Chris Foster

Financial resilience part 4: Insuring a Sustainable Future?

Chris Foster

This article was first published by Alliance Trust Investments on 7 March 2016.

In the final part of our four part series on financial resilience we talk about insurance. Insurance can spread the risk faced by an individual or a corporation amongst many other factors. In markets where there is high penetration of insurance, companies are prone to poor practices when trying to maintain high returns.

Insurance can spread the risk faced by an individual or a corporation amongst many other factors. The benefits of good insurance are:

  • Provides a safety net (at a small cost)  to mitigate: death in family; medical emergencies; material loss from natural disasters
  • Supplements state social protection for individuals
  • Mitigates financial impact of catastrophes for corporations
  • Lowers the capital a firm needs to operate
  • Increases investment by reducing uncertainty 
  • Provides a price for risk

In markets where there is high penetration of insurance, companies are prone to poor practices when trying to maintain high returns. Particularly in areas where pricing is transparent and easily comparable, like car insurance.

Does insurance increase prosperity; or prosperity increase insurance? 

Probably a bit of both

GDP/Non-life insurance

Source: Lloyds – Global Underinsurance research October 2012 – page 41

According to Lloyds a 1% increase in insurance penetration leads to (or is correlated with) a 13% reduction in uninsured losses; a 2% increase in investment (as % of GDP); and a $6000 per capita increase. 

Catastrophe Insurance

Another proposed benefit of insurance is that in the event of a catastrophe the speed of payment of compensation is more rapid and the taxpayer does not have to foot the bill.

Two different catastrophes and levels of insurance: China and the UK.

Earthquake in Sichuan Province 2008      

Losses resulting from China

Floods in the UK 

Losses resulting from UK Floods 07
 
Life Insurance Companies

Life insurance demand comes from individuals setting aside a portion of their income to get a degree of compensation for them or their families in the event of death, injury, illness, or loss of employment. They also administer defined contribution pensions and provide annuities on the capital sum on retirement. Growth is correlated with population size and age, affluence, and the role of the state (where the welfare state is in retreat; so the need for private life insurance grows).

Where should we expect the most growth?

Premiums as % of GDP

Growth in life and non-life premiums has reached a plateau in developing markets – the strongest growth was from the 60s to the 90s. In emerging markets there is still reason to expect strong growth. 

Global Insurance Market: Historic shares and forecasts

Life vs non-life premiums

Swiss Re estimate annual growth rates in premiums of 8% in emerging markets over the next ten years, compared to 2.3% in developed markets - led by Asia at 10%. Our view is that ageing populations will boost demand for private life insurance and high government debt levels of governments will lead to cuts in social security systems.

How do insurance companies make profits?

Insurance company structure

 
With non-life insurance there is only a short lag between premiums coming in and claims going out. For life companies this can be much longer. For these investment strategies, guarantees (if any) and underwriting are vital elements for a successful strategy. In UK Life much of the investment risk has been shifted onto the client (no guarantees), leaving the insurer’s role as more administrative.

Potential winners

We prefer companies exposed to strong growth in the number of clients and the amount they insure – either through: population growth, growth in middle class, or market share gains. We do not like companies dependent on selling spurious insurance; buying market share through high acquisition costs; nor companies offering products with guarantees; or those with weak capital structures. Companies that accurately and conservatively price risk are also preferred. We believe that Prudential and Legal & General stand out as long-term winners from attractive structural trends and as such, are held across the SF fund range.

We are still in the process of researching this theme and will be producing more content on our findings in the coming months.


For a comprehensive list of common financial words and terms, see our glossary here.

Key Risks

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Disclaimer

This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. 
Monday, March 7, 2016, 12:00 AM