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How disruption brings investment risk and opportunity

Date: Sep 16th, 2016

Businesses that have succeeded for decades will become unseated by innovative start-ups and tech companies if they don’t adapt to rapid change. At AMP Capital, we looked at the potential impact driverless cars will have on insurers and the economy.

Disruption is proving to be a buzz word of 2016. Airbnb, Uber and Tesla have dominated the headlines and company boards have been taking trips to Silicon Valley to meet executives at tech darlings such as Twitter, Facebook and Google.

There is a sense that the world is spinning faster, ‘digital’ is driving rapid change, and businesses that have succeeded for decades may be unseated by innovative start-ups or simply become disintermediated if they do not adapt to this new digital world.

The analysis of disruption and other long-term industry drivers is an integral part of AMP Capital’s environmental, social and governance (ESG) research. In fact, in our detailed review of the Australian-listed insurance and diversified financial services sector, the risks and opportunities posed by driverless cars, the sharing economy, automation and blockchain feature heavily.

In contrast, traditional ESG research often focusses on the way in which particular companies manage ethical and governance risks and opportunities, skipping the social component of ESG research that can be a critical component of an investment decision.

The world is changing, and looking at the way in which insurers and diversified financials are positioning themselves for these changes can provide unique investment insights.

Ride-sharing and driverless cars

Perhaps the most significant long-term challenge for the insurance industry is the advent of driverless cars and the growth of the sharing economy.

These three questions crystallise the risks and opportunities for the mature motor insurance industry:

  1. What if people no longer own their own vehicles?

  2. What if cars drive themselves?

  3. If cars don’t crash (or rarely crash) and you don’t own your own car (and/or rarely use a car), do you need insurance?

The reality is that car sharing is already occurring and the technology for driverless cars largely exists although cars are not fully autonomous just yet. In fact, driverless cars aren’t as Jetson-like in character as most of us would assume. They are simply cars that use sensors, cameras, GPS technology and short-range radio communications to talk to each other as well as the roads and infrastructure. They then use that information to drive the car automatically.

Some are forecasting that fully autonomous cars will be on the road in Australia by 2025. Others say autonomous cars will not be mainstream until 2040. But of course, the speed and extent of adoption of both trends depends on a range of factors, not just technology, and there are natural inhibitors to both forms of disruption that need to be considered when assessing the potential impact. The potential impact, however, is large.

The impact on insurers

Motor books are extremely significant to the earnings of Australian and global insurers. Personal and CTP insurance account for approximately 50 per cent of Suncorp’s premiums and 44 per cent of IAG’s premiums, according to Bank of America Merrill Lynch, and 42 per cent of the world’s property and casualty premiums are motor. In emerging markets, motor insurance is an even greater proportion of property and casualty premiums, at 58 per cent of the total.

Irrespective of if or when the tipping point occurs, there are a number of short and medium-term impacts for insurers as the technology that underpins driverless cars, such as auto-braking systems and laneway departure warning systems, appears in new cars. In the short to medium term, it is thought that claims costs will reduce because semi-automated cars will significantly reduce the number of accidents on roads. According to Bank of America Merrill Lynch, collision claims account for about 80 per cent of the total claims cost on the average comprehensive motor policy in Australia and about 54 per cent of motor vehicle premiums.

This suggests that, if automation technology reduces car collisions to the extent expected, motor premiums may fall by up to 50 per cent without impacting insurers’ margins. This neatly demonstrates disruption in action: it can bring opportunities as well as challenges.

The sharing economy is likely to be impacting insurers at the same time, with some researchers saying that ‘peak car ownership’ has already passed, thanks to Uber and cheap car rental services like GoGet in urban centres. According to KPMG, owning a car in the US today costs about US82 cents per mile travelled, on average, while the cost of a shared car costs about US44 cents per mile, on average.

In Australia, fewer 18 to 24 year olds see the need to get their driver licenses. One-third of 18-24 year olds in Victoria don’t have a license, according to Victorian motoring organisation the RACV. In 2014, there were 12 per cent fewer 18 to 24 year olds in Victoria that held a license than there were in 2001.

Understanding ESG issues can lead to better investment outcomes

Disruption aside, AMP Capital’s ESG research demonstrates there is a strong positive correlation between the way companies manage short, medium and long-term ESG risks and opportunities and their investment performance.

In our sector review that included detailed analysis of driverless cars, the sharing economy and bitcoin, the five companies with the highest ESG scores outperformed the five companies with the lowest ESG scores every year over five consecutive years.

When measured over a longer time frame (10 years), the outperformance was even stronger. The only exception to this is when performance is measured over seven years.

Underperformance of good ESG companies on this timeframe appears due to the global financial crisis and high share prices in 2009 in the lead-up to the global contagion.

The outperformance of ESG stocks over most periods demonstrates the value in considering the way in which companies are managing short and long-term ESG issues when making investment decisions.

Read the full report here

Source: AMP Capital

About the author
By Kristen Le Mesurier, Senior ESG Analyst, Investment Research

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

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