Edition #9 - Risk Fluidity, Earnings Notables

Another couple of busy weeks since Edition 8. I’m currently in Singapore to host a CEO panel at the 2023 International Insurance Society annual meeting, followed by client meetings for a couple of days before heading to Hong Kong for the rest of the week.

Plenty to think about and report on over the last couple of weeks. It’s earnings season with lots to chew on for Life, P&C and Brokers (more on this below).

Before diving in, the confluence of a number of themes I’ve previously touched on has been top of mind — specifically: risk fluidity, macro resilience, and the perennial asset management-led insurer (see here for a fuller exposition of each).

Insurance market views

Three charts this week to illustrate the point. Exhibit 1 shows a history of movements in the US 10-year Treasury Rate (left-hand side) and the underlying composition of the rate changes in terms of real rates and breakeven inflation expectations (right-hand side). We’ve moved from a 40+ year period of secular declines in rates into a ‘New Monetary Order’ of sharp increases and the prospect of ‘higher for longer.’ The speed of the change has been dramatic with a 3.5%+ increase in the 10-year yield between a low point in Q3 2021 to today. Perhaps, what’s even more interesting is that a majority of that shift has been driven not by inflation expectations, but by real yields with investors now able to access US government real interest rates not seen since the early 2000s.

Exhibit 1 – A New Monetary Order

Why is this relevant and how does it link to the themes described? Firstly, from a ‘risk fluidity’ perspective it’s relevant because insurers writing long-term guarantees make pricing and ALM decisions based on these underlying rates. Given the speed of recent movements, a logical question to ask is: “how fluid are my pricing and ALM processes”, for example, and “Is the ‘machine’ I have sufficiently nimble to allow me to make effective decisions in the current environment?”

Oliver Wyman conducts a comprehensive set of surveys of US insurers every year with a rich collection of data to inform this question.

Below, Exhibit 2 shows typical repricing times on different product lines. The good news is that in a rising rate environment, price stickiness generally means that new business economics should be better than expected: “I priced a guarantee assuming rates were at one level, when in fact they were higher and, assuming I still write the same volume of business, my new business profitability should be higher.”

Of course, if I’m competing in price sensitive products and channels against more nimble competitors then the risk is that I don’t write the same amount of new business and, despite unit profitability being higher, overall profit volumes are down. The landscape behind Exhibit 2 is too nuanced to draw any definitive conclusions from the chart other than to say that repricing in many cases is a relatively slow process which raises the question about the ability to take share and better manage overall economics through a faster finance and actuarial ‘engine,’ which, not surprisingly, is an area we are seeing significant focus on in today’s environment.

Exhibit 2 – Retail and Institutional Repricing Times by Product

New business economics are one thing, in force economics another. Another provocation the rapidly moving rate environment prompts is: “How robust is my ALM approach and decision-making engine?”.  Below, Exhibit 3 shows an extract from our 2023 ALM Survey. The left-side chart compares average liability durations by product type compared to the duration of underlying asset portfolios. The distance to the dotted line shows average duration mismatch (positive and negative) in years. The bubble above the line implies that assets have longer duration than liabilities, and below the line implies liabilities have longer duration than assets. 

Exhibit 3 – How fast is my investment decision-making engine?

Duration mismatches overall are, in almost all cases, relatively modest and carefully managed against risk tolerances and limits. So, these positions are being deliberately taken and are within reasonable limits. The decision to be short or long duration, however, does have consequences in terms of profit/loss on insurers’ in force books. If I’m net short duration and rates increase, then all else being equal, I’ve realized an economic profit and vice versa. These gains/losses should be more obvious from US public company financial disclosures going forward given the new GAAP (LDTI) requirements effective in Q1 of this year in most cases. That’s a topic for a future edition.

The right-hand side of Exhibit 3 shows information from survey respondents on reporting frequency (horizontal axis) and reporting processing times (vertical axis) for ALM. Obviously, what’s wanted in a fast-moving rate environment — where I’m making decisions about how long or short to be from a duration perspective — is to have a very frequent ALM review process with short reporting times so that I can dynamically manage my ALM decision-making. The chart suggests that there is a wide dispersion in practices with significant lag times in some cases.

It's easy to say that I want frequent reporting and decision-making, and much harder to do. Sitting under these charts in most cases is a very complex picture with multiple source systems, often fragmented data infrastructures, manual forecasting processes, and disconnected modeling of liabilities and assets. That said, we’ve seen a marked increase in efforts to tackle these problems given the current environment — often under the banner of Finance and Actuarial transformation programs — and, most recently, Gen AI provides further promise of acting as a positive catalyst for change. Getting closer to an efficient position on ALM and investment decision making will make insurers more resilient to the macro environment.

So, how does this relate to the topics of risk fluidity and the asset management-led insurer? As we’ve described before, there has been a rapid rise of private capital-backed and other non-traditional players in the life insurance space. The archetypical model tightly links private asset origination and structuring with a life insurance balance sheet, often backed by a sidecar with third-party capital sources. In order to execute this model effectively, there needs to be very tight integration and rapid, two-way communication and decision-making across asset origination/management and liability origination/management teams in order to have ‘risk fluidity,’ the ability to quickly understand how to tranche and where to assign risk and capital. As incumbents reshape their models to better allow for competition with new players, it’s again not surprising to see the sharp focus emerging on transforming modeling, ALM, and decision-making structures. Hard to do but ever more essential.

Onwards to observations on the latest batch of earnings releases.

Earnings notables

At the time of writing this edition, Q3 earnings have been reported by the following large US public insurers (not exhaustive):

• Life: Aflac, Ameriprise, Apollo, Equitable, Globe Life, Lincoln, Principal, Prudential, Unum
• P&C: Allstate, AIG, Arch, Chubb, Cincinnati, Erie, Everest, Hartford, Lowes (CNA), Progressive, Renaissance Re, Travelers, WR Berkley
• Broking: AON, AJG, Brown & Brown, MMC

I’ve highlighted a selection of comments from Q3 earnings calls below that resonated against various of the themes we’re actively watching. 

Asset management-led insurer

• Apollo: “When regulators ask banks in the U.S. to put up 15% more capital, they're asking the banks to shrink or to shrink lines of business. When Europe moves from Basel III to Basel IV, they're asking banks to shrink. This is happening around the world. Debanking is not something that is periodic. It is that it's very early infancy. It does not mean that banking is a bad business. It does not mean that four big banks don't have amazing businesses. They do. But it means on the margin, they will continue to play less and less as a percentage of the total and investors will play more and more. That tells me as investors that you will see over the next decade a series of financial products that you've never seen before because they have historically been resident only on the balance sheets of large banks, and they are on their way to you as investment product. As I mentioned, I believe we are in the first inning or the infancy of private credit. Private credit is a secular trend, and it follows the debanking that I mentioned, and it is not just a U.S. phenomenon. It is a worldwide phenomenon. We have, to date, as a financial press and as an industry, talked about private credit as if it meant to be — if it is levered lending, sometimes called direct lending, was private credit. Invested assets attributable to third-party investors in ADIP now exceed $50 billion, representing 20% of Athene's total invested assets. As third-party capital, ADIP has multiple benefits, including validating Athene's business model, providing capital support, driving greater profitability on business retained and enhancing AGM's overall group capital efficiency. We expect to close out 2023 with a normalized SRE growth rate exceeding 30%, reflecting our expectations for strong organic inflows in the fourth quarter, a lower core outflow rate, ADIP growth participation and a normalized net spread of approximately 165 basis points in the fourth quarter.”  [Marc Rowan, Co-Founder, CEO & Director]
• Lincoln: “I first want to provide you with an update on the reinsurance transaction we announced with Fortitude Re in the second quarter of this year. We are very pleased to announce today that both our regulators, the Indiana Department of Insurance and our partners regulator, the Bermuda Monetary Authority have approved the transaction. With these approvals, we expect the transaction to close this month with economic benefits in line with what we originally communicated with an effective date of October 1 of this year.” [Ellen Cooper, Chairman, President & CEO]
• Prudential Financial: “During the quarter, we launched Prismic, a life and annuity reinsurance company, alongside Warburg Pincus and other investors. It is one of our most exciting opportunities to drive sustainable long-term growth across our investment management, insurance and retirement businesses.” [Charles Lowrey, Chairman, CEO & President]

Transactions

• AIG: “Yesterday, we announced the successful closing of the sale of Validus Re to RenaissanceRe for which we received a total consideration of $3.3 billion in cash, including a pre-close dividend and approximately $275 million at RenaissanceRe common stock….. In August, Corebridge entered into a definitive agreement to sell Laya Healthcare to AXA for EUR 650 million, which closed on October 31. Proceeds to Corebridge, net of purchase price adjustments and deal-related expenses, will be approximately $730 million.” [Peter Zaffino, Chairman & CEO]
• Allstate: “We decided to pursue our sale of Allstate's Health and Benefits businesses. After successful integration of Allstate's voluntary benefits business, with National General's group and individual health businesses, we've created a really well-positioned benefits platform, and that strategy was part of the National General acquisition plan. Our success now positions us to achieve additional growth that potential could be maximized by aligning this platform with a broader set of complementary products, distribution channels and capabilities. We anticipate completing a transaction in 2024.” [Thomas Wilson, Chairman of the Board, President & CEO]

Reinsurance platforms

• AFLAC: “We are continuing to build out our reinsurance platform, and I'm pleased with the outcome and performance. In Q4, we intend to execute another tranche with similar structure and economics to our first transaction from January this year. Our capital position remains strong, and we ended the quarter with an SMR above 1,000% in Japan. And our combined RBC, while not finalized, we estimate to be greater than 650%.” [Max Broden, EVP & CFO]

Expense management

• Ameriprise: “We are now focused on adjusting our global operating model and expenses so we can continue to generate good margins in a tough climate. For Asset Management, adjusted operating margin was 36% and above our targeted range. G&A was down 3% adjusted for foreign exchange. We also have taken action to tightly manage expenses and we're looking more fully across the business to continue to reduce expenses and leverage more operating efficiencies for the rest of this year and into 2024.” [James Cracchiolo, Chairman & CEO] 
• AON: “Accelerating our plan requires greater upfront investment. And as announced in our press release, we will execute this through a $900 million restructuring program focused on two areas. First is on accelerating our Aon Business Services plan by focusing on standardized operations, integrating operating platforms and driving product innovation. And the second is on workforce planning to align skills and capability required to deliver on the digital-first opportunity embedded in AI business services as well as workforce changes to strengthen our client-serving capability and risk capital and human capital.” [Gregory Case, CEO & Executive Director]
• Lincoln Financial: “Turning briefly to company-wide expenses. Expenses in the quarter remained elevated and are one of the key pressures to earnings and free cash flow for the company. As such, expenses are an important area of focus and opportunity for us as a management team and we are actively engaged in a comprehensive review in which we are closely examining our expense base across the organization in order to mitigate expense growth and identify opportunities for further cost reduction.…both the inflationary headwinds and the cost of the deferred maintenance, it's incumbent on us to find offsetting savings elsewhere in the organization, and this is a project we're currently shaping…. but simply, there is opportunity to continue to right size the expense base of the company.” [Christopher Neczypor, EVP & CFO]

Market-pricing dynamics

• Arch: “Let's take a moment to recap the current state of the market and where we are likely headed. I see it as a play in three acts. The first act, the current hard market started in primary liability insurance in 2019 and then has a unique circumstance of a 2-year pause in claims activity due to a global pandemic. The second act introduced Hurricane Ian as a main character where property reinsurers had to adjust both their pricing and risk appetite. In addition, capital got more expensive and the industry has to respond to meet new expectations from investors. While property has been the most recent driver of this market as we move into Act 3. We are faced with increasing evidence at casualty rates widely underpriced and oversold during the last submarket need to increase. We expect this third act of the extended hard market already one of the longest in memory to persist until the industry's reserving issues are resolved and until capital rates generate positive results.” [Marc Grandisson, CEO & Director]
• Chubb: “In terms of the Commercial P&C rate environment, rates and price increases in property and casualty lines in aggregate remains strong in the quarter in both North America and our International divisions, while decreases in financial lines in North America continued. We remain vigilant and diligent about staying on top of loss cost inflation.” [Evan Greenberg, Executive Chairman & CEO]
• Everest: “Looking ahead, our outlook for the January 1, 2024, renewal remains strong. We fully expect the robust pricing and favorable conditions to continue. And as a lead market, we stand to benefit. Our nimble, creative and collaborative approach allows us to simultaneously improve our economics and strengthen client relationships. This tremendous relationship equity will serve us well. Expectations for pricing and terms and conditions in the global property market are now well understood, which should make future renewals more orderly.” [Juan Andrade, President, CEO & Director]
• Marsh McLennan (MMC): “Primary insurance rates continue to increase with the Marsh Global Insurance Market Index up 3% overall, in line with the second quarter. Property rates increased 7% compared to 10% in the second quarter. Casualty pricing was up in the low single-digit range. Workers' compensation increased slightly, while financial and professional liability insurance rates were down mid-single digits. Cyber insurance pricing decreased modestly after several years of increases.” [John Doyle, President, CEO & Director]

Generative AI

• AJ Gallagher: “And I'll conclude with some comments regarding our bedrock culture. A few weeks ago, I had the pleasure to visit our associates in our India Gallagher Center of Excellence. It was awesome to see our team in action again. The energy, the excitement and relentless pursuit of improvement is thriving among our 10,000 colleagues. It's a huge competitive advantage for us because we can take a process, streamline and standardize it and then move it to our centers of excellence. Once there, the process is refined even further, and then we make the service available to all our geographies. At the same time, we are refining, automating, deploying robotics and using AI.” [J. Patrick Gallagher, Chairman, President & CEO]
• Marsh McLennan (MMC): “And we are investing in technologies that enhance our internal productivity, insights for clients and improve colleague experience. One example is LenAI, Marsh McLennan's internal AI assistant. LenAI offers the power of ChatGPT in a safe and data secure environment and is available to all colleagues.” [John Doyle, President, CEO & Director]

That’s it for this week’s Reinventing Insurance edition.

Oliver Wyman releases

A Visionary Leader’s Perspectives: Meredith Ryan-Reid, CEO of Versant Health (a subsidiary of MetLife) joins Paul Ricard on the Reinventing Insurance podcast and shares her reflections on leadership — including experiences on driving growth and #reinvention for the world’s leading #healthcare, #insurance and financial services companies. Meredith shares perspectives into future healthcare trends, new ways of working, and Gen AI capabilities. Tune in to Reinventing Insurance.

Win in the Small and Medium-sized Business Market: As the insurance industry is starting to evolve, the small and medium business (SMB) market becomes an interesting growth opportunity. Customer needs and wants are beginning to shift, opening new value pools. To win, thrive and gain market share in the SMB market, Oliver Wyman presents 10 considerations should be at the top of every insurance carrier’s list.

Keeping up with Generative AI — Part 1 the opportunity for insurers: Generative artificial intelligence (AI) has arrived in force and has the potential to transform many ways insurers do business. Poster child of the age of acceleration, it has gained daily media coverage, and its possibilities have captivated headlines. Our initial edition discusses the generative AI opportunity for insurers, how significant generative AI will be for insurance organizations’ business strategies and ways-of-working, and how quickly the impact is likely to materialize.

Reinventing Insurance Newsletters

In this newsletter, my aim is to pick topical issues and news and relate them to the macro issues happening in the insurance industry. I publish biweekly and look forward to your thoughts and comments.

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• Edition 1: A look at the macro shape of the Insurance Industry
• Edition 2: A look at the latest insurance macro trends
• Edition 3: A Look at Personal Lines P&C
• Edition 4: Become an Asset Management-Led Insurer
• Edition 5: P&C market cycles, underwriting challenges, and relative sources of profitability
• Edition 6: Private equity’s rapid growth in the insurance sector
• Edition 7: CIAB Meeting Dispatches
• Edition 8: Asset-owned Insurer moves (US & UK); Growth opportunities in Asset & Wealth Management

Mick Moloney  is a Partner at Oliver Wyman, based in New York. He is Global Head of Insurance & Asset Management and Managing Partner for Oliver Wyman Actuarial. In combination these groups include over 750 colleagues globally dedicated to providing advice to Life, P&C, and Health insurers, asset managers, and private capital sponsors across strategy, operations, technology, finance, risk, and actuarial disciplines

Mick spends his time working with leading insurers, asset managers, and advisory firms on a range of strategic and execution topics with a particular focus on growth, innovation, and efficiency in retail and institutional markets. He’s passionate about growth and reinvention in the industries he serves, with a strongly held belief that while each is facing disruption and dislocation, there are massive unmet needs which provide the prospect of a bright and vibrant future.