Industry at a crossroads
Changing markets are making the more forward-looking insurers more tempting as investment prospects. By Roderick Hinkel and Murali Krishna-Murty
Investors need to choose carefully before attempting to play the macro-opportunities (see box) through investing in banking, insurance, bancassurance or pure play quoted companies, such as specialist life insurers.
The German government, for example, is attempting to remove privileges from life insurers, giving similar tax status to all forms of savings for retirement. It is also slapping a tax on reserves that it considers to be overstated, penalising insurance companies at a time when investment yields are at historical lows and there are questionmarks over their ability to meet guaranteed policyholder returns.
The continental European countries exhibiting the best returns prospects for investors eager to profit from the savings products boom are Germany, Italy, France and Spain. This is because of population size, demographic trends, high historic reliance on state pensioning and the effect of wealth creation by the post-war inheritor generation.
European insurers are realising that their approach to customers must change radically if they are to survive in the changing market of heightened domestic and foreign competition. Foreign providers have been eyeing the lucrative European market for some time, expecting massive growth. The public is now able to purchase savings products from a wide range of cost-efficient global providers, including those offering an Internet alternative.
Product innovation and flexibility is paramount for survival and profitability. Italian group Mediolanum is a shining example of a young company possessing both these qualities. It is not restrained by historic links with banks for distribution and can choose its partners on the basis of the best deal. Nor is it shy about using its highly qualified sales force to gain new clients rapidly, using a new private bank and an Internet bank to be launched soon. Mediolanum has also cleverly switched its clients’ funds under management to the Irish tax haven to substantially reduce its tax bill. Other European companies have been doing the same.
The key to success is not only product innovation, service and quality, but also distribution. Notwithstanding massive new IT investments, bancassurance networks are still crucial, although structure and delivery need to be carefully examined. The larger quoted companies have been much slower to react to the changing market and are often trying to come to terms with bancassurance agreements that did not go as planned. SEB, for example, has just ditched Trygg Hansa. This experiment, crucial for distribution, obviously did not work.
Apart from Mediolanum, other Italian companies profiting from the growth in the savings market include market leader Alleanza, which has a substantial mutual funds business. INA and Alleanza’s parent Generali (with its AMB operations in Germany adding further territory) and Allianz’s subsidiary RAS, which expects a 32% rise in profits this year, are also beneficiaries of this growing business area.
German broker and insurer Marschollek (MLP) has also proved a highly innovative provider of financial services and is moving increasingly into fund management products. Like Mediolanum, MLP shows a clear ability to adapt quickly to changing conditions and is known for its innovations.
After strong growth in the early 1990s the development of the French life market has trailed off below the EU average, dampened by the public’s belief that the state will continue to provide for their retirement. Nevertheless, it is only a matter of time before AXA and Allianz subsidiary AGF capitalise on what will continue to be a huge growth market for private pensions and savings. The French market for mutual funds is the largest in Europe.
The Spanish savings market is surely one of the most exciting, given demographic changes. However, Mapfre, the most liquid stock, has the disadvantage of substantial diversification into South America, which to an extent negates domestic growth prospects, making investors cautious.
Dutch company Aegon makes 60% of its profits in the US, so the share is not a pure European play. Competitor ING has half its premium income outside Europe, but Fortis is predominantly a Benelux company, and sees one of its key goals as tapping the savings market in whichever way possible, using advisers, banks and investment funds.
In the past, continental European fund managers were focused on achieving a safe but uninteresting return. Now, the banks and insurers’ funds are competing directly with top-flight international fund managers. To retain existing funds under management and to gather new assets, they will have to show a marked improvement in returns, or lose market share.
The UK and the Netherlands already have strong business in occupational pensions, but this is a very new field for Italy, Germany, France and Spain. This should lead to a rise in the savings ratio in these countries, relative to the UK and Netherlands.
We have focused on the retirement benefits opportunities for the savings market. This should not detract from the increasing investment by individuals in private fund vehicles. Most life insurance companies have already made the decision to change their status from insurer to manager of assets and provider of financial services.
Unlike in the UK and US, continental Europe still lacks a quoted sector for asset managers but this will develop, given the huge opportunities available. Today, an investor in asset managers can only participate through a stake in one of the growing army of foreign operators in the continental European market – although Mediolanum’s fast-growing asset management business is a good proxy.
Insurance companies are setting up their own asset management businesses on a large scale. Allianz and Munich Re (with Ergo) will soon have vast assets under management, AXA and Generali are similarly focused on this new and fast-growing activity. Swiss Life’s acquisition of Gotthard Bank is another example of the trend.
Having examined the possible routes for an investor to share in the booming savings market, we should now address the question of whether the available investments offer good value. Bugged by worries over taxes and the effect of low interest rates on investment returns and ability to pay guaranteed bonuses to policyholders, continental and UK life insurance companies have lagged the stockmarkets’ performances this year. Furthermore, they are treading water after an exceptional performance in 1998, which was fuelled by booming stockmarkets and take-over speculation.
The Dow Jones Stoxx European insurance index has declined by 7.5% to mid-July and under-performed the overall index by almost 19%, after a 40% nominal and 18.5% relative rise in 1998. Sentiment for the continental European insurance stocks is likely to remain under pressure with the low interest rate environment and looming taxes. Nevertheless, the medium and long-fundamental opportunities for strategically advantaged players with special skills or with the market power to gather vast assets for managing, suggest that the sector’s under-performance is a buying opportunity.
Roderick Hinkel and Murali Krishna-Murty are European insurance analysts with HSBC Securities in London. HSBC will be publishing an in-depth research document on the European savings market later this year