The recent wave of privatization of the insurance sector has introduced to us a whole new set of players and names. In the past, we had to deal with LIC for all our life insurance needs and GIC for our general insurance needs. But now, there are over a dozen insurance companies to choose from each with their own range of multiple products to meet our varied needs. Most of the new private insurance companies have one thing in common: the backing of a large international parent entity.

The names of these international parents are advertised with great fanfare and the image that is created is one of immense power and immeasurable strength. But that is a myth and, while there may be a few international players who can claim to still have solid balance sheets (for example, AIG of USA, the partner in Tata-AIG), many of the global insurance companies - whether in the life or the non-life side of the business - have barely managed to survive the recent storm in the global financial markets.

The MSCI Index for global insurance companies declined -31% since August 31st, 2001 (the month preceding the September 11th terrorist attack on the World Trade Center) and has done considerably worse than the MSCI World Index which has declined -15% in the same time period. Investing in the BSE-30 Index would have been far more profitable with a +2% gain! (see Table 1).

Even more frightening, many of the larger and well known global insurers like Axa and Zurich (and there are many more in this list from "A" to "Z") have declined by -42% and -43% in the same time period and did considerably worse than their sector average decline of -31% (see Table 2).

The global build-up and loss of control.
How did these insurance companies, keepers of our savings and holders of our faith, end up in such a mess? While external factors like the "9/11" terrorist attack and the Afghanistan and Iraq wars are the events that exposed the problems, the real issues that resulted in these problems was an over-zealous and rapid expansion into unchartered territory. The boring insurance business sought to become a high-growth profit engine to rival the boom promised by the internet and technology companies. From 1995 to 2001, Zurich Financial, the venerable Swiss-based insurer, grew into a global organization buying and building insurance operations in UK, USA, and other parts of Europe.

In addition to increasing its geographical scope, Zurich also expanded its product lines and became a multi-line insurer offering life insurance, non-life insurance, and re-insurance (acting as the final insurer for other insurers). Zurich also used its financial muscle and brand name to buy into the asset management business with an ambition to manage money for retail investors. An online bank was launched, huge amounts were spent on technology, and money was invested in many venture capital situations.

But the insurance business requires discipline and systems to track the risks and stresses that an insurer can face at any point in time. In its desire to grow and show short-term "results" to investors, Zurich may have slipped on the basics of controlling its mainline insurance businesses. Faced with a deteriorating investment environment, Zurich had to report to its investors that its business expansions had not produced the desired results. A change of management and change of strategy was implemented in 2002. Businesses were sold (Deutsche Bank bought most of its asset management operations, while its reinsurance business was spun off in an IPO), geographical areas not core to the long-term plans were closed down or sold off, and cash was raised to strengthen the balance sheet. Zurich even had to do a rights issue to raise further capital and retain its investment-grade ratings. The 105-year old Zurich was fighting to survive.

What is true for Zurich is true for many other insurers like Allianz, Axa, Aviva, Munich Re, Old Mutual, Prudential, Royal Sun Alliance, and Swiss Re all of whom - in some form or the other - have had to re-look at their strategies, admit to large losses and write-downs, raise more money, and get back to basics.

Re-building balance sheets.
The focus of the global insurers is now to rebuild their balance sheets and reduce the risks they had exposed themselves to. Some estimates I have seen suggest that over US$ 300 billion of capital has been wiped out from the balance sheets of all insurers in the past 3 years. The "9/11" terrorist attacks will account for "only" US$ 50 billion of that total. So where did the other US$ 250 billion go? Bad acquisitions (Allianz's purchase of Dresdner Bank in Germany) and over-payment for businesses (Old Mutual's purchase of an asset management business in USA) will probably account for another US$ 50 billion.

But the chunk of the erosion in the shareholders funds comes from the equity exposure that the people managing the investments of the insurers had built up over the years. In the year 2000, the typical European insurer had over 30% of their general account investments riding the ups and downs of the equity markets. Companies like Munich Re and Prudential had over 40% exposure to equities. The US insurance companies, due to stricter investment guidelines, had less than 15% exposure to equities and - hence - have suffered less than their European peers. With a desire to re-building their balance sheets, many of the European insurers reduced their equity exposure which probably stands at around 25% today - still high compared to the US insurers.

The irony is that while the insurers were selling to get their businesses and risk-profile back in shape, the global equity markets continued to tumble in anticipation of the large-scale selling by the insurers. It is a bit like knowing that UTI, even though it has shrink in importance, is about to sell shares - everyone sells ahead of them and stays away from the market allowing prices to fall faster and further than they normally would have. And with no other large buyer around to counter their selling pressure, the insurers may have sold at the bottom of the markets!

The future: back to basics.
In the immediate future, the humbled managers of these battered global insurers may stick to their core business and stay away from aggressive pricing or product creation to generate new businesses. They will re-build their systems and ensure that safety, proper pricing of risks, and adequacy of return - the fundamentals of an insurance business anywhere in the world - are the driving forces. That is not to say that they will be docile in new markets like India. They will take risks and they will be aggressive - but it will be on a much smaller scale and in new markets where they wish to establish a quick beach-head position around which to build a long-term business.

But will they stay passive and staid forever? Unlikely. Every turn in a business and economic cycle will bring out another aggressive wave of global expansion and another downturn will bring another consolidation of the industry. The key to remember is that insurance, at the end of the day, is a local business and the safety of your policy or the strength of your insurance company is a function of how solid the rules and regulations are in the local market. The past few years has proved that the Europeans had a lax system whereas the US system proved more resilient and withstood the multiple shocks of external, unpredictable events and a meltdown of the global financial markets.

Is this a pitch for you to stay with LIC and to avoid the private insurers? Absolutely not! The UTI-dominated scandals since 1992 have shown that even a quasi-government entity can make blunders while the hundreds of finance companies set up since the early 1980's proved that even the private sector can cheat you of your hard earned savings. The key to remember is that a more conservative regulatory environment (which we do have in India) may end up in lower returns for you but chances are that the same conservatism gives you a better chance of getting your principal back.

The author is the co-founder and Chairman of Quantum Information Services Ltd, founder of Quantum Advisors Pvt Ltd, and is the Deputy Chief Investment Officer of Hansberger Global Investors, Inc. The views expressed are his own and do not necessarily reflect that of any of the organizations that he represents or is affiliated with.

This article forms a part of "Money Simplified – Life insurance: Hear it from the experts", a free-to-download online guide from Personalfn. To download the entire guide, please click here.

Also read, "Life Insurance: Frequently Asked Questions"

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