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Retrenching in the European market.

IN THE GROWTH-ORIENTED era of the mid- to late 1980s, European insurers were locked in a predatory mode. If you did not swallow up your competitors, insurers thought, they would probably make a meal out of you. This way of thinking was inspired partly by the success that such tactics had played in building new business empires in the early 1980s, but also by the belief that as Europe became borderless in 1992, the addition of the other 11 European Community (EC) countries would result in a large, single market. Therefore, the prevailing view among insurers was that to merely survive in the new Europe, a company had to increase its size.

Besides taking over the competition, insurers that wished to grow regarded mergers as an effective way to increase their size: at the very least, such a maneuver neutralized any counterthreat another company might pose as a potential buyer of one's firm. Expensive new operations constituted a third way of developing a bigger presence in the growing marketplace.

However, since those years, the attitudes of European insurers have undergone a drastic change; today, a battered London market, combined with insolvencies among some of the leading continental insurers, has deluged the industry like an unexpected tidal wave. The new, more conservative philosophy among today's European insurers signals the industry's realization that expectations during the 1980s were overblown. As a result, risk managers shopping in the current European market should be cautious, especially considering the large number of insolvencies that are currently plaguing the industry.

Troubles in Europe

WHAT IS THE SCOPE of the difficulties European insurers are currently experiencing? First, consider the situation in the United Kingdom. London's Lloyd's market is at an all-time low point where, its underwriters hope, things can only get better. The U.K.'s insurance company market chalked up underwriting losses in the billions last year, and a number of overseas companies have recently withdrawn from underwriting in London.

In addition, virtually all the leading continental European insurers are suffering from a deterioration in non-life technical results. Overcapacity is a problem, rate increases for industrial risks are difficult to achieve, and the effect on competition of 1992's freedom of services is bringing an end to the era of high margins, such as those on personal lines in Germany. The Scandinavian insurance market has also been devastated; even the mighty Allianz of Germany has cause for worry.

Many continental insurers are realizing that it may be a long time before they reap the benefits that they expected from the spate of acquisitions they indulged in over the past five years, often with little regard for the value of money. In fact, times are so tough that even Germany's giant Allianz is having to draw in its horns. And if Allianz can no longer afford to be in an expansive mood, presumably no one else can afford to either.

The Allianz case is instructive of how even the most efficiently organized and financed companies can suffer problems. Not long ago, Allianz was talking about its war chest of 1 DM billion, which it was going to use for expansion. However, the resulting international expansion has produced underwriting losses, as has business Allianz took over from East Germany. In 1991, Allianz experienced its first underwriting losses in 20 years: DM 1.8 billion, compared with a profit of DM 181 million in 1990.

Up until the mid-1980s, Allianz's principal focus was the West German market, which it dominated and where its expertise and low cost base was a guarantee of large profits. Then, when the internationalization movement began, Allianz invested in countries such as France and the United States, where returns are traditionally lower than in West Germany. As a result, the overall returns of the group began to go down. In effect, Allianz stopped doing what it knew best and started getting involved in business activities that it didn't properly understand-primarily, it would seem, because it had more money than it effectively could use domestically.

The case of Hafnia, Denmark's second largest insurance company-which has been reduced to seeking protection from its creditors - provides another example of why Europe's insurers are now taking a more cautious attitude toward business. This case also serves as a reminder to risk managers of the importance they should attach to the selection of carriers: Loss-making insurers can go out of business, and can also fail to deliver on services. And the new, unprotected and highly competitive European marketplace leaves many European insurers exposed in an unstable climate.

Not long ago, when the prevailing business philosophy held that big was beautiful and the way to become big was through taking over or merging with your competitors, Hafnia's former chairman, Mr. Per Villum Hansen, believed that his company was too small to compete in a liberalized Europe or to fend off takeover bids. So he set the company on a new track that led to its present predicament: first Hafnia had to seek protection from its creditors, now it is being sold.

But why? Mr. Hansen approached Denmark's largest insurer, Baltica, and suggested that the two companies jointly form a new financial conglomerate. Since Baltica was unresponsive to the idea, Mr. Hansen tried to force its management's hand by taking a 34 percent (L350m) share in the company. However, nothing came of Mr. Hansen's longed-for union, so last year he turned his attention to Sweden's Skandia. To accomplish this, Hafnia sought Uni Storebrand, the largest insurers in Norway, as a partner in its bid to take control of Skandia. The two companies then bought 42 percent of Skandia's stock.

Was Hafnia overextended? Only if one thinks that an insurer investing in two rival firms that represent almost twice the value of its own capital constitutes overextension, for that was the value of Hafnia's holdings in Baltica and Skandia. However, at the height of merger mania, this sort of behavior didn't seem crazy to many analysts, merely a little adventurous.

With insurance market conditions worsening in Scandinavia, Hafnia's insurance investments, representing about a third of its total equity holdings, began to suffer badly when the share price of Skandia and Baltica started a downward drift. By the middle of last August, Hafnia's liabilities exceeded its assets by DKr 100m.

Consequently, Hafnia failed in its ambition to head a pan-Scandinavian financial services group. The failure stands as a warning of the dangers of too much ambition. And what became of Uni Storebrand after its joint venture with Hafnia? It was recently taken into government administration after a turbulent day's activity during which it suspended payment to creditors.

A Defunct Philosophy

SO WHAT WAS the prevailing philosophy behind the expand-at-all-costs mentality of the late 1980s and early 1990s? There was never any solid financial logic behind most of the deals made during this period: generally, it was a case of one insurance company that was making underwriting losses buying another firm also making underwriting losses for a sum of money that could be justified in relation to turnover, but not to profitability.

But why should anyone have wanted to buy losses? That is the key question. Since profitability in the insurance industry was in decline, and Europe's liberalization in 1992 was just around the corner, many insurance companies believed that if they were going to survive in the new borderless Europe, it was a simple question of needing, in a bigger market, to get bigger themselves. And since the new market was going to increase enormouslyin size in a short period of time, insurers reasoned that they would also have to increase their size enormously, and as quickly as possible; hence their belief that the only way to accomplish this was through mergers or takeovers of companies, even if the firms were unprofitable.

At writing time, the besieged Scandinavian insurance market has suffered a collapse of shareholder confidence. Shares in Sweden's two biggest companies, Trygg Hansa and Skandia, plunged following reports that the credit insurer, Svenska Kredit, could face losses of between SKr 5 billion and SKr 10 billion. Skandia and Trygg each have 47 percent stakes in Svenska.
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Author:Best, Chris F.
Publication:Risk Management
Date:Dec 1, 1992
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