Insurance Industry Challenges

Insurance Asset Growth Lags

Insurance company assets-under-management growth is weak compared to other global asset management.
By: | July 23, 2014 • 3 min read
Assets

Global insurance assets under management are growing — but not nearly as much as they could be, according to the Boston Consulting Group.

One key problem, though not the only one, is that insurers tend to under-invest in information technology, securities processing and other operations integral to asset management, according to BCG.

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Insurance company assets comprise nearly 20 percent of the $68.7 trillion in total global assets under management, as recorded by BCG last year.

Insurers’ total assets under management (AUM) reached $13 trillion in 2013. Yet, their AUM growth of 7 percent in 2013 was far lower than the overall average 13 percent increase in global AUM.

The fact that global insurers have lagged behind their asset-management peers in operations and information technology capabilities is something of a Catch-22, said Achim Schwetlick, a BCG partner and managing director in New York.

“The lower growth has likely contributed to the under-investment, not the other way around,” he said.

But clearly, this is an area that needs to be addressed, he said.

Between 2012 and 2013, insurance asset managers reduced their operations and IT spending by 4 percent per unit of AUM, said Schwetlick, who is a member of BCG’s insurance practice. In contrast, the broader asset-management industry increased that spending by 3 percent.

The serious expense reductions required by the “meager years” during and after the financial crisis prevented increased investments, he said.

“Now that we’re getting into growth territory again and expense pressure has mitigated, we think this is a good time to break that pattern,” Schwetlick said.

In addition, whereas most insurers have outsourced asset management in alternative asset classes, the vast majority of insurers still manage most of their assets in-house, he said.

The newly released BCG report, entitled “Steering the Course To Growth,”also pointed to the “large proportion of fixed-income assets” held in insurance company portfolios as a reason they “did not benefit as much from the global surge in equity markets.”

Insurers’ “exposure to high-growth specialties was similarly limited,” it said.

Regulatory and Organizational Inefficiencies

That may be difficult to overcome, said Schwetlick, given regulatory constraints preventing insurance companies from investing more aggressively.

This is particularly true in the United States, he said, although even European insurers tend to have no more than 10 percent of their assets invested in equities. In the U.S., equity investment is closer to 1 percent, said Schwetlick.

Organizational impediments have helped to sustain inefficiencies related to asset management, according to the BCG report.

The inefficiencies include regional fragmentation of assets, so that the asset managers of most insurers operate in regional silos as well as asset class silos, exacerbating fragmentation and complexity.

Insurers should move to a more global model to address those issues, said Schwetlick.

“You really want to have processes that are similar across the globe,” he said, that are related to both investment management and access to information about insurance company loss exposure.

Third-Party Management Benefits

The good news, finally, is that many insurers have benefited from third-party asset management over the past several years.

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“While insurers’ asset managers have not historically focused on profitability and growth, they are tempted by the high returns on equity of third-party management,” according to the BCG report.

“Some managers have built this business to more than a third of their activity, and, in doing so, have invested and grown stronger commercially,” the report stated.

“As a result, they have achieved higher revenue margins and profits — averaging 25 basis points of revenues and 39 percent profitability, compared with 12 basis points and 26 percent, respectively, for mostly captive managers that focus predominantly on the insurer’s general account.

Leaders in this area include Allianz, AXA, and Prudential, said Schwetlick.

Janet Aschkenasy is a freelance financial writer based in New York. She can be reached at [email protected]
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Exclusive Memoir

In Memoriam: Liam McGee

Recalling the turnaround at The Hartford, in his own words.
By: | July 1, 2015 • 12 min read
Liam McGee CEo The Hartford

Part One of an exclusive two-part memoir written before McGee’s untimely death in February.

In the wake of the Great Recession, it’s tempting to think that the surviving banks and other financial service companies have gotten a severe wake-up call.

Surely they’ve become very different companies now. They must have overhauled their controls and their strategies to prevent themselves from carrying so much risk in the future.

I’m hopeful that things have changed, but my own experiences have sobered me on this point. Organizational overhaul is possible, but it is difficult.

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When I became CEO of The Hartford in October 2009, soon after the company nearly collapsed, I was struck by the organization’s resistance to major change. I didn’t find a sense of urgency.

We ultimately succeeded in restoring the company’s strength, and it is now well positioned for future growth. But it was much more challenging than I expected.

Good Intentions Gone Bad

Founded in 1810, The Hartford Financial Services Group was one of the largest property and casualty insurers in the United States in the 1990s. That’s when the managers in the company’s small life insurance business started offering variable annuities.

Let’s start with how The Hartford got in such a mess.

Their initial success in this new product category led to a major push, to the point where the company became an industry leader and a stock market darling. But as the annuity marketplace became crowded, the company tried to maintain its growth with riskier products and expansion to overseas markets, supported in turn by a riskier investment portfolio.

The financial crisis of 2008 brought this all to an end, and the stock price fell from $100 all the way to the low single digits. Only a $3.4 billion capital infusion from the federal government’s Troubled Asset Relief Program, coupled with $2.5 billion in crisis capital from the big European insurer Allianz, kept the company going.

From the outside, the turnaround of The Hartford might look pretty simple. In the short term, we got a lift from the recovery in the financial markets.

We also had a successful capital raise in March 2010. That allowed us to pay off TARP and gain breathing room to work on the underlying problem. (We paid off Allianz a year later.)

We then determined that the company’s balance sheet was simply not big enough to absorb the risk in the annuity business, so we stopped issuing new policies. The remaining life-related activities were not strong enough to survive on their own, so we sold those off to better-capitalized companies that specialized in those areas.

We refocused around our historic expertise in property and casualty insurance, which had languished during the run-up in annuities. The company is now in a solid capital position, with much better risk-management capabilities and a more collaborative senior executive team. It’s poised for sustained growth.

Rule of thumb: Financial services firms are just not equipped to handle revenues rising much faster than the rate of GDP growth.

Like other financial services companies that sank in 2008, however, the story is more complicated. Let’s start with how The Hartford got in such a mess.

It had lots of smart, talented people who understood risk. The people in variable annuities started off doing just what they were supposed to do: exploring opportunities. When the product became a hit, they understandably built up a process to ramp up sales domestically.

Then they went overseas, including a decision to enter Japan without hedging the currency risk. Executives in headquarters, delighted at the profitable growth, encouraged them, while investors cheered.

Prompted by The Hartford’s successes, competitors entered the markets and offered even riskier annuity products. It was the same story that played out elsewhere in the run-up to the financial crisis, with subprime lending, collateralized debt obligations and other financial innovations that got out of hand.

Liam McGee CEO of The Hartford 2009-2014

Liam McGee
CEO of The Hartford
2009-2014

Soon, the company was growing faster than it could add infrastructure to support the added size. It didn’t keep up with risk management and technology platforms in the life business, because all the spare capital went directly into new annuity programs.

Rule of thumb: Financial services firms are just not equipped to handle revenues rising much faster than the rate of GDP growth.

The complexity was the biggest challenge, as The Hartford was suddenly a multi-line business, not a P&C-dominated company with a few smaller operations.

Each division was watching over its own risk in the narrow sense, but management did not develop a strong risk management function at the corporate level. It couldn’t aggregate the risks from the separate divisions.

Meanwhile the rapid growth in the company’s annuity and other life businesses meant that the company had to build up its investment portfolio quickly. It had a lot of liquidity to invest.

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But the investment management division’s incentives were geared to maximize return, not to balance risk versus reward. The division lacked the tools to properly assess the risk it was taking or to see how it correlated to risks embedded in the annuity products that were being sold.

Like a sales force rewarded for gross revenue, not profitability, the managers didn’t fully factor risk into their investments. As a result, like many investors, they went after riskier assets, especially securities backed by commercial and residential real estate — right before the real estate market crashed.

The Hartford’s organization was inevitably influenced by the mood in financial services generally. People were dazzled by complex new packages of securities that managed risk in creative new ways. So the real estate bubble didn’t bother The Hartford’s executives as much as it should have. They tolerated more risk than they would have otherwise.

When one of your businesses is thriving, it’s hard for anyone at headquarters to tell it what to do.

Still, there were certainly smart people who understood that The Hartford had bitten off more than it could chew. In 2007, the company decided not to match competitors that were adding even riskier elements to their variable annuities. And well before the crash, some executives were urging the company to cease selling annuities or to sell the life business to a better-capitalized rival.

But decisions were deferred by leaders who understandably couldn’t give up on the money machine. When the company finally accepted the seriousness of the situation, the economy tanked.

It’s easy to blame headquarters for failing to assess risk at the corporate level. But you have to remember that throughout its history, The Hartford had had a fairly narrow product line.

When one of your businesses is growing fast, you want to put your resources first into supporting that business directly. That leaves less time and energy to put into setting up new resources at the corporate level. Assessing aggregate risk is a complex undertaking that requires sophisticated tools and staff.

It’s a political as well as a resource challenge. When one of your businesses is thriving, it’s hard for anyone at headquarters to tell it what to do. And traditionally, the business unit CFOs had much more power than their corporate counterpart, who was more of an adviser than a boss.

After all, even larger insurance companies had trouble understanding their risk as they diversified. When AIG got in trouble in 2008 because of its complex financial products, regulators struggled to capture the total risk and calculate how much capital the company needed to regain its footing.

For headquarters, allowing a successful product line to keep expanding is one kind of decision, a pretty easy one. But reining in that same product line because of risk on the corporate level is a much harder decision that inevitably invites pushback from the managers whose bonuses depend on the business.

Insurance involves long time horizons, so people like to deliberate and study a problem carefully. You can always find a relevant issue to justify a delay. Combine that with a headquarters staff less powerful than the businesses it’s supposed to oversee, and you inevitably end up with a kind of “states-rights” mentality that refrains from making tough calls.

Don’t Assume You Have a Burning Platform

Turnarounds may be tough, the thinking goes, but at least people will be open to changes. They know their company is in trouble, so you’ll get less of the political resistance you usually find when you push a major initiative.

That’s certainly what I thought. When I was offered the CEO position in September 2009, the company was in such bad shape that I almost didn’t accept.

Even with the TARP bailout to cover some of the toxic assets and buy some time, I worried that the unprofitable annuity policies, especially in Japan, would destroy the company’s insurance ratings and therefore its ability to compete.

The problems were so severe, and so clear to me from the outside, that I assumed the organization shared my anxiety. I had very little background in insurance, so I figured I got the job because the directors wanted a fresh start. At least I would have a burning platform.

Boy was I wrong. Many senior executives didn’t think things were so bad. They blamed the troubles on the deep recession coupled with some excesses in variable annuities. Now that they had the TARP and Allianz money, they figured they needed to make only incremental changes and just ride out the inevitable economic recovery.

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After all, they had had such an impressive run of profitable growth until 2007. It was hard to give that up and fashion a new strategy. At a minimum, they argued, difficult decisions should be deferred to give the economy time to improve and rectify our situation.

The company’s siloed structure also kept people from seeing the big picture. Executives could focus on their individual product lines and customer bases, rather than the macro financials.

At the same time, the size of the overall company insulated them from threats in the marketplace. How could a big, 200-year-old institution like The Hartford really be in dire straits?

People weren’t outright opposed to changing the strategy. I found several plans filed away when I arrived. Almost every kind of move had been looked into. But I still remember those early meetings, where we would talk for hours about a change. And then people would want to go back and study the issue further. I wanted to move forward, but the organization didn’t share the same urgency.

Start Changing Everything

The first thing I did was to focus on the immediate challenge: boosting our capital levels in order to withstand the continuing volatility in the market. As an insurer, we had strict rules in place to protect policyholders. Once we were able to raise capital, in March 2010, I was eager to focus on the strategic issues.

We formulated a rough strategy as follows. We wanted to be in businesses with growth prospects, where we could invest and increase profits. But these businesses had to generate capital over time, not consume capital. And third, they had to lower the overall market volatility for the firm.

Which businesses should we sell, in what kind of package, and when? We needed to find a buyer at a good price. And how were we going to unload the Japan albatross?

By those standards, the life business didn’t make sense. The only way we could make the credible guarantees we needed for a competitive annuity business was through a much bigger boost in our capital ratios. That wasn’t going to happen.

The annuities really belonged in the hands of a scale player. As for individual life insurance and other products in the life division, we didn’t have a strong enough market position to expect much growth. The annuities really dominated the division.

Meanwhile, we still had a core competency in property and casualty. Parts of that business had atrophied because the company had put most of its available capital into the annuities business, but it was still performing reasonably well with a strong market position. It also came with ancillary businesses in employee benefits. So we formulated a clear strategy to return to the company’s historic focus on property and casualty.

I was eager to move forward, but we couldn’t, for two reasons. First, like most financial services companies in multiple businesses, the company’s position was so complex and market-dependent that the structure couldn’t change quickly.

Which businesses should we sell, in what kind of package, and when? We needed to find a buyer at a good price. And how were we going to unload the Japan albatross?

Second, I didn’t think the existing senior team was capable of such a major shift. They had just gotten too used to the old ways, and would have difficulty with major changes.

So we set the overall direction, but we couldn’t carry it out immediately. We were also hoping to get some short-term benefit from the “green shoots” of economic recovery that people were talking about in early 2010. Our mix of businesses wouldn’t work in the long term, but in the short term they could improve their numbers and get us a better purchase price down the road.

Meanwhile, I realized we needed to get to work overhauling the company’s culture. We needed to make the company more decisive, and make people think outside their own silos.

That latter point really came home to me when all the senior managers in the company got together to discuss the big issues. It seemed an obvious thing for a Fortune 100 company to do. But it turns out they never did.

When we held our first gathering of the top 50 or so executives, most of them didn’t understand the point of it all. Many had never met their counterparts in different business lines. “What did all of this corporate talk have to do with me?”

To get everyone focused on the whole company, we launched the “One Hartford” campaign. Executive bonuses got flipped around so people couldn’t get big payouts unless the company as a whole prospered. Division-level results still mattered, but the priorities were clear.

Without that foundation, people wouldn’t be willing to speak out on problems that affected The Hartford as a whole. We wouldn’t get the support we needed for carrying out the new strategy. We might still be able to restructure the company, but it would fall into the same kind of trap in the next recession.

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We also developed significant risk management capabilities. The board established a risk committee composed of all the directors, and it convened at each quarterly board meeting. I established a chief risk officer position, reporting directly to me as CEO.

Working through an internal committee of all our senior leaders, the CRO, CFO and I established credit, market and other risk tolerances, and presented scorecards on each at every board meeting. We now understood the risks in each of our businesses and in our investment portfolio, and how those risks correlated.

Part Two of Liam McGee’s account of turning around The Hartford will be published online by Risk & Insurance on Wednesday, July 15.

Liam McGee led The Hartford from 2009 through 2014. He passed away in February, 2015.
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Sponsored: Liberty International Underwriters

Detention Risks Grow for Traveling Employees

Employees traveling abroad face new abduction risks that are more difficult to resolve than a ransom-based kidnapping.
By: | June 1, 2015 • 6 min read
LIU_BrandedContent

It used to be that most kidnapping events were driven by economic motives. The bad guys kidnapped corporate employees and then demanded a ransom.

These situations are always very dangerous and serious. But the bad guys’ profit motive helps ensure the safety of their hostages in order to collect a ransom.

Recently, an even more dangerous trend has emerged. Governments, insurgents and terrorist organizations are abducting employees not to make money, but to gain notoriety or for political reasons.

Without a ransom demand, an involuntarily confined person is referred to as ‘detained.’ Each detention event requires a specialized approach to try and negotiate the safe return of the hostage, depending on the ideology or motivation of the abductors.

And the risk is not just faced by global corporations but by companies of all sizes.

LIU_BrandedContent“The world is changing. We see many more occasions where governments are getting involved in detentions and insurgent/terrorist groups are growing in size and scope. It’s the right time for a discussion about detention risks.”

— Tom Dunlap, Assistant Vice President, Liberty International Underwriters (LIU)

“Practically any company with employees traveling abroad or operations overseas can be a target for a detention risk,” said Tom Dunlap, assistant vice president at Liberty International Underwriters (LIU). “Whether you are setting up a foreign operation, sourcing raw materials or equipment overseas, or trying to establish an overseas sales contract, people are traveling everywhere today for so many reasons.”

Emerging Threats Driven By New Groups Using New Tools

Many of the groups who pose the most dangerous detention threats are well versed in how to use the Internet and social media for PR, recruiting and communication. ISIS, for example, generates worldwide publicity with their gruesome videos that are distributed through multiple electronic channels.

Bad guys leverage their digital skills to identify companies and their employees who conduct business overseas. Corporate websites and personal social media often provide enough information to target employees who are working abroad.

LIU_BrandedContentAnd if executives are too well protected to abduct, these tools can also be used to identify and target family members who may be less well protected.

The explosion of new groups who pose the most dangerous risks are generally classified into three categories:

Insurgents – Detentions by these groups are most often intended to keep a government or humanitarian group from delivering services or aid to certain populations, usually in a specific territory, for political reasons. They also take hostages to make a political statement and, on occasion, will ask for a ransom.

In other cases, insurgent groups detain aid workers in order to provide the aid themselves (to win over locals to their cause). They also attempt prisoner swaps by offering to trade their hostages for prisoners held by the government.

The most dangerous groups include FARC (Colombia), ISIS (Syria and Iraq), Boko Haram (Nigeria), Taliban (Pakistan and Afghanistan) and Al Shabab (Somalia).

Governments – Often use detention as a way to hide illegal or suspect activities. In Iran, an American woman was working with Iranian professors to organize a cultural exchange program for Iranian students. Without notice, she was arrested and accused of subversion to overthrow the government. In a separate incident, a journalist was thrown in jail for not presenting proper credentials when he entered the country.

“Government allegations against detainees vary but in most cases are unfounded or untrue,” said Dunlap. “Often these detentions are attempts to prevent the monitoring of elections or conducting inspections.”

Even local city and town governments present an increased detention risk. In one recent case, a local manager of a foreign company was arrested in order to try and force a favorable settlement in a commercial dispute.

Ideology-driven terrorists – Extremist groups such as Boko Haram and ISIS are grabbing most of today’s headlines with their public displays of ultra-violence and unwillingness to compromise. The threat from these groups is particularly dangerous because their motives are based on pure ideology and, at the same time, they seek media exposure as a recruiting tool.

These groups don’t care who they abduct — journalist, aid worker, student or private employee – they just need hostages.

“The main idea here is to shock people and show how governments and businesses are powerless to protect their citizens and employees,” observed Dunlap.

Mitigating the Risks

LIU_BrandedContentEven if no ransom demands are made, an LIU kidnap and ransom policy will deliver benefits to employers and their employees encountering a detention scenario.

For instance, the policy provides a hostage’s family with salary continuation for the duration of their captivity. For a family who’s already dealing with the terror of abduction, ensuring financial stability is an important benefit.

In addition, coverage provides for security for the family if they, too, may be at risk. It also pays for travel and accommodations if the family, employees or consultants need to travel to the detention location. Then there are potential medical and psychological care costs for the employee when they are released as well as litigation defense costs for the company.

LIU coverage also includes expert consultant and response services from red24, a leading global crisis management assistance firm. Even without a ransom negotiation to manage, the services of expert consultants are vital.

“We have witnessed a marked increase in wrongful detentions involving the business traveler. In some regions of the world wrongful detentions are referred to as “business kidnappings.” The victim is often held against their will because of a business dispute. Assisting a client who falls victim to such a scheme requires an experienced crisis management consultant,” said Jack Cloonan, head of special risks for red24.

Without coverage, the fees for experienced consultants can run as high as $3,000 per day.

Pre-Travel Planning

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Given the growing threat, it is more important than ever to be well versed about the country your company is working in. Threats vary by region and country. For example, in some locales safety dictates to always call for a cab instead of hailing one off the street. And in other countries it is never safe to use public transportation.

LIU’s coverage includes thorough pre-travel services, which are free of charge. As part of that effort, LIU makes its crisis consultants available to collaborate with insureds on potential exposures ahead of time.

Every insured employee traveling or working overseas can access vital information from the red24 website. The site contains information on individual countries or regions and what a traveler needs to know in terms of security/safety threats, documents to help avoid detention, and even medical information about risks such as pandemics, etc.

“Anyone who is a risk manager, security director, CFO or an HR leader has to think about the detention issue when they are about to send people abroad or establish operations overseas,” Dunlap said. “The world is changing. We see many more occasions where governments are getting involved in detentions and insurgent/terrorist groups are growing in size and scope. It’s the right time for a discussion about detention risks.”

For more information about the benefits LIU kidnap and ransom policies offer, please visit the website or contact your broker.

Liberty International Underwriters is the marketing name for the broker-distributed specialty lines business operations of Liberty Mutual Insurance. Certain coverage may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. This literature is a summary only and does not include all terms, conditions, or exclusions of the coverage described. Please refer to the actual policy issued for complete details of coverage and exclusions.

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This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.




LIU is part of the Global Specialty Division of Liberty Mutual Insurance.
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