models and assumptions are sufficiently consistent, these combined frameworks could be the integrated driver for the insurance company.
Insurance companies should also review their risk mitigation strategies. Reinsurers are offering capital relief solutions tailored to Solvency II requirements. Having an optimised reinsurance strategy can help balance the risk and capital needed for profitable growth. New technologies can help prevent claims from arising, thus lowering claim costs and decreasing the difference between claim expectations and realised claim payments.
In this Outlook we look forward and discuss capital optimisation, in preparation for the upcoming IFRS 17 accounting standard.
Raise the anchor | Conclusion
This is the time to shed excess weight, trim the sails and set course for new, profitable shores!
From a distance, the sea might look flat and quiet but as one comes closer he or she will see huge waves. And although you cannot see it, underneath the surface even more is going on. The sea changes, strong currents change directions, high tide and low tide alternate. Sailing these waves in a controlled manner is challenging and requires advanced equipment and continuous improvement. Like the sea, the insurance sector is always changing. To an outsider, it may appear that not much is going on, but beneath the surface there is a lot of movement.
The competition is not standing still. One should aspire to be faster and cleverer than the competition, and to quickly respond to their moves. That, in itself, is challenging enough. And then the rules and regulations keep piling up, too.
The race has started, so the players must raise the anchor and choose the right course, forecast the weather conditions, improve the ship and determine the tactics. There’s a window of opportunity and we hope this Insurance Outlook can inspire you on the journey to the destination of your choice.