Despite the current turmoil in global capital markets, most insurers are beginning 2016 in relatively good shape from a capital adequacy perspective. However, there are a myriad of macroeconomic, competitive and technological challenges facing the industry. Here are several predictions that S&P Capital IQ foresees for the insurance industry in the coming year:
Investor activism will increase, particularly in the life insurance industry. Property-casualty, multi-line and reinsurance stocks, as measured by the S&P sub-industry indices, all outperformed the broader market in 2015, rising 7.7%, 7.4% and 5.2%, respectively; compared with a 1% decline in the S&P 1500 Index. Life insurance stocks, however, under-performed the broader market for the second year in a row, declining 7.1% in 2015 and rising a mere 1% in 2014 (when the S&P 1500 was up nearly 11%). Having already placed multi-line insurers like American International Group (AIG 59***) in their crosshairs, we think activist investors will soon turn their attention to the laggards in the life insurance space and agitate for change.
Margin expansion will continue to be a challenge. Based on data from SNL Financial, operating margins for most insurers contracted year-to-date through September 30, 2015. Life insurers were the one exception, though. Margins for this group actually expanded by 138 basis points, to 9.68%. While this is an improvement, aggregate margins levels remain well below historical levels and below levels in other segments of the insurance industry. Multi-line insurers experienced the greatest contraction, with operating margins down 196 basis points to 10.46%; while property-casualty insurers experienced a 169 basis point contraction in their operating margins, to 12.28%.
Against the backdrop of margin pressure amid a still-low interest rate environment, and likely fueled by investor and consumer pressure, many insurers may be forced to conclude that a broad based product and segment strategy is no longer a viable business model. Many will trim product offerings, selling or running off non-core and underperforming lines of business. The value of diversification versus a more streamlined approach will also be questioned. This injects a degree of execution risk into the industry, further bifurcating insurers.
Usage -based insurance (UBI) will gain traction, particularly in the auto insurance market. The theory behind UBI is that auto insurance premiums and driving behaviors would be closely aligned. UBI programs are not new- the first program was started about a decade ago by Progressive Insurance. However, the penetration rate of usage-based insurance is less than 1% currently. Estimates cited by the National Association of Insurance Commissioners (NAIC), project that by 2020 36% of auto insurers will employ some form of usage based insurance. Demographics are a factor likely to spur the acceptance of this practice. Millenials- those individuals born between 1981 and 1997- have overtaken baby boomers (those born between 1946-1964) as the largest population segment in 2015. These 75.3 million 18-34 year olds are very comfortable sharing and using technology. They typically do not have the privacy concerns that may have hampered acceptance of UBI by older generations.
As a result, data breaches and privacy issues in the insurance space will increase, reflecting the greater use and sharing of personal data and information. High profile data breaches in the banking and credit card industries have become all too common. A sharp rise in insurer data breaches will likely draw the ire of consumer advocates and lawmakers and may renew calls for another revamp to the current state-based insurance regulatory system.
Technology will continue to disrupt distribution platforms. The insurance industry remains heavily dependent on third party intermediaries- agents and brokers- to market and distribute their products. However, a growing number of consumers prefer to research products and make purchases online. The gap between insurance distribution models and consumer purchase patterns will narrow for those firms able to pivot and evolve. This will be most keenly felt in the personal lines insurance market, particularly the auto insurance market. The degree to which an insurer is able to meet these shift in purchasing trends will be a key competitive factor.
Finally, the nature of competition will also continue to change. While the insurance marketplace has seemingly always been highly competitive, now insurers must contend with competition from outside their industry. Tech innovations like PolicyGenius and Google Compare, shopping sites which allow consumers to compare policies, are two examples. While these sites may help insurers increase their online presence, they also serve to further commoditize insurance products.
We believe 2016 may serve as an important inflection point for many insurers. The degree to which they are able to address these salient issues will determine their long term viability. Some insurers we believe are well positioned to address these challenges are ACE Ltd (ACE 111****), Everest Re Group (RE 178*****), Principal Financial Group (PFG 40****), Travelers Companies (TRV 106 ****) UNUM Group (UNM 31****) and XL Group PLC (XL 37****).
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Copyright©2016. For important regulatory information, please go to www.capitaliq.com/home/legal-disclaimers.aspx.