Introduction to the Insurance Industry
Insurance and risk management make up an immense global industry. According to a survey conducted by a leading global insurance firm, Swiss Re, worldwide insurance premiums totaled $4.59 trillion in 2011 (the latest data available), up from $4.33 trillion in 2010. This was equal to 6.6% of global GDP. Global life insurance premiums were $2.62 trillion during 2011, while all other types of insurance totaled $1.96 trillion.
In America alone, the insurance business employed about 2.3 million people in 2011. Gross life insurance premiums in the U.S. totaled $166.2 billion (per the National Association of Insurance Commissioners), while property and casualty premiums totaled $445.0 billion. A large number of companies underwrite insurance in America, but the industry is dominated by a handful of major players.
In emerging nations, where the fastest growth is to be found, total premiums in 2011 were about $700 billion, up only 1.3% over the previous year. Life insurance premiums dropped 5.1%, due primarily to poor markets in China and India. However, non-life premiums made a solid gain of 9.1%. These figures are from Swiss Re (www.swissre.com/sigma/).
Premiums on a per capita basis remain very low in much of the world, pointing to excellent long-term opportunity for expansion of sales of insurance products of all types, including annuities. It would be hard to overstate the importance of emerging nations, especially China, India, Brazil and Indonesia, to the future growth of the insurance industry. Total premiums in South and East Asia (including China) were only $347 billion in 2011. Much of the world is still clearly a fertile field for expansion of companies that are willing and able to invest time and money in emerging markets. The insurance market in these areas will be boosted by a combination of rising household incomes; increasing education and financial sophistication among consumers; extending life spans; and a tradition of families relying on personal savings and initiative rather than government social programs to provide for retirement funds and health care.
Massive amounts of insurance company earnings come from the sale of annuities and other retirement and investment products, along with profits (or losses) that insurance underwriters earn on the investment of their own assets and reserves. A recovery in stock and bond markets that began in the spring of 2009 and ran through late 2012 provided a boost to the investment earnings of the insurance industry. The total amount of capital held by insurance underwriters has increased dramatically, according to Cavignac & Associates, growing from $290 billion in 2001 to $550 billion in 2011. Meanwhile, competition has been intense, and rates for commercial insurance policies have been very low. Insurance firms will be tempted to raise rates over the mid-term, and they will point to major losses from events such as recent earthquakes, hurricane Sandy in the U.S. and the nuclear disaster in Japan as justification.
In America, insurance is unique in the financial services field because, unlike banking and investments, which are regulated largely (although not entirely) by federal agencies such as the Securities and Exchange Commission, insurance is regulated primarily at the state level. This means that insurance firms must deal with up to 50 different sets of state regulations and 50 different state regulatory agencies. At the same time, they must develop dozens of different premium rate structures that appropriately reflect the costs of meeting local risks and fulfilling state requirements. As a result, few insurance underwriters offer all of their insurance products in all 50 states; many do business only in a limited number of states. It is a regulatory and administrative nightmare that limits consumer choices and drives up overall insurance costs.
Insurance underwriting does not earn consistent levels of profits. Property and casualty insurance companies sometimes face a year of losses, rather than profits, due to natural disasters such as hurricanes, floods or an overly active fire season. Occasionally, insurance underwriters go broke, and firms that rate the financial stability of insurance underwriters always list more than a few that are not financially sound. For example, Yamato Life Insurance Company, a leading Japanese firm that had been in business for nearly 100 years, took bankruptcy in October 2008.
During 2005, Hurricanes Katrina and Rita in the U.S. cost insurance underwriters vast amounts (damages, both insured and non-insured, totaled about $58 billion) and created significant controversy over flood insurance in general. Many changes resulted, and insurance underwriters felt compelled to boost rates for many types of insurance, especially in Gulf Coast markets. More recently, some of each hurricane season’s risk has been sold by primary underwriters to hedge funds and reinsurers who buy portions of large, high-risk insurance policies. This enables property & casualty underwriters to continue to earn reasonable profits while laying-off a significant part of potential losses if there is a devastating hurricane. The total cost of the 2012 hurricane Sandy in the New York area may have economic impacts that total more than $50 billion, but a vast portion of that cost will be uninsured.
The insurance industry includes a wide variety of sectors and services. The most obvious are insurance underwriters that cover the risks and issue the policies, along with the agencies that sell insurance. However, there are also large numbers of consulting firms, claims processing firms, data collection firms and myriad other specialized fields serving the industry.
In addition, there are insurance brokers, which have traditionally posted enviable profits. Insurance brokers represent the interests of corporate clients while finding their customers the best coverage at the best rates.
Recent regulatory changes have heightened competition within the insurance industry—an area in which competition has always been fierce. Massive mergers and acquisitions have resulted, creating financial services mega-firms, some of which offer a broad range of services and products to their customers, from checking accounts to investment products to life insurance. In some cases, this strategy was a failure, most notably in Citigroup’s attempt to put together a financial empire by adding a major investment firm (Smith Barney) and a leading insurance company (Travelers) to its existing banking organization.
Elsewhere, banks such as Wells Fargo are doing reasonably well in the sale of insurance products, particularly annuities and life insurance. Investment companies like Merrill Lynch (now part of Bank of America) have been eager to sell insurance to their customers as well. At one time, bank holding companies were aggressively acquiring insurance agencies.
Competition will only become more intense. While there are tens of thousands of small insurance firms worldwide, the industry tends to be concentrated in a few hundred major companies, many of which enjoy brands that are household names. A handful of these top firms operate on a truly global scale.
In the world’s leading economies, regulators are in the process of forcing vast changes in the regulation and oversight of financial services firms of all types. The focus is on making risks held by such firms more transparent, and maintaining sufficient levels of capital to cover potential losses. The insurance industry is going through significant scrutiny and oversight as a result.
In the U.S. a sweeping reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act, was signed by President Obama in July 2010, after European finance ministers approved similar regulations a few months earlier. Most of the 2,300-page reform act does not apply to the insurance industry. For better or worse, regulation of insurance remains largely with the 50 states. However, one section of the act creates a new Federal Insurance Office (FIO), described as a non-regulatory, informational office. The FIO’s role includes monitoring the American insurance industry, including gathering data from the various state-level insurance regulators. It will advise Congress and various federal agencies on insurance matters. Also, the act streamlines the reinsurance and surplus lines sector. A key provision makes the home state of an insured party the sole regulatory authority in a surplus lines transaction. The FIO will also represent America, when needed, in dealings with the International Association of Insurance Supervisors.
In March 2010, President Obama signed the Patient Protection and Affordable Care Act. Designed to strengthen insurance company regulation and provide medical coverage to more than 30 million uninsured Americans, the act was hotly contested in both houses of Congress.
The act calls for sweeping changes in the near term to be followed by even more comprehensive changes by 2014 or beyond. Provisions taking effect within the first six months of signing included coverage for adult children up to age 26 on their parents’ policies; making it unlawful for insurers to place lifetime caps on payouts or deny coverage should a policy holder become ill; and new policies being required to pay the full cost of selected preventive care and exempt that care from deductibles. Effective in 2010, small businesses with fewer than 25 employees and average annual wages of less than $50,000 became eligible for tax credits to cover a portion of staff insurance premiums.
After 2014, a 3.8% unearned income tax will be levied on individuals earning more than $200,000 per year and families earning more than $250,000 per year to fund the programs in the act. Large employers with more than 50 employees that do not offer health benefits would begin paying $2,000 per full time staff member if any of the workers receives a tax credit to buy coverage. Businesses with more than 200 employees will be required to enroll all staff automatically in health insurance plans. Also in 2014, the government will begin fining citizens who choose not to carry health insurance. The fine will start at $95 per year or 1% of annual income (whichever is greater), and rise to $695 per year or 2.5% of income by 2016.
Initially, health care reform may provide positive growth to the earnings of health insurance providers. The problem for the industry is that Congress will undoubtedly attempt to reduce costs and profits throughout the health industry. Insurance providers may eventually suffer, or be forced into consolidation in order to streamline operations and deal with lower profit margins. On the other hand, insurance providers may find that they have to innovate and evolve by offering supplemental policies—that is, policies that provide enhanced coverage above and beyond basic coverage mandated by universal care. Supplemental insurance is typically a much higher profit margin business.
The result could easily turn into a profit squeeze for both insurers and providers. Costs for the government could rise so quickly and so high that it could even impose profit limits. For example, both Massachusetts and Tennessee have been forced to backtrack substantially on their relatively recent statewide universal plans because costs ramped up much higher and much faster than they ever thought possible. It is reasonable to assume that pain from a scenario like this would be passed along to insurers.
Internet Research Tip
Excellent sources of in-depth insurance industry information can be found at the following sites:
· National Association of Insurance Commissioners, www.naic.org
· National Association of Mutual Insurance Companies, www.namic.org
Video Introduction to Insurance Industry