“It is not that London is terrible in infrastructure and service, it is that the whole industry is terrible.” – European Risk Manager on the insurance industry in London, from the London Market Group report.
The insurance industry often encounters unexpected results. When the Law of Large Numbers, a bedrock principle, breaks down, such incongruous results abound. This is fine, provided reserves are sufficient to cover incongruous losses.
When an insurance company cannot calculate its risks, it loses its ability to compete. When it cannot price risk properly, unexpected results are all but assured. Just consider the American International Group’s $180 billion bailout in 2008, one of the largest in US history.
The London insurance industry finds its “position as the undisputed global market for specialty commercial interest under threat,” according to London Matters. The November 2014 report by the London Market Group (LMG) states that London, the birthplace of the insurance industry and home to Edward Lloyd’s coffee house on Tower Street, is finding it increasingly difficult to compete in a game for which it wrote the rules.
The London Market is confronting the decline of its competitive advantage – its “competitive position” – without an adequate strategic response at the ready. The industry is undergoing fundamental structural changes of the kind Professor Michael Porter of Harvard University described in his analysis of The Five Forces (see below).
The London Market is only beginning to recognize the dynamic these forces have set off in the global insurance industry, which prompted LMG to remind the world that London still matters. The insurance industry will have to navigate a restructuring competitive environment combined with technical advances that are changing the very art of underwriting.
What a disappearing competitive advantage looks like
The competitive situation facing LMG sees Porter’s Five Forces combining to redefine the structure and operation of the industry:
1. Growing Threat of New Entrants: The Economist points out that non-traditional firms such as Google, ADT, FitBit, and JawBone pose serious competitive challenges to traditional insurers. Google offers brokerage services in UK auto, California auto, and travel insurance. A director at one insurer says, “I’m far more concerned about the Silicon giants than about the AXAs and Generalis.”
2. Increasing Bargaining Power of Buyers: Customers are growing more price sensitive. LMG recognizes “customers have a preference for buying…in their local market.” To many, London is not local, putting “30% to 40% of London premiums at risk.” Further, London is losing market share in reinsurance and emerging markets, where business declined 20% between 2010 and 2013.
3. Decreasing Bargaining Power of Suppliers: As more competitors enter the market, and as buyers grow more price sensitive, power shifts away from suppliers. London’s expense ratios are above average, and service is abysmal, requiring suppliers to cede price advantage to buyers.
4. Growing Threat of Substitute Services: The underwriting value chain is being re-engineered by technologies putting their own pressure on pricing, further squeezing margins. As The Economist puts it, “the law of large numbers is threatened by the rule of precise data,” meaning LMG’s expertise based underwriting must compete with policies priced using data mining and monitoring to better assess risk. In many instances, data based underwriting will outperform and undermine LMG’s traditional approach.
This generally leads to pressure on margins through increased rivalry between competitors (5).
For those in peril on the sea
The LMG has followed a differentiation strategy for centuries, built on underwriting innovation, flexibility, information, and proximity to customers. Now competitive forces are driving insurance towards a lower cost model.
This is not an easy transition for LMG to navigate. Like a hazardous sea voyage, to survive requires a detailed map, the best navigational instruments, flawless seamanship, and the ability to read the sea and sky.
Peter Bernstein wrote of the original Lloyd’s in his masterful work, Against the Gods:
“One corner [of the coffee house] was reserved for ships’ captains where they could compare notes on the hazards of all the new routes that were opening up.”
LMG is in danger of going aground if it cannot follow the inspiration of its origins.
Facing a double whammy
The strategic environment facing LMG consists of two competitive dynamics that have developed for a decade at least, but the London Market has only recently awoken to its significance. Unfortunately, rapid change is now required for London to maintain its competitive advantage, which itself requires restructuring.
Rapid change is its own strategic challenge, especially in the transition from differentiation to low-cost structures.
Over three centuries, the London Market built up a large-scale commercial insurance infrastructure unrivaled in the world. It considers itself an “ecosystem of capital providers, underwriters and brokers” known particularly for expertise in underwriting all conceivable types of risk (see graphic below).
However, the London Market’s greatest strength, a “wide range of market participants competing and working together in a few blocks of the City of London,” has become “a weakness when rapid change is required,” in the words of the LMG report.
For the London Market to reposition itself in the global insurance industry and extend its ability to command competitive advantage, it must address two demanding challenges simultaneously.
The London Market must develop a strategic response to the industry’s changing competitive structure, while also harnessing and mastering the technological and analytical revolution at the very core of its competitive advantage – the centuries-long tradition of expertise-based underwriting.