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16 July 2013 Insurance

People drive change

Mike McGavick, the chief executive officer of XL Group, is renowned for his outspoken views on the industry almost as much as he is admired in some quarters for the way he has reinvigorated the XL Group during his tenure at the company.

Perhaps it is because he brings a perspective from outside the industry that he finds it easy to criticise some of its outdated business practices and somewhat slow pace when it comes to adapting and underwriting new risks.

Despite an impressive track record working for a number of big US insurers and financial services companies, McGavick’s former role as chief of staff in the US Senate gives him a very different take on things.

He believes the insurance industry is not keeping pace with the needs of businesses—a slippery slope for the industry. But unlike some of his peers who also preach the need for change and innovation, what is interesting about McGavick, is that the XL boss is also very specific in why he thinks the industry acts the way it does and what can be done to change it. He can point to a number of examples of where his own business has done just that.

Held back by history

First of all, he is clear about the problem. “The rate of change in the industry and the business world is exponentially faster than product development is in the insurance world. As such, the industry risks shrinking and becoming less relevant within modern economies. The industry needs to step things up.”

He notes that although rates have since softened substantially, this has simply led to a price war among insurers and reinsurers. “And that is distracting attention away from the larger and more pressing issue of the industry’s lack of innovation,” he says.

“The fact is that if certain regulations are introduced under their current form, it will become much more difficult to innovate and introduce new products.”

There are three core reasons for this slow rate of innovation. First, he says, post September 11, the industry’s profitability was sufficiently healthy that it had no need to consider innovation. “That environment was simply not conducive to innovation—people tend to innovate far more when it is tough to make money,” he says.

The second big reason cited by McGavick revolves around the way the industry uses data. He explains that the industry is very good at using data and its careful analysis of such information has always been a big part of its ability to price risks accurately. But he believes the industry has become too dependent on such analysis and is now wary of writing business where the vast quantities of data it is used to are not available.

“The industry has got into the habit of requiring too much data, in too much detail, before it will make a decision and create new products,” he says. “But that is too slow in this day and age. By the time it has analysed a new risk, whole industries will have come and gone.”

Finally, he believes that the nature of many modern risks is fundamentally different from the types of risks the industry has been used to dealing with. “The insurance industry has always been very good at pricing and insuring physical things; it is not so good when it comes to dealing with very technical risks or a number of interconnected risks.

“So many industries are changing very quickly and beyond recognition thanks to technical advances, and insurers are struggling with that.”

New risks, new horizons

While some companies baulk at such challenges, McGavick has made it his—and XL’s—mission to embrace them. He sees these as opportunities for the industry and he believes there are several areas of potential growth and opportunity if the sector innovates correctly.

It is time, he says, the industry re-evaluated how best to use data. “Instead of requiring vast amounts of historical data on risks where that is simply unrealistic, we could instead look at methods whereby we use parallel sets of data to establish an element of certainty.

“Alternatively, we simply allow the product’s price and exposure to reflect the level of certainty we have attained—whatever that might be.

So the less data we have, the less risk we take, but at least working in this way allows us to get a toe in the water.”

He also believes that many insurers and reinsurers have the wrong type of relationship with their clients. The key to solving many problems lies in working much closer with clients—the real experts in many of the exposures the industry is grappling with.

“Instead of viewing our clients as the enemy, we need to partner with them and learn from them and their problems. When you sit down with risk managers and their technical experts, you can almost always find common ground and ways in which you can work together.

“We spend a lot of time in what we call innovation workshops with clients. Through these, we sometimes develop new products and sometimes new ventures that we might part-own. I believe this stuff is important for the industry to ensure it remains relevant.”

According to McGavick, the bottom line of making such philosophies work, however, comes down to how companies resource them. He believes insurers should be putting their best people to work not in the most lucrative areas of the business or in the most challenging—but in those with great growth potential.

“The best people from within organisations should be allowed to innovate rather than simply working on the biggest and most profitable areas of the business,” he says.

“People say the insurance industry has less talent compared with other sectors. I disagree with that. We have no problem with talent but it depends on how you use it and where you put it to work.”

The debate around talent can be split into two issues: one option is to recruit clever people specifically to work on new projects; the other is to shift the business’s best people around and get experienced people to focus on new challenges in the business.

“Insurance expertise combined with the capacity in the capital markets could see the industry cover some of the huge energy risks that have been self-insured for many years.”

“Either starting point is fine, if they are the right people with the right skills to take on new challenges,” he says.

Put People first

Within the XL Group, McGavick cites a number of instances where he has done this. For example, Greg Hendrick, now the chief executive of insurance operations, was made executive vice president of strategic growth in 2010 with a mandate to develop the business’s strategy and seek new opportunities. Prior to holding that role, he had held a number of other senior positions at XL including chief underwriting officer for XL’s Bermuda reinsurance operations and vice president of US property underwriting for XL Mid Ocean Reinsurance.

McGavick says Hendrick, a mathematician by background, was always very good at analysing data. “So we put those skills—combined with his track record as an underwriter—to good use developing new products,” he says.

Another example is Paul Tuhy, who now leads the group’s global aerospace business. Perhaps not coincidentally, he was appointed into the position by Hendrick who said in a statement at the time: “XL is known for taking on businesses’ toughest risks. Paul’s industry experience will bring an exciting perspective to our aerospace business. Attracting and retaining top talent is at the core of our strategy and we feel this is an excellent example of this in action.”

XL Group’s global aerospace team provides insurance coverage for a global book of airline business, products manufacturers, general aviation and space risks around the world. Prior to becoming the global head of claims in 2006, Tuhy managed XL Group’s claims operations in Continental Europe and Asia, and served as head of claims for North America when he joined XL in 2003.

McGavick says this change was made because Tuhy had a passion for the sector, combined with the experience on the claims side required in a complex data-driven industry. His unique perspective has helped the group establish itself as a leader in this sector.

But he stresses that such an approach rarely pays off overnight—another reason many companies will be wary of trialling their executives in this way. A long-term strategy must be agreed on, and often substantial investments made. Meanwhile, vast effort must be put into ensuring the details of such an approach, such as contract wordings, are also in place to back up such development.

“When you take this approach you have to be patient and willing to invest long term,” he says. “You have to ensure your products are well designed and thoughtful but even then they can take time to develop in the market—in the real world.

“A big operation is also required working behind the scenes to get such new products to market. You have to consider things such as compliance and regulation while always keeping one eye on your long-term commercial prospects. You must ensure your limits are set in a sensible way.”

Change for the better?

Such operations are part and parcel of many companies in other industries—product development sitting under what would be called a research and development budget. But, he adds, “the fact is also that your earnings from traditional lines of business must be solid enough to support such innovation”.

He does strike a note of caution on some points. He is deeply concerned about recent trends in the way regulations are being drafted. He believes that the regulators’ penchant for applying risk aversion measures to an industry designed to do just that could well hamper innovation even further.

“The fact is that if certain regulations are introduced under their current form, it will become much more difficult to innovate and introduce new products,” he says. “I must stress, this has not yet been a problem for us but I can see new regulations such as Solvency II causing us problems.

“If very high levels of data are not there to support a new product it looks as though the capital requirements will be much greater. And there is no doubt that would impede innovation.”

For now, however, XL continues to move into new product lines. McGavick says he splits these activities into two categories of innovation: new risks, which the insurance industry has never covered before; and existing risks where existing products are refreshed to reflect modern risks.

“We have innovated around D&O, global property, cyber risks, environmental risks in the environmental space, food and beverage environmental risks and product recall risks reflecting new developments in the law,” he says, adding that the company has also issued some pioneering new policies in the surety space and developed its existing fine art & specie policy to reflect a loss of revenue from the unavailability of artworks. “This has never been done before,” he says.

Finally, he turns to the particularly topical subject of alternative capital and insurance-linked securities (ILS). Perhaps unsurprisingly, he also sees this as a form of innovation and one that could become central to the industry’s future success and ability to deal with the world’s rapidly changing needs and risk profile.

“XL was born out of innovation and it comes very naturally to us. We have the experience of doing this and it is central to our long term plans.”

“I do not see ILS as a threat—rather, it is just another form of innovation,” he says. “Investors still need good underwriting teams to price risk correctly regardless of where the capital is coming from. As things stand, this type of capital can only go so far. Underwriting is central to the whole thing.”

Preparing for change

XL has been at the forefront of embracing new developments in this market. XL was the sponsor for Cyrus Re, one of the first post-Hurricane Katrina sidecars—an example of early capital market involvement in the reinsurance industry.

And coming back to his philosophy that people are what really matters, last year XL’s reinsurance segment hired Craig Wenzel as senior vice president, in its capital markets arm, luring him away from Deutsche Bank Securities. Wenzel is responsible for managing and developing relationships with third party capital providers.

McGavick certainly sees the industry’s relationship with ILS and alternative capital as pivotal to its future. But he goes further than most, suggesting that such a marriage could actually extend the scope of insurance into previously uncharted waters. Insurance expertise combined with the capacity in the capital markets could, in theory, see the industry cover some of the huge energy risks that have been self-insured for many years, for example.

“As long as there is an insurable risk at the heart of it, anything is possible,” he says.

However big or small the ambitions of different companies, he insists that standing still is not an option. He believes it is vital that the industry as a whole embraces innovation and he is determined XL leads from the front.

“The reason I talk about this is because I am concerned about the sector’s overall relevance,” he says. “The reality is that pricing and handling complex risk is a unique skill that the industry is very good at.

“XL was born out of innovation and it comes very naturally to us. We have the experience of doing this and it is central to our long-term plans.

“But everyone should be doing it. We can’t allow customers to become marginalised. And let me assure you, many customers are frustrated with the industry. Not everything we do will lead to a new product being launched but some will, and that is enough. The important thing is that we need to try.”

Meet Mike McGavick

Mike McGavick has been chief executive officer of XL Group since 2008, winning several industry awards during his tenure.

He is also currently the chairman of the Association of Bermuda Insurers & Reinsurers, the chairman of the Geneva Association and the Global Reinsurance Forum.

From 2001 to 2005, McGavick was chairman, president and CEO of Safeco Corporation. Prior to joining Safeco, he spent six years with CNA Financial Corporation, where he held various senior positions, including president and CEO of the company’s largest commercial insurance unit.

McGavick has been involved in a number of industry, political, public affairs and community service activities. He was a vice chairperson of the American Insurance Association and served as director of its Superfund Improvement Project.

He is a former chief of staff in the US Senate and ran for Senate office in the State of Washington.

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