PC Forecast Poor As Execs Ponder Mergers

While the report did not reveal how many CEOs were surveyed, or what proportion came from the property-casualty insurance industry, much of the news delivered at the press briefing yesterday suggested that p-c insurers have a more dismal near-term future than other sectors of the financial services industry.

In particular, Mercer Oliver Wyman experts said earnings growth for financial services firms hinges on revenue growth?not cost-cutting initiatives?and that revenue growth is near and dear to investors' hearts.

While outlining some bright prospects for other financial services industry segments, the experts commented dismally that "growth will be challenging in p-c insurance, where top-line revenues are likely to stagnate."

Kicking off the briefing, Mercer Oliver Wyman director Nick Studer said, "Earnings growth is the primary driver of market value" for publicly traded financial services firms?commercial and retail banks, investment banks, insurers, and diversified financial firms taken together.

He reported that market value grew 19 percent for financial services firms globally to $7.5 trillion in 2004, noting that earnings growth of 24 percent was the key driver behind the leap in market value.

He went on to report findings about market value growth from two separate analyses?one based on shareholder performance indices for 400 financial services firms and another based on the survey of chief executives.

Using a proprietary tool called a "Shareholder Performance Index," or SPI, which is a risk-adjusted measure of shareholder returns, the consulting group reported that top-line revenue growth is the most powerful lever of earnings growth for financial services firms, with revenue sprinters posting much higher SPIs than cost cutters.

While firms with both high revenue growth and high cost efficiencies reported the best SPIs?an average of 164?high growth/low efficiency firms left low growth/high efficiency firms in the dust.

High growth/low efficiency firms had an average SPI of 150 while low growth/high efficiency firms averaged an SPI of 58. (SPIs shown in the report for the top 100 of the 400 individual firms studied ranged from a low of 111 to a high of 502.)

According to the second analysis?the CEO poll?executives are quite in tune with how the markets respond. Not only are 95 percent making organic revenue growth a top priority, but 40 percent expect a major merger, and 47 percent said that involvement in smaller transactions will be a big issue for them (up from 20 percent last year).

Interestingly, at one point during the press briefing, Mr. Studer noted that smaller firms?potential merger targets?are being rewarded by the markets with higher price-to-earnings ratios, while those viewed as too large to grow may be priced lower by investment markets.

Turning to some conclusions from the SPI analysis, Mr. Studer said that by analyzing top revenue growers, the consulting firm found three emerging themes among successfully growing financial firms. Many of these firms, he said, have:

? Entered high-growth markets.

? Focused on distribution effectiveness to attract, expand and retain customer relationship.

? Emphasized product and service innovation to achieve organic growth.

To the first point, Mr. Studer noted that while some high-growth opportunities seized upon by top growers are outside U.S. borders?in Asia, for example?others are domestic. He gave the example of Bank of America's emphasis on Hispanic customers within the United States.

Property-casualty insurer Progressive got a tip of the hat from the consultants for its presence among the last two category of growers?the distribution innovators and the product and service innovators. Not only has it focused on improving customer experiences by delivering a one-stop-shop claims process, but it has invested in technology to improve service levels for agencies.

Progressive got the highest SPI of any large p-c insurer, a 216 SPI. With that measure, Mercer Oliver Wyman consultants ranked the insurer 26^th on a top-50 list of large financial services firms (firms with market capitalization above $10 billion).

The highest SPI reported for a single firm in the report was a 502 for United Health Group. Pure health insurers had the best SPIs among insurers, and nine life and health insurers ranked in the top-20 large companies.

As for the rest of the p-c field, p-c insurers and brokers listed among the top-50 midsized firms all had SPIs better than Progressive. Notable names were brokers Willis Group Holdings (SPI 297, ranked 23rd among midsized firms) and Brown & Brown (SPI 296 ranked 24^th), reinsurer Renaissance Re (SPI 303, ranked 20^th), and White Mountains Insurance Group (SPI 279, ranked 30^th).

Brown & Brown was highlighted as one of 10 midsized financial services firms that consistently has a high SPI. Large insurers Progressive, ACE Limited and Allstate, and midsized Mercury General and SAFECO made the consultants' "Rising Stars" list?named for firms that improved their SPI rankings the most since last year.

Both Progressive and Seattle-based SAFECO kicked off earnings season last week with messages about slowing growth trends in the personal lines business.

Agreeing that growth is sagging for p-c insurers generally, Mercer Oliver Wyman consultants expressed some upside for well-positioned personal lines insurers when asked what strategies insurers might pursue to keep pace with the rest of the financial services universe.

"I think there's a very definite breakdown between personal lines and commercial lines," said Henry Essert, managing director in the insurance practice. "In personal lines, it's going to be a question of [focusing on] distribution and [being attuned to] customer behavior for companies that are going to be successful."

"Progressive is an obvious example," he said, highlighting the firm's use of technology and precision in underwriting and pricing.

"Looking at the p-c industry, we don't see it growing, but we do see real opportunities for individual companies that take on customer-oriented strategies to grow," he said.

"On the commercial side, I'm going to dodge the question," Mr. Essert said, explaining that "it's difficult to predict how changes in the distribution?the broker-client relationship"?will play out. Perhaps in six months, a clearer picture will emerge, he said. "My prediction is there are going to be significant changes? I think that business is going to change dramatically."

(Mercer Oliver Wyman is a Marsh & McLennan company.)

As for merger and acquisition activity in the p-c world, he said that insurance industry participants might look beyond their boundaries to banking approaches.

He added: "On the personal lines side, I think a company that has an independent strategy can augment that through acquisition. And that's what we expect to be seeing among companies like Progressive. But the challenge there is that sometimes [their strategy] is so unique that if you buy someone else who isn't doing that, it's a challenge to retool them."