Insurance on a global scale.

If your business is global, should your insurance be global, too? Not necessarily. Examine your company's needs to find out.

There is no doubt the 1990s will be the "global decade." In nearly every annual report, the letter from the chairman stresses how the company is positioning itself to compete in the global environment. Manufacturing and service industries alike believe that they must expand their markets around the world if they are to survive.

Expansion, be it domestic or international, brings new risks along with new rewards. Insurance and risk management is one element of managing those new risks. How best to handle this part of the expansion process can be difficult to gauge. Should you leave risk management in the hands of local management, or should you coordinate it from the corporate level? Should you segregate the non-U.S. business from the U.S. business or combine all the elements? Are globals applicable only to Fortune 100 companies, or can mid-size multinational companies also benefit? And is the insurance industry capable of providing the insurance and risk management products you need?

GLOBAL TREND

Multinational companies of all sizes are moving toward global programs. Historically, most U.S. insurers wrote coverage only in the U.S. and Canada, while most European insurers wrote only European risks. Those few insurers that did cross the Atlantic generally still segregated their portfolios, in part to satisfy their reinsurers. This meant that identical buildings in Rome, New York, and Rome, Italy, were treated as totally different risks. In a global program, both U.S. and Canadian and international coverage are coordinated by a single major insurer.

Global programs are not new to the insurance industry. Coverages such as excess liability and directors' and officers' liability have been written on a worldwide basis for decades. But these forms of insurance are not complicated. They require only one policy to be issued to the parent corporation, and policies for operating subsidiaries around the world are not necessary. It has only been within the last several years that companies have undertaken the more complex forms of global coverage, forms of coverage that require local servicing.

WHAT HAS CHANGED?

Global insurance programs have become more prevalent as a result of increasing demand for insurance products and as Europe - and much of the rest of the world - has opened its insurance marketplaces to competition. Insurance companies and brokers, just like manufacturing companies, have been forced to become global to survive.

Throughout much of Latin and South America, strict government control of insurance has diminished. Starting with Chile in 1980, through recent changes in Argentina, Colombia, and Mexico, regulations controlling rating and reinsurance have been overturned. Competition among insurers has increased, and foreign insurers have begun to enter the local markets.

Changes are also occurring in the East, albeit at a much slower pace. China, which doesn't allow foreign insurers, will allow some reinsurance. Japan has gradually eased its strict tariff-rating structure, allowing deductible and loss prevention credits and broader use of the freely rated inland transit policies, which apply to movable assets.

The Eastern European borders have also opened up, and Western insurance companies are quickly entering that market.

The most dramatic changes have occurred within the European Economic Community. The opening of the European insurance marketplace to competition actually began before Europe 1992. The European Economic Community's Freedom of Service Directive, issued in 1988 and effective as of July 1, 1990, for the first time allowed insurers licensed in one EC country to write risks in the other EC countries without being licensed in these countries. So an insurer licensed in the U.K. can now write coverage for risks in Denmark, France, or Germany, for example.

Even though the directive excludes certain classes of business such as pharmaceutical product liability, nuclear liability, worker's compensation, and employer's liability, and exempts four countries - Greece, Ireland, Portugal, and Spain - until 1995, it has had a major impact on the European insurance industry and has set European insurers off on a program of acquiring other European and U.S. insurers.

Before the directive, Europe had been dominated by mid-sized domestic insurers that were able to survive because their marketplaces were sheltered from competition. The realization that these marketplaces would be open to foreign competition forced many of these companies to form alliances in the belief that companies still wanted local policies and local service. The acquisition of Italy's RAS and Britain's Cornhill by the large German insurer Allianz typified the European insurers' desire to broaden their European bases.

Several European insurers decided the time was right to expand their presence in the U.S. as well as in Europe. Allianz originally opened its own office in the U.S. and then acquired Firemen's Fund. While Allianz undertook this expansion to serve its German clients, it now is serving other multinationals as well.

Allianz is not alone. Through acquisitions, expansions, and alliances with U.S. insurance companies, many European insurers - Zurich, Winterthur, Royal, and Generali, for example - are now in the global field.

Outside of Europe and the U.S., the only other center of large insurance companies is Japan. The Japanese insurers have followed their clients to the U.S., but are still in the early stages of international growth. The Japanese insurers are not presently a viable market for most non-Japanese companies because, for the most part, they have chosen to insure only Japanese companies.

What is striking is that few U.S. insurance companies have gone global. The traditional international insurers, such as American International Group and CIGNA, have made a push for globals, but few of the traditional domestic insurers have done so. So, while the European insurers saw the need to expand globally in the face of domestic competition, and even though many European insurers have entered the U.S. market, U.S. insurers have not expanded outside the U.S.

There are several reasons why they have not.

* Costs - a foreign insurer entering the U.S. has to establish one company licensed in 50 states. But a U.S. insurer entering the world marketplace may have to establish 50 separate companies. * Small premiums - the potential premium from any one country is small compared to premiums in the U.S. (See the table below.) * The length of time to become profitable - New insurance operations don't become profitable for several years. Most U.S. insurers are under pressure to improve profitability, especially with the current low interest rates which have reduced their investment income and, for many, their poor return on junk bond investments. The major European insurers are not subject to the same pressures and feel that the profit potential is worth the wait.

Representative
Non-Life Insurance Premiums

COUNTRY              PER CAPITA       WORLD
                (U.S. $ in Billions   RANK

USA                 1,0335.5           1
Germany               698.5            3
Japan                 574.7            6
Denmark               554.2            8
Luxembourg            545.9           10
Netherlands           526.0           12
United Kingdom        492.7           14
France                476.7           15
Belgium               447.4           16
Ireland               382.8           19
Italy                 254.1           20
Spain                 193.2           22
Czechoslovakia        176.7           23
Portugal               93.8           26
Greece                 43.7           35
Hungary                32.5           39

Source: Viewpoint, Marsh & McLennan, Fall 1991
(based on 1988 figures)

GLOBAL BENEFITS

Why go global? The answer is simple: to establish uniformity and consistency of coverage, thereby minimizing exposure to risk, and to reduce the cost of coverage.

The control offered by a global program allows the corporation to manage its risk more effectively and with uniformity. Thus, if a global program is to be successful, the corporate parent needs to centralize control. If centralized control is not feasible within a corporate structure, a global program is not viable. This doesn't mean, however, that a decentralized company can't have a global program. Many decentralized companies, such as the Swiss firm Asea Brown Boveri, which considers itself multi-domestic, believe that insurance should not be left to the discretion of local management. ABB feels that the protection of the corporation's physical and financial assets is paramount to its survival and must be coordinated at the corporate level.

The global program will almost always result in lower insurance costs than fragmented programs. Combining all of a company's property risks, for instance, offers the insurers a greater spread of risk and pool of premiums from which to give discounts. And, for the company, the uniformity of coverage reduces the chance of an uninsured loss.

How much a global program will reduce premiums is difficult to say. It will, in part, depend on your current program structure. Companies that already have international programs coordinated by one insurer have probably already achieved a significant savings. A large electronics firm that had a coordinated international program saved only about 10 percent by placing its property insurance with a global insurer. But a mid-size manufacturing firm with a fragmented international program was able to reduce its property premiums by nearly 40 percent by going global.

IS IT FOR EVERYONE?

The feasibility of, and benefits from, a global program are dependent on a number of factors, including country spread and type of coverage.

Country spread - Not every country has opened up its insurance marketplace to competition. Limitations on insurance competition take various forms around the world. Whenever the state controls who can write business, at what price, and to whom they can reinsure the risks, competition is limited.

Global programs operate best when the insurer can establish one rate, allocate the payment of premium around the world, and recapture the premiums through reinsurance of the local policies. Globals become difficult when you have:

* Risks that are situated in countries where the state mandates rates through tariffs. In countries such as Brazil, Japan, and Thailand, the global insurer is not free to use a global rate. They must charge what the tariff mandates. * Risks in countries where the global insurer is not permitted to have its own operations. China, Costa Rica, India, and Kuwait permit only state-owned insurers, which don't accept ratings suggested by global insurers. This was true in Eastern Europe, although the situation there is changing. * Risks in countries where state reinsurers operate, such as Brazil and Korea, which don't allow the premiums to be reinsured to the global insurer.

Type of coverage - Globals are the most effective in coverage of property risks. Insurers are better able to underwrite a global program when the risks they are underwriting are basically the same around the world. While U.S. property risks are better protected on average than non-U.S. risks, a building is basically a building, be it in Baltimore or Berlin.

In addition to providing consistent coverage throughout the world, global property programs have successfully covered companies' worldwide interdependency risks. As companies have moved many parts of their manufacturing overseas and adopted just-in-time production strategies, the risk of business interruption resulting from the breakdown of any link in the chain has magnified. If a U.S. company has two separate programs - one in the U.S. and one international - it must carefully dovetail the two programs to avoid gaps in coverage. But the global approach wraps it all up in one package by assuring coverage for a business interruption loss anywhere in the world. The production of a plant in Utah would be protected against business interruption resulting from a fire at a plant in Japan and vice versa.

Coverages such as worker's compensation and automobile insurance don't lend themselves to global programs for distinct reasons. In most countries, worker's compensation is provided by the government, so private insurance has a very limited role in this type of insurance outside the U.S. And because automobile insurance requires extensive local servicing, most of the global insurers avoid it.

Primary product liability insurance also may not fit well into a global program. A company's U.S. primary product liability program often has deductibles higher than the standard limits in the countries in which it has operations. For example, a major U.S. chemical company has a $7.5 million deductible on its U.S. program, but the standard deductibles in the countries in which it has operations ranges from nothing to $50,000. And the typical insured limits of many of their local foreign competitors are only $1 million to $5 million.

The discrepancy in deductibles and limits reflects the fact that liability risks in the U.S. are a very different risk, given the litigious nature of our society and the high cost of legal defense, than liability risks outside the U.S.

BROKER'S ROLE

The insurance broker's role in global programs is to provide local servicing in addition to designing, marketing, and servicing the global policy.

Brokers have sought to broaden their horizons through acquisitions, recognizing that the best way to assure consistency in service is to control local brokerage operations. Marsh McLennan's purchase of the U.K. brokerage, C. T. Bowring, in the early 1980s began a trend of combined U.S.-U.K. brokerage businesses continued by Alexander & Alexander, Frank B. Hall, and others. These U.K. acquisitions and mergers in the early 1980s gave the U.S. brokers access to Lloyds and the London market.

More recently, brokers have acquired local brokerage operations to expand their global servicing capabilities. Marsh & McLennan acquired its long-term associate Gradmann and Holler in Germany, and Johnson & Higgins did the same with its Dutch associate Mees and Zoonen. Aon Corporation, the parent of Rollins Burdick and Hunter, acquired Hudig-Langeveldt in the Netherlands, and Willis Faber, a U.K. brokerage, merged with the U.S. broker Corroon & Black.

Where acquisition has not been possible, brokers have established new operations. Johnson & Higgins set up its own operation in the U.K. when its long-term correspondent, Willis Faber, merged with Corroon & Black. Marsh & McLennan did likewise in the Netherlands when it couldn't acquire Hudig-Langeveldt.

GLOBAL IMPLEMENTATION

If a company already has a controlled international program, it is usually not difficult to add the U.S. and Canadian portions. But if the company doesn't already have a controlled international program, the implementation of a global might be delayed by long-term local policies. It is not uncommon for operations in countries such as Italy and Holland to have ten-year policies, and cancelling them can be expensive. Sometimes the penalties can be equal to the premium for the entire ten-year period!

Aside from complications posed by existing local policies, it is not unreasonable to expect the implementation of a global to take at least a year. The risk manager must sell the product throughout the organization, and obtaining the support and cooperation of local and corporate management can be a long process. Local managers are generally initially resistant to the process because it reduces their autonomy. They must be won over to the process by displaying clearly the cost and coverage benefits of the global program while emphasizing their continuing role in loss prevention and risk evaluation.

ARE GLOBALS HERE TO STAY?

Insurance, particularly in the U.S., is infamous for its cycles of abundant capacity and low rates followed by reduced capacity and high rates. Global programs have flourished during a soft market, but will they last through a hard market?

I'm confident they will. Traditionally, international programs have seen less dramatic insurance cycles than U.S. programs. And the European markets have never been as volatile as the U.S. markets. Hopefully, the combination of the international program and U.S. programs and the introduction of the European insurers as potential markets will stabilize the industry.

Nevertheless, it's essential to consider the health of the prospective global insurer. The financial health and size of U.S. insurers are monitored and reported by Best's Insurance Reports. The major brokers also maintain market security groups which continually monitor U.S. and foreign insurers' financial strength. Certainly a number of U.S. property and casualty insurers have experienced financial difficulty and closed down or reduced their scope of business.

Other insurers have expanded globally only to contract their activities later. The latest example is Schweiz, a subsidiary of Swiss Re, which expanded into international liability programs for U.S. multinationals in 1987 only to announce recently their withdrawal from this market. So, if you are going to put your eggs in one basket, it is vital that you have a strong, viable, experienced insurer.

Global insurance programs are here to stay. They will continue to grow in number and size as more insurers, brokers, and insureds go global. While global insurance programs take considerable work to implement and run, they will play a critical role as corporations position themselves to compete in a global environment.