At first sight, it might seem a relatively straightforward task to define the size and scope of the European insurance market. Statistics show that the property and casualty (P&C) market in Germany is worth DM100 billion, for example, and that Switzerland has Europe’s highest life premiums per capita.

But statistics mask industry trends that pose significant strategic questions for every chief executive officer of an insurance company. The traditional delineation between life and non-life insurance products is beginning to fade, as is the distinction between the insurance and reinsurance businesses. At the same time, the very boundaries of the insurance industry are blurring. Life investment companies, reinsurers, asset managers, investment bankers, and private bankers all find themselves competing in the same arena for business not always traditionally regarded as insurance.

To define insurance in terms of the types of cover available, such as motor, death, invalidity, and fire, therefore no longer suffices. A different gauge, capable of reflecting the industry’s growing complexity, is required if CEOs are to understand the trends in their industry and plan accordingly. It is therefore useful to examine the four value propositions around which today’s European insurance industry appears to be grouping.

Insurance as an instrument to cover unpredictable cash needs

For many customers, insurance policies are instruments for meeting unpredictable cash needs: a premium paid in advance gives the insured the right to get cash when a clearly defined event happens, be it fire, death, or a hurricane. In many respects, insurance policies are similar to financial options traded in today’s derivatives markets, whereby a premium paid in advance gives the investor the right to sell (or buy) certain assets at a fixed price sometime in the future.

It is a similarity that a handful of the most sophisticated insurance companies and multinationals are beginning to exploit to their advantage. Rather than paying premiums to an insurer or reinsurer to cover their risks, these companies are de facto buying an "insurance option"—an instrument that guarantees cash as and when losses occur, regardless of any specific line of business. If these new instruments become common currency, they will threaten great chunks of traditional insurers’ revenue.

There is an emerging trend toward placing severe risk in the market by issuing "risk bonds" instead of buying insurance

It works like this. Rather than insuring every aspect of its business, a multinational splits its traditional insurance needs into predictable risk (risk that can be predicted statistically and for which it can plan, such as a small fire or a strike) and severe risk. The predictable risk is no longer insured, as the company will itself be able to provide the necessary cash. Severe risk, however, such as a hurricane that destroys an entire plant and could bankrupt a company, needs to be covered. Although this risk is still largely placed with insurance or reinsurance companies, there is an emerging trend toward placing it in the market. Instead of buying an insurance policy, a company could issue "risk bonds." Normally, buyers of these bonds would receive an annual premium, but in a year when unpredictable risk occurs, they could lose part of the principal of their investment. In effect, insurance risk could start to be securitized just like credit risk.

Some multinational corporations are already going one step further and wondering why they cannot combine their insurance risks with other risks, such as currency risks, issuing a single instrument to cover losses from whatever source—be it a huge fire or a currency collapse. Reinsurance companies such as Swiss Re and other global insurance companies, mostly via their Bermuda subsidiaries, are starting to offer products in this area.

As the trend toward these new instruments grows, some big insurance companies will end up acting more like bankers and capital providers than suppliers of insurance cover. Investment bankers, on the other hand, are starting to apply financial engineering tools to cover traditional insurance risks, and are in the process of exploiting new alliances with insurance brokers and top reinsurers to offer clients as wide a range of insurance services as possible.

For the insured, this trend is a clear, new value proposition. By replacing line-by-line insurance coverage with a single instrument to cover all unpredictable risk, the chief financial officer eliminates unnecessary premium payments and has greater control over cash flow. For conventional insurance players active in commercial and corporate business as well as in reinsurance, the trend could represent a significant threat to the structure of their portfolios. Premiums traditionally paid by corporations for predictable risks will, essentially, disappear from the statistics, as could traditional reinsurance mechanisms, to be replaced by new, cash-oriented insurance instruments which could also be offered by investment bankers.

Two points highlight the magnitude of the changes ahead. Predictable risk could easily represent 40 to 50 percent of the total premiums paid by corporations today, and 80 percent of UK companies already retain a significant proportion of their own risks. Under these circumstances CEOs of middle-size insurance companies, whose business has largely depended on predictable risk, will have to ask themselves how far they will be able to compete for the more sophisticated business in markets dominated by investment bankers and a few giant insurance players such as Allianz, Swiss Re, Munich Re, Gerling, Zurich, and Generali.

They should also bear in mind that there is no apparent reason why the trend toward all-inclusive insurance should not spread to other market segments, such as the small commercial market or high net-worth individuals (HNIs). HNIs, for example, might be interested in a product covering their unpredictable risks (accident, invalidity, or severe healthcare problems), while retaining more predictable risks.

Mass market demand

If demand for insurance as a cash instrument in the corporate sector poses a threat to insurers, there should be new opportunities in the mass market in areas that are not yet a primary focus of the insurance business. Rather than providing cash to cover for the unexpected, future insurance products will provide cash to deal with the kinds of problems people commonly, if not inevitably, have to confront in the course of their lifetimes, such as unemployment, old age, and sickness.

The degree to which traditional insurance companies already participate in these markets depends largely on national regulation and the domestic welfare system. In some countries—like France and Italy—the state gives insurers little room to compete. In others, private insurance companies are allowed to compete on a more or less marginal basis. In Germany, for example, private health insurance plans can be offered to wealthier individuals (earning more than DM73,000) as an alternative to national health insurance products. Hamburger Volksfürsorge went one step further into what was exclusive state territory, launching a private unemployment insurance scheme intended to cover cash losses above the minimum guaranteed by the public system.

As the burden of social costs continues to rise across Europe, it is difficult to imagine that governments will not increasingly welcome the introduction of similar kinds of private insurance products as substitutes for, or at least supplements to, the basic cover offered through the welfare system. These new products could include coverage for health, invalidity, accident, and long-term care, as well as pensions in the form of a life policy. They could be sold either to individuals or households, or to corporations as fringe benefits for employees.

The historical (and legally enforced) separation between accident (P&C), life, and health insurance business is therefore becoming an increasing burden for insurers wanting to offer a comprehensive package of personal cover. In the Netherlands and Switzerland, where semi-public health insurance already exists, alliances between different types of insurers are already springing up. Winterthur, for example, has integrated into its Swiss structure the fifth-biggest national health insurer, KFW, and created out of it a Wincare unit.

A "privatization" of the European pension system to the same degree as already exists in the US (with its 401(k) regulation) could conceivably generate more than 3,000 billion ecus in additional assets to be managed, either by insurers or professional asset managers—such is the magnitude of the potential opportunities emerging. Similarly, 500 billion ecus in premiums could be generated by opening the healthcare market to private insurers.

Insurance as an investment instrument

Beside being an instrument for meeting cash needs in return for premiums paid in advance, insurance is also seen as an investment. Life insurers manage 10 to 15 percent of the world’s financial assets, accumulated thanks to generous tax incentives from the state for those who take out life polices. Life policies have become not only a means of absorbing risk, but of saving money. Banks, on the other hand, have had to contend with modest, or even negative growth of their traditional deposit accounts.

To try to restore some equilibrium, banks have been establishing their own life insurance businesses or allying with life insurers, with considerable success. "Bancassurance" now represents more than 20 percent of the individual life market in the UK and half of the French market.

Banks are aggressively selling personal equity plans as tax-efficient rivals to life products ...

In the most liberal European markets, such as the UK, banks have, however, been able to win back still more of the revenue enjoyed by life insurers as a result of the "neutralization" of historical tax advantages given to life products. By giving some long-term investment products the same tax breaks as those enjoyed by life insurance products, governments have not only put traditional life insurance under severe performance pressure, but have also blurred the distinction between life insurance and investment management. In the UK, banks are aggressively selling personal equity plans (PEPs) as tax-efficient rivals to life products.

... Insurers, however, are slowly waking up to the fact that they are now in direct competition for asset management money

Insurers, however, have largely been slow to wake up to the fact that they are now in direct competition for asset management money. Some have turned their investment function into a profit center, or acquired asset management expertise. The best-known examples are the acquisition of Kemper ($60 billion under management) by the Zurich Insurance Group, and the acquisition of Barings by Dutch insurer ING. Other players have chosen instead to outsource their investment function, as Scandia Life has done. Scandia now offers unit-linked products of a selected number of chosen funds, run by external asset managers and banks. But many insurers in continental Europe are only now discovering unit-linked products that allow clients to choose how to invest their savings.

Some banks have moved still further ahead. They offer not only their own traditional life products, but also a new range of products, mostly mutual funds, that replicate financially the attributes of typical life insurance products: a guaranteed minimum return with the opportunity of additional returns depending on the underlying asset chosen for the investment. The difference, of course, is that there is no guaranteed lump sum payable on death. The recently launched asymmetric funds of SBC Warburg are examples of these kinds of products.

In the medium term, every insurance company should probably plan for a more even playing field in which fiscal advantages given to products with little real "insurance" content have been eliminated, and they find themselves in direct competition with investment managers for long-term savings. To survive, they will either have to wholeheartedly enter the asset management business, or outsource the investment function. In the case of the latter, insurers might continue to prosper as "asset gatherers," using their own sales channels to offer other financial products through a third party. IDS in the US is already doing this.

For some life insurers in the high net-worth segment, an entry into private banking might also be possible (as it has been for ING through Barings). In Belgium, some large insurance companies such as Royale Belge or La Patriotique have acquired small banks (or refocused a bank unit belonging to their group) with the purpose of giving their brokers more muscle to compete with the bancassurance channel in this field.

It is clear that the boundaries of the life insurance business are changing, not only for the individual market but also for group business. Here it is interesting to note that in many countries, group life insurers still offer undifferentiated investment products. The idea of offering unit-linked products for group life (as investment managers would do for pension money) is only just dawning.

Insurance as a service to avoid distress in difficult situations

Despite their primarily product-oriented approach, insurers have traditionally offered few product-related services. Until recently, they have been simply payors, not service providers.

But as traditional lines of insurance become more like commodities, insurers will have to start looking for new value propositions beside the purely cash one (you pay now and I pay you cash when needed; or I invest your money for you). A service offered either to prevent or limit distress in difficult situations is one such proposition.

The first movers in this field have been not P&C insurers, but health insurers. In Switzerland, health insurers have started to reinforce their role as payors by offering clients a whole range of real services: a selection of hospitals from which to choose, a network of physicians, and in some cases direct delivery of drugs and other medical supplies. This US-inspired approach, known as managed care, has not only given health insurers a significant role in the reshaping of the whole healthcare industry, it has also redefined the boundaries of the health insurance business.

The same thing is happening in other insurance lines. Car insurers such as Direct Line in the UK or Centraal Beheer in the Netherlands offer to take care of the whole repair procedure after an accident—providing a replacement car, bringing the damaged car to the repair shop, and repairing it. As the repair industry is fragmented and inefficient, extensive restructuring can be expected. Some insurers are becoming major parts wholesalers, negotiating for and buying parts directly from the manufacturer. Others, such as Direct Line and Churchill (Winterthur), are entering the car repair business and building repair centers. Direct Line has recently built the biggest repair center in the UK, with capacity to service more than 350 cars a day.

Home-owner insurers such as Germany’s Gothaer Insurance are starting to offer similar services to help customers deal with damage to their homes, organizing immediate assistance and then providing a network of specialist repair services. In Belgium, several insurers have an agreement with Mondial Assistance to offer home repair services.

For lost or damaged belongings, some insurers already replace stolen or damaged goods rather than paying out cash

In the case of lost or damaged belongings, some US insurance companies already replace stolen or damaged goods rather than paying out cash—a service that is not only convenient for customers, but more likely to discourage fraudulent claims. One, USAA, has become one of the leading direct retailers in the United States, able to negotiate professional purchasing agreements with suppliers of consumer goods for items likely to be stolen or damaged. The same trend is likely to emerge in Europe. Indeed, replacement rather than cash payment already seems to be an option offered by some UK insurers.

Risk-prevention services could also become a new source of income for insurance companies interested in delivering better value propositions, particularly to their commercial clients. The Gerling and Zurich groups already provide a risk-consulting service, while P&C companies would seem well-positioned to link their home-owner coverage with advice about home security or even to fit burglar alarms.

First-mover advantage in the trend toward offering additional, insurance-related services could be critical for success.

Insurance as an administrative service

One last role that insurers could play is that of transaction specialist. Clients would use insurers not because they smooth their cash flows or invest their money, but because they have the systems in place to deal with the administrative tasks related to the insurance business: keeping track of thousands of contracts, checking cover rules when claims are made, paying the cash required in time.

Although this role might appear dull, it is a value proposition already offered by some, especially in the commercial and corporate sectors. Allianz, through its APS-unit (Allianz Pension Services), offers a full service for the administration and handling of pensions, for instance. For insurance companies losing volume because of greater retention of risks by their client base, offering captive management services to customers could become an increasingly important source of revenue.

Some corporations are starting to use their insurers as administrative partners for whole employee compensation programs and related insurance cover (pension schemes, accident, health, and life cover), ensuring that they have an efficient, logistical system to track and comply with all the administrative and regulatory requirements linked to their insurance and pension plans.

What does all this mean?

What was once a clearly defined industry is changing its scope. The speed of change may vary by country, depending on the regulatory environment, but not the growing complexity of the market. For companies that would like to stay in the old world of product lines and traditional sales channels, the market will also be an increasingly difficult one. Significant chunks of traditional business are set to be eaten away by new competitors from other industries, or by competitors with new value propositions.

It means CEOs of traditional insurance companies have a lot to deal with. Emerging technologies and new sales channels present operational challenges, and pressure on costs and operational results will be severe. Yet their first concern must be to act early at the strategic level, for two reasons. First, they will take the right operational and investment measures only if they have a clear vision of where to go, and second, strategic advantage will go to those that are first into new areas because they will capture the best partners and the most attractive customers. The opportunities are there for early entrants who identify areas in which they can offer new, clearly differentiated value propositions. The field is wide open—but only for so long.