Setting the pace: leading insurers employ similar intelligent-growth strategies to outperform their competitors. (Cover Story).

Simultaneously growing top-line revenue and increasing profitability is an elusive and challenging goal in most industries. Given the economics of the insurance industry, this can be especially difficult. For most lines of insurance, carriers must wait several years to generate positive free cash flow and determine whether or not the business written is truly value creating. This protracted timing of cash flows makes managing a high-performing insurance company year after year particularly difficult. So how can one measure and identify carriers who are achieving intelligent growth?

To answer that question, IBM examined five years of operating performance of insurers worldwide with 2000 net premiums exceeding $1.5 billion. The global study sought to identify insurers that have grown intelligently and to uncover value-creating strategies, tactics and capability implications. It included mutual and stock insurers that collectively wrote more than 40% of worldwide premi urns and had more than $8.8 trillion in cumulative assets. The study included five years of operating performance from 1996 to 2000, public filings, analyst reports, secondary data and numerous interviews.

The study found that intelligent-growth insurers shared three common strategic and tactical themes: scale and scope economies; resource access; and option space.

Crafting the Study

IBM's approach to the study was to develop a set of intelligent-growth measures, screen global insurers and draw insight from the select number of high performers. Intelligent-growth insurers were selected based on three key financial and operating performance metrics:

* premium growth measured by five-year revenue compound annual growth rate;

* profitability measured by weighted average operating cash flow as a percentage of revenue; and

* capital efficiency measured by weighted average operating cash flow as a percentage of total assets.

Insurers that are considered intelligent growers have been defined as those achieving above-average performance along all three dimensions.

Selected Findings

A sequential analysis along the three screening metrics provides several key insights. First, 35 of the 80 insurers in the study achieved greater than the average revenue growth rate of 7%. Most of the 35 insurers were focused on life insurance, as expected, with higher growth rates in worldwide life vs. nonlife premiums during this period (9.1% vs. 2.7%).

Second, only 12 among the revenue-growing 35 insurers surpassed the population average of 15% for the profitability dimension. A negative correlation based on all the insurers along the first two dimensions reinforces the difficulty of simultaneously achieving both growth and profitability.

Finally, the average capital efficiency of 3.1% resulted in the selection of seven intelligent growers:

* Six stock insurers: Aegon, Aflac, American International Group, Axa, ING and Munich Re.

* One mutual insurer: Northwestern Mutual.

A portfolio of the six publicly traded intelligent growers had an annual total shareholder return of 29%, far surpassing all major indices for this period: DAX, 21.1%; S&P 15.7%; FTSE, 10.6%; and NIKKEI,-7.9%. Furthermore, these intelligent growers collectively continued to perform better than the market indices as the global equity markets fell in 2001 and 2002.

A further testament to IBM's intelligent-growth approach is its strong correlation to annual total shareholder return of select subgroups and the individual intelligent growers. Segmentation of the 80 insurers into four subgroups based on their performance along the three metrics reveals the alignment of the market to the intelligent-growth performance indicators:

* Poor performers: Those that were below average along all three metrics experienced a dismal 2.2% annual total shareholder return;

* Potential intelligent growers: Those with strong revenue growth but mixed operating cash flows had a 14% annual total shareholder return;

* Efficiently operated slow growers: Those with reasonable operating cash flows but low revenue growth experienced 15.5% annual total shareholder return;

* Intelligent growers: Those that were above average along all three metrics achieved a stellar 29% annual total shareholder return.

Moreover, the intelligent-growth model was an accurate total-shareholder-return predictor for each intelligent grower. The correlation of determination exceeded 95% for the intelligent growers. This indicates that the three performance variables explained more than 95% of total-shareholder-return variations for the intelligent growers.

Key Strategies and Tactics

When the model is expanded to the full set of global insurers, the correlation of determination dropped to 45%. The study then sought to identify the unsystematic or qualitative measures shared among the intelligent growers to explain the remaining variation for the full set of global insurers. The three qualitative levers identified are scale and scope economies, resource access and option space. While the complete study has detailed intelligent-growth information around each lever, the following highlights some of the more prominent attributes.

First, the intelligent growers leveraged their scale and scope economies across three dimensions for competitive advantage: dominance in distribution, product line and customer segments. Dominance in these areas allowed them to resist price competition and, in most cases, practice price leadership. Since the early 1980s, AIG's dedication to premium pricing based on strong underwriting policies saved it from price wars that brought heavy losses to most insurers. And when a market is universally unprofitable, the intelligent growers are willing to sacrifice market share to sustain profitability. For instance, Aflac exited in 2000 an annuities product line that was a best seller in 1999 when analysis revealed that this product line did not meet its profit objectives.

Second, the intelligent growers had better access to high-skill, high-will resources. Aegon attracts high-per-forming managers with its internationally renowned training program formed in conjunction with INSEAD business school in France, Johns Hopkins University in the United States and Nyenrode University in the Netherlands. Northwestern Mutual fosters consultative selling that has made its sales force No. 1 in the United States as measured by policyholder satisfaction and low lapse rates of 3% to 4% for permanent life products. ING introduced in 1999 a groupwide performance-management system to link managers' compensation to their contribution to group synergies and talent building.

Lastly, the intelligent growers exhibited significantly more strategic flexibility and operating adaptability by expanding option space. They created alliances and expanded judiciously through both mergers and acquisitions and the disposition of non-core businesses. For instance, Munich Re joined forces with KarstadtQuelle, the German department store and mail-order group, to provide financial products and services through the retailer's customer channels.

Regarding new markets, Aegon, MG, Axa, ING and Munich Re have been granted licenses to establish joint ventures with domestic Chinese insurers to sell insurance. And, when acquired businesses do not fit with overall growth strategy, intelligent growers wait patiently to shed these businesses profitably. Though Axa realized soon after acquiring DLJ in 1993 that the business did not fit its core business, the insurer held the business until the height of the equity markets in 2000 to sell DLJ at a lucrative price.

Clearly, the pursuit of intelligent growth is an exceptionally challenging aspiration with few insurers achieving the goal. Nonetheless, other insurers can apply these intelligent-growth strategies and tactics within the context of their own companies to build high-performing organization, process and information-technology capabilities.

Intelligent Growth Screening Results

Only seven of the 80 insurers examined met the three criteria necessary to be deemed intelligent growers.

Premium Growth: 7% Revenue CAGR

Above Average (35 insurers, 44%)

Below Average (45 insurers, 56%)

Profitability: 15% Operating Cash Flow as Percent of Revenue

Above Average (12 insurers, 15%)

Below Average (23 insurers, 29%)

Capital Efficiency: 3.1% Operating Cash Flow as Percent of Assets

Above Average (7 insurers, 9%)

Below Average (5 insurers, 6%)

Total Insurers (80 insurers, 100%)

CAGR: Compound annual growth rate

Source: IBM Global Insurance

Beating the Indices

The six best Performing public companies achieved a 29% annual total
shareholder return, far outperforming the major indices.

                                   Total Shareholder Return CAGR

* IG                                             29%
DAX                                            21.1%
S&P                                            15.7%
FTSE                                           10.6%
NIKKEI                                         -7.9%

CAGR: Compound annual growth rate

* Six best-performing public insurers in "Intelligent Growth" survey
taken as a portfolio of stocks

Source: IBM Global Insurance

Note: Table made from line graph
Tracking Performance

The IBM study found the leading insurers turned in strong performance
across the board.

                                             Operating     Operating
                                            Cash Flow as  Cash Flow as
Subgroup                        Revenue      Percent of    Percent of
(# of Insurers, % of Total)       CAGR        Revenue        Assets

Poor Performing               [down arrow]  [down arrow]  [down arrow]
(28 Insurers, 35%)             [up arrow]   [down arrow]   [up arrow]

Intelligent Growth Potential   [up arrow]   [down arrow]  [down arrow]
(20 Insurers, 25%)             [up arrow]    [up arrow]   [down arrow]

Efficiently Operated          [down arrow]   [up arrow]    [up arrow]
Slow Growers                  [down arrow]   [up arrow]   [down arrow]
(25 Insurers, 31%)

Intelligent Growth            [down arrow]  [down arrow]   [up arrow]
(7 Insurers, 9%)               [up arrow]    [up arrow]    [up arrow]



Subgroup                      Total Shareholder
(# of Insurers, % of Total)      Return CAGR

Poor Performing                      2.2%
(28 Insurers, 35%)

Intelligent Growth Potential          14%
(20 Insurers, 25%)

Efficiently Operated                15.5%
Slow Growers
(25 Insurers, 31%)

Intelligent Growth                    29%
(7 Insurers, 9%)

CAGR: Compound annual growth rate

Source: IBM Global Insurance

William N. Pieroni is general manager of IBM Global Insurance Industry, White Plains, N.Y.