NU Online News Service, Dec. 8, 11:43 a.m.EST

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The insurance industry will undergo increasing consolidation aspart of the fallout from government intervention and potential taxlaw changes following the financial crisis, a consulting firm isadvising.

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And insurance industry stability and certainty may not returnfor a few years as insurers react to regulatory reform,PricewaterhouseCoopers LLP said.

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PwC projects in a report that within five years the industrylandscape could look markedly different and Americans may findtheir insurance policies underwritten by a handful of large,well-capitalized firms that can demonstrate financial strength andeconomies of scale.

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Titled "Emerging from the Storm: The Day After Tomorrow forInsurance," the PwC analysis outlines nine key developments thefirm said are expected to reshape the insurance industry and theirstrategic implications during the next five years.

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The most significant of these developments for U.S. insurers,PwC said, will likely be sweeping regulatory changes resulting fromproposed legislation to reform health insurance and increasefederal oversight of the insurance and financial industries.

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Creation of a Federal Insurance Office could provide federalpolicymakers with the information and resources to better respondto crises, mitigate systemic risks and help ensure awell-functioning financial system, but it could also lead to dualregulation at both the state and federal levels, according to thereport.

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Bill Chrnelich, PwC insurance sector partner, said, "Insurersare in the business of managing risk and measuring probability.They don't like uncertainty, yet they are facing two massive reforminitiatives, the outcomes of which are unknown but could altertheir destiny."

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He noted, "Some insurers are taking a cautious wait-and-seeapproach, while others see this period as a once-in-a-generationopportunity to shape their future."

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According to PwC, the insurers most likely to succeed onceregulatory changes are enacted are those that closely monitordevelopments and create business strategies that anticipate themost likely possibilities for reform.

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PwC said the U.S. insurance market remains highly fragmented,and there is a strong underlying rationale for consolidation andrestructuring, which means merger and acquisition activity may beset to accelerate rapidly.

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This could particularly occur, according to the firm, as larger,better-capitalized firms consume smaller firms.

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The report said consolidation is expected to help deliver thecapital stability and economies of scale that will be important inattracting customers and demonstrating financial strength, not onlyto ratings agencies but also to third-party distributors whose"ownership of the customer" makes them a key determinant of aninsurers' fate.

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PwC found that the faith of investors, who had become accustomedto high yields but were unaware of the related risks, "appears tohave given way to shock, disillusionment and caution."

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A pursuit of innovation, said PwC, appears to have beendisplaced by a focus on stability, risk management and demand forsimpler, more straightforward and transparent policies andinvestment products such as index-linked investments.

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As an example of this, the firm mentioned the recent resurgencein demand for whole life insurance.

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But it cautioned that the apparent desire for guarantees couldcreate dilemmas for insurance companies that want to scale backsuch products as they seek to limit risk.

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Potentially higher costs of risk and guarantees, along with whatmay be higher commission payments to distributors, could changeproduct economics, and insurers will need to better understandcomponent costs, pricing and profit profiles, the reportadvised.

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PwC predicted that governments will be looking closely atinsurance companies' tax status as the industry is a major sourceof potential tax receipts and has moved significant businesscapacity to other jurisdictions in recent years.

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Insurers, PwC said, can expect renewed scrutiny of their taxplanning techniques, as well as more stringent requirements fortransparency and information exchange relating to clients.

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As a result of the financial crisis, the consultants noted, manyinsurers have been forced to raise prices, restrict the pursuit ofnew business, or withdraw from high risk and peripheralmarkets.

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It forecasted that as insurers withdraw from some of theirgeographic markets and scale back particular lines of business, themarket shares and opportunities for those that remain could sharplyincrease, leading to a significant reconfiguration in the list ofleading players.

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Companies with a better understanding of their risks, said PwC,are likely to be in a stronger position to capitalize on potentialopenings that less-informed and less-assured competitors maymiss.

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PwC warned that without an industry consensus on a genuinelyrelevant, intelligible and comparable basis of accounting anddisclosure, insurers may find it increasingly difficult to competefor capital.

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Further, with funds constrained, many portfolio investors couldsimply choose to put their money elsewhere, leaving the insuranceindustry with major challenges, according to the firm'sanalysis.

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PwC said in a statement that "it seems imperative that theindustry come together to develop a basis of relevant disclosuresthat reflect the nuances of their business and satisfy analyst andinvestor demands."

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As the government exerts a stronger influence over the insurancemarket as a result of bailouts, regulatory reform and greatercontrol over pensions, health care, trade credit and mortgagesupport, the relationship between the public and private sectorscould change, PwC suggested.

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With the appointment of the Special Master for Troubled AssetRelief Program Executive Compensation in the United States,insurers are likely to base much more of their performance-relatedpay on risk-adjusted measures aligned to their business strategy.They also are expected to face tougher regulation over howcompensation is governed, said PwC.

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The firm also found that for reinsurers, while demand is likelyto increase within emerging markets, this is unlikely to offset thedecline in reinsurance buying in developed markets and may forcemany reinsurers to rethink how they sustain profitability andgrowth.

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The trend toward higher retention of straightforward risks couldaccelerate. As companies become more risk-aware through advances inenterprise risk management, they will be better able to choose whatrisks to retain and which to reinsure, PwC said.

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Mr. Chrnelich said the coming changes mean the competitivelandscape will be very different in five years from what existstoday. "This will jeopardize some insurers' business, but it shouldalso enable those who are better prepared to excel in a newenvironment."

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The full report is online at www.pwc.com/dayaftertomorrow.

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