Point of View. Elevating Four Strategic Themes to the CEO Level. Financial Services

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1 Financial Services Point of View Elevating Four Strategic Themes to the CEO Level Authors Bernhard Kotanko, Head of EMEA Insurance Richard Surface, Partner The insurance CEO and his top team are well aware of the strategic challenges facing their business. However, we see four themes emerging that today require the CEO to reassert his or her personal ownership. This is so because, increasingly, they cut across multiple business functions and involve significant organisational change. It is no longer good enough to let the organisation s separate units continue to grapple, in relative isolation, with regulation, the customer proposition, the value chain, and talent. These four themes demand a firm-wide perspective that only the CEO can provide. This paper sets out our perspective on these themes and why the CEO must lead the organisation s resolution of them.

2 1. Regulation A new arsenal of CEO weaponry Traditionally, CEOs have seen regulation as a hygiene factor. Compliance demanded complex models and extensive documentation but was not seen as aiding and abetting better business decisions. The CEO kept a watchful eye on compliance and was sporadically involved in lobbying efforts. Beyond this, he or she delegated to finance and risk the task of constructing a framework that satisfied requirements at a minimum cost and disruption to the business. However, the game has changed. Solvency II and IAS give rise to significant opportunities for reallocating capital to achieve substantially improved returns. To realise this potential, some of the initiatives currently underway across the sector include the following: Acquisitions to make full use of diversification benefits Merging of legal entities to benefit from greater capital fungibility Creating Group ALM capability to optimise investments across operating companies Enhancing the central reinsurance, risk structuring and risk transfer activities. While implementation details are for the functional heads to manage, the amount of value at stake and the change required to capture it make what to implement and how to do it a CEO issue. We estimate that the typical insurer has more than a third of its capital locked up in nonfungible or illiquid assets For composite insurance groups, the capital incentive for acquisitions can be 15% of total capital requirements, as group diversification across different business lines is the largest contributor to overall diversification benefits 1 Optimising the risk and capital structure for the highly geared balance sheet of a typical life insurer, leveraging enhanced Group ALM, hedging and liquidity management capabilities, could raise shareholder returns by more than 50% 2 We estimate that Solvency II could increase demand for reinsurance in Europe by up to 20%. The decision about what risks to retain and which to transfer will have a major impact on shareholder value 3. Ultimately, the optimal way forward entails both hard choices about the portfolio and major, enterprise-wide transformation. The scale of change required to achieve the huge potential benefits at stake demands the personal ownership and push of the person at the top. 1 Solvency II: Quantitative & Strategic Impact The Tide is Going Out (Oliver Wyman/Morgan Stanley Joint Report, September 2010) 2 Oliver Wyman analysis 3 Solvency II: Quantitative & Strategic Impact The Tide is Going Out (Oliver Wyman/Morgan Stanley Joint Report, September 2010) 2

3 2. Customer value proposition Taking back the insurance heartland Yesterday s insurer customer value proposition was driven in a large part by tax advantages against an easy background of rising equity markets and high fixed income returns. Opaque products with expensive distribution costs did not matter when savings-like insurance contracts were the only way for the broad middle market to access these returns. But the removal of tax advantages coupled with falling returns have exposed insurers to new mass market competitors. Many life insurance markets have gone ex-growth as their products look like expensive mutual funds. In retail P&C the challenge is different: high penetration in core products has driven insurers to focus on price and efficiency. In doing so, they have failed to stay abreast of changes in the assets covered, such as the move from new car sales to leasing and flexible mobility concepts. That said, the traditional advantage of an insurer superior understanding of the interaction of both sides of the balance sheet, the complex relationship between assets and liabilities still holds true. Indeed, risk-related value delivery has, if anything, become of greater importance to today s post-crisis customer than ever before. The challenge in today s market is to articulate this value in a way that customers understand. Arcane, inward-looking processes grounded in actuarial science are still so deeply embedded in insurance companies DNA that this challenge is more forbidding than commonly acknowledged. It s not just a matter of using simple words and modern branding techniques. There needs to be a root-and-branch redesign of the product. Some of the recent efforts in this direction include the following: The launch, in German-speaking Europe (where historical memory of the horrors of hyperinflation persist) of a real purchasing power protection product, which guarantees a real return at product maturity date The innovative serious illness product of a leading UK health insurer, providing cover for an advanced set of illnesses with scaled benefits linked to severity grades and rewarding a healthier lifestyle through a vitality programme A European insurer s joint venture with a car manufacturer to deliver motor and accident coverage as a seamless element in an overall service package Dynamic de-risking products that provide a practical way for small pension funds with limited resources to reduce their ALM exposure. The reason why value proposition development in the new insurance world is a CEO theme is that product development typically is one of many functions in a Marketing department that again, typically is under the thumb of Sales. And Sales is worried about shifting today s products, not reinventing them. Unless the CEO elevates this activity to the strategic level it deserves and endows it with his personal authority it will continue to produce bland, business-as-usual solutions. And the business will continue to lose its customer heartland to the competition. 3

4 3. Depth of value chain Taking a fresh look at vertical integration Accepted wisdom has it that administration of insurance policies is so grounded in local tax, pensions and regulatory regimes that it must be done in-house. Moreover, unreclaimable VAT at 19% or higher makes cost savings look like wishful thinking. Accordingly, pioneers in outsourcing, off-shoring and right-sourcing focused their efforts on mainframe computer operations and call centers. The former have met with mixed success and the latter have suffered some spectacular customer service breakdowns. Today, as a result, there is little appetite for taking a renewed look at what an insurer should do via its own employees versus what it is better done by external suppliers. But the fact remains that today s insurer looks more like an elephant than a gazelle. It is estimated that 80% of the cost of the product delivered to the insurance customer is produced by the insurer itself. The corresponding figure for automotive OEM is 25-30% and for labelled consumer goods as little as 10% 1. Moreover, while pioneering-but-chastened insurers were closing down their Mumbai call centers and bringing them back home, the outsourcing opportunities have grown steadily. Celent estimates that the core European insurance business process outsourcing market will grow from $2.5 BN in 2008 to $3.5 BN in 2013 Recent Oliver Wyman client work suggests that 80% of the typical financial institution s IT application development and maintenance activities can be outsourced, delivering savings of 20% to 40% European and North American insurers asset management outsourcing has grown to over $1 TN, primarily aimed at tapping into specialist management expertise. Indeed, some of the most successful insurers in today s market have already embraced these realities. For example: VAT has been mitigated by cross-border solutions and/or industry utilities A highly successful UK P&C insurer has outsourced aggressively and consciously adopted the strategic role of a pure packager European bancassurers are rediscovering the value (aided by Basel III) of distribution only business models The only UK life company still able to boast of a profitable and growing new business operation has from its inception outsourced asset management, administration and even advice. The latter is achieved not through the traditional IFA channel but by contracting with a US firm that specialises in sophisticated evaluations of fund performance. How vertically integrated should today s insurer be? This question, if left to the Purchasing, Administration and IT departments, will not be answered with anything close to an optimal, game-changing solution. The CEO perspective is required. 1 Oliver Wyman analysis 4

5 4. Talent A gap that looks like a chasm In a survey commissioned by the Swiss Insurance Association 1, insurance ranked second from bottom in employee attractiveness. To an extent, this is an unalterable fact of the business world. No insurer can look like Google. There is something intrinsic in insurance products and services that will always come across as boring, even if acknowledged as vastly more important to a customer s life and well-being than an internet search engine. That said, the insurance company of the future will look a lot different from the one of the past if the insurer is to continue to have a macro-economic role to play in the savings-like life industry and the protection of retail and commercial assets. And here we see the biggest gap of all emerging between today s point of departure and tomorrow s point of arrival: people. Insurers desperately need not more people, but substantially better ones in terms of skills, experience and business acumen. But, and this is why the CEO must take charge, the Human Resources department cannot fill the skills gap with its traditional tools. It s not just a matter of throwing more money at search firms and salary grades. And it is certainly not a problem solved by internal training initiatives. The CEO must shine his personal laser on those key value adding functions in his vision of the future enterprise. These include especially those implied by the above three themes: risk and capital management; product and service innovation; and operational excellence. He must take ownership of the effort to transform the talent pool in these areas, becoming in effect the Chief Personnel Officer of the company, to reach far beyond the insurance sector for new blood. 1 Customer survey conducted by DemoScope Research & Marketing, for Swiss Insurance Association (July 2009) 5

6 Conclusion Huge programs are underway across the insurance sector to deal with regulation. Likewise, major revisions of the product line have been launched along with cost reduction initiatives and recruiting drives. Most of these efforts, in our view, leave unanswered the real challenge: how is the enterprise going to look in the future? Indeed, to the extent these projects are being managed in the traditional silos, the future is destined to look much like the business of today. And that could, at the least, amount to a big opportunity loss. At worst, it could result in the insurer spiralling down to a closed-book business without a future beyond the run-off of existing policy obligations. It is the CEO s job to make sure this does not happen. We are not just advocating that he or she craft an updated vision statement. Regulatory opportunity, the new-world customer proposition, organisational model and talent these are the dominant themes that will determine the future health of the enterprise. Dealing with them requires in the first instance recognition that they go right across the organisation. Secondly, it requires recognition that significant upheaval and departure from the status quo will be necessary. At stake is the potential for the insurer to lift itself to a new universe of value delivery for all stakeholders. This potential can only be realised if the CEO takes personal charge of the challenges they present. 6

8 Oliver Wyman is an international management consulting firm that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, organisational transformation, and leadership development. For more information please contact the marketing department by at or by phone at one of the following locations: EMEA North America Asia Pacific All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The opinions in this report represent the views of the author(s) and may not necessarily reflect the views of other partners within Oliver Wyman or the company. This report is not a substitute for tailored professional advice on how a specific financial institution should execute its strategy. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisers. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. This report may not be sold without the written consent of Oliver Wyman.

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