April 13th, 2009

Manage the Cycle, Part V: Protect Portfolio, Profitability

Posted at 12:30 AM ET

venter_gary_thumbGary Venter, Adjunct Professor, Statistics, Columbia University

Profit pressure is the norm for the insurance industry. For short periods, market conditions may favor the risk-taker, but they are rare. Quickly, this mature, competitive industry returns to tighter margins and a battle for market share. Thus, managing to survive the leaner years until the market turns for a moment does not lead to long-term success. Carriers should optimize for tough markets … and be ready for the occasional favorable swing.

Market share retention is one of the keys to successfully managing through competitive times and periods of largesse. In some segments it is easy for a strong player to pick up market share when the market tightens, but in other areas, building market share is a very slow process. Those insurers have to be careful not too lose too much business in a buyers’ market. If some business must be given up when conditions are challenging, re-underwriting to keep the best accounts is one alternative. If an insurer or reinsurer can maintain its hold of the market over the course of the cycle, it’s easier to develop a platform from which to improve profitability and ultimately create shareholder wealth.

So, carriers need to identify long-term growth strategies that will deliver a financial and competitive advantage regardless of market conditions — with market share growth a primary factor. Three specific, actionable measures are: mergers and acquisitions (M&A), niche markets, and outperformance.

Mergers and Acquisitions

M&A activity is among the most common ways to grow market share quickly. Instead of investing heavily in attracting new clients or reaching deeper into existing accounts, a company can grow its book by buying a company with similar risks, or it could add complementary capabilities that would be difficult or costly to develop internally.

Periods of lower profitability tend to favor this strategy. Insurers and reinsurers that have maintained some degree of pricing discipline internally may be able to pick up competitors at depressed valuations, as changes to profitability tend to be magnified in market capitalization. “Discount shopping,” essentially, is possible with outsized returns occurring when market conditions turn to the sellers’ advantage.

Capital, of course, is crucial to the execution of an effective M&A agenda. Doubtless, financial markets are constrained today. Equity prices have dropped precipitously, and credit markets remain in turmoil. Yet, claiming that there is a shortage of capital in the marketplace would be hasty. Private equity funds are sitting on more than USD1 trillion in aggregate capital, according to research firm Private Equity Intelligence, Ltd. Sovereign wealth funds continue to invest in the insurance sector. And, despite having lost close to 20 percent of their aggregate capital last year, insurers and reinsurers are still generally healthy. There is money on the sidelines, and investors are waiting for the right time to act.

Niche Markets

Mature markets often require established players to fight for a stable or slow-growth revenue opportunity, frustrating efforts to grow market share organically. Yet, even these sectors have niches that can be exploited — usually with the promise of faster revenue growth and wider profit margins. Carriers that can locate, enter, and dominate these markets will secure a substantial and sustainable competitive advantage, almost without regard to broader market conditions.

The insurance industry may still have niche markets that can be developed. Auto lines for farmers, government employees, and former military service members, for example, have been historical niches, and there may be similar opportunities today. Medical malpractice, marine, and directors and officers (D&O) lines were historical commercial lines niches — not to mention unusual niches, such as actors’ faces and pianists’ hands.

Innovation makes the difference in the insurance space. Identifying exposures not yet covered by many carriers can result in a first-mover advantage (or early-mover advantage, at least) that can be difficult for the competition to overcome. The emerging exposure space — from internet-related liability to casualty catastrophes — will define the next generation of insurance industry leaders and set the bar higher for capital efficiency, profitability, and overall company value.


Mastering the basics can also provide an advantage in any market environment, even if only temporarily. Outperforming the competition through savvy risk selection, underwriting expense management, ratings, and the optimal use of capital can put distance between an insurer and the competition. This thinking is not new, but it’s often overlooked, as carriers focus on near-term challenges in a mature market. An insurer that can overcome this tendency, particularly as other succumb to it, can take advantage of the resulting market inefficiency to gain market share and bolster profitability.

In theory, this approach has a limited shelf life. Once one insurer finds areas where incremental gains can be secured through improved basic management, others would be likely to follow, closing the inefficiency gap and rendering operational effectiveness a necessity for survival rather than a competitive advantage. The realities of a competitive market, however, make this unlikely. There will always be some management teams that are forced by market conditions to make decisions based on immediate need rather than long-term opportunity, and this is likely to preserve the operational gap for the foreseeable future.

Gary Venter was previously a Managing Director in Guy Carpenter’s Instrat® Unit

This is the fifth in a six-part series. To have the next installment delivered directly to your inbox, register for e-mail updates.

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