BERENBERG EQUITY RESEARCH

Insurance Sector

The rise of the machines

Peter Eliot

Analyst

+44 20 3207 7880

peter.eliot@berenberg.com

Trevor Moss

Specialist Sales

+44 20 3207 7893

trevor.moss@berenberg.com

11 June 2013

Insurance

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We would like to thank Kai Mueller and Ben Slingsby for help in compiling this report. For our disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz WpHG) and our disclaimer please see the end of this document. Please note that the use of this research report is subject to the conditions and restrictions set forth in the disclosures and the disclaimer at the end of this document.

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Table of contents

The rise of the machines 4

Investment summary 5

The basics of telematics 7

The telematics revolution is imminent 10

The impact of telematics 14

Insurers face more challenges than opportunities 18

Insurance companies with the most to win or lose 23

Other technologies in the pipeline are significant 26

Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz WpHG) 30

Contacts: Investment Banking 34

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The rise of the machines

Telematics and other technologies will have a significant impact on the motor insurance market: We expect adoption of telematics technology, which monitors how, where and when policyholders drive, will accelerate across Europe and particularly across the UK. The technology will be very disruptive. Other technologies are being introduced which can significantly reduce claims frequency over time and therefore the value available for insurers to capture. We believe that all of these developments offer some opportunities to the industry, but much bigger challenges.

At tipping point: The underlying growth in telematics usage is already strong and accelerating. In the UK, it has doubled over the last year to 360,000 policies and could represent over half the market by 2020. Italy already has more than 2m policies. Regulatory changes are acting as catalysts. An ongoing shift in consumer behaviour, improving economics and an increased awareness of the value of telematics products relative to traditional insurance products will all help accelerate the adoption of this technology threat.

A game-changing technology: Telematics enables much more accurate pricing than traditional insurance, can attract better-risk customers who are prepared to further improve their driving by responding to feedback and encourages loyalty. Telematics will enable insurers to sell new products and services, reduce fraud and improve claims management. Early movers should be able to cherry pick the best customers but will incur development costs. Telematics will command an ever increasing share of the insurance market and first movers will be best positioned to take advantage of this. Those who ignore the change will face very serious challenges.

However, the insurance industry faces significant challenges: In most cases we believe that these may more than offset the benefits. We expect consumers ultimately to own the data behind telematics and that they will benefit more than providers. There is a risk that the insurance product becomes very commoditised. Other industries in competition with insurers include original equipment manufacturers (OEMs), telecoms companies, and telematics services providers (TSPs). Many of these other industries may have competitive advantages over the insurance industry.

Some winners and some losers: Data analysis will need significant expertise. Early movers and those with scale may have an advantage but smaller companies are understandably reluctant to lead the way. We believe that OEMs stand to take a significant slice of the value and that insurers that manage to forge relationships with these OEMs should benefit. Allianz (Buy), Generali (not covered), Catlin (Sell) and Mapfre (Hold) all look well positioned to us. Admiral (Sell) also has the potential to make good use of the technology but has much more than most to lose. It derives more than 100% of its earnings from UK motor insurance, which is likely to be attacked first, and has been very good at exploiting inefficiencies behind traditional insurance.

Advances in safety technology also provide a long-term structural challenge: Many initiatives in the pipeline, whose mainstream introduction is imminent, can significantly reduce claims frequencies and therefore the value available for insurers to capture. Share prices may take time to react to these developments, but we believe they can be a material issue for the insurance industry over the next decade.

11 June 2013

Peter Eliot Analyst +44 20 3207 7880 peter.eliot@berenberg.com

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Investment summary

The focus of this note is the impact that technology, specifically telematics, is going to have on the motor insurance industry. We believe that it will have a very disruptive effect. We discuss the following.

The basics of telematics from page 7.

How quickly, and why, telematics is being adopted from page 10. Italy already has over 2m policies and the UK is quickly catching up.

The exposures of, and commitment to, this technology of the main players. Figure 12 on page 23 summarises this. Allianz, Generali, Catlin and Mapfre are all well positioned, while we consider Admiral1 to be the most exposed.

Why telematics is so different to traditional insurance policies, the opportunities that it opens up, why first movers can achieve a significant advantage, and why non-adopters will suffer, on page 14.

The reasons for why we believe the technology is a negative for the industry from page 18. These include that insurance companies are unlikely to retain ownership of the data they collect in the long term and that there are many other industries, with competitive advantages, vying for a slice of the value.

The growth of telematics over the last few years has been significant and we see many reasons for this growth to accelerate. Consensus is for a significant proportion of UK motor insurance policies being telematics based within the next five years. Some forecasts estimate over EUR9bn in premium income by 2020 from the UK alone. Regulatory changes are acting as catalysts, including the EUs eCall project which is to be introduced from 2015, the recent EU gender ruling and, in Italy, Montis decree. Consumers aversion to the perceived invasion of privacy is declining and they are being assured that data will not be used for prosecution. The economics of offering telematics is improving due to falling technology costs. Large increases in premiums in the UK in recent years also help.

Telematics is not simply about enabling insurers to better price risks by accessing previously unavailable data. It enables insurers to attract better-quality customers, manage claims better and reduce fraud, as well as providing an opportunity for them to sell new value-added services (VAS) such as theft recovery and breakdown assistance. However, we expect a common data standard to emerge and that consumers, rather than insurers, will ultimately own the data. In the long run, we believe that the insurance product itself could become highly commoditised, and insurers (as well as other industries) are likely to concentrate on trying to extract value from the additional services. However, we believe that insurers will only be able to capture a small part of the value from these services.

We believe that the economics of providing telematics products have now improved sufficiently that insurers need to participate. In our view, the relative winners will be the early adopters while those that delay acting may suffer. Late adopters are likely to find that the most attractive customers have already been targeted and that they are left with an inferior portfolio. However, we believe that OEMs have competitive advantages over insurers. They can install telematics devices in vehicles at the point of sale and they can provide many of the VAS that telematics enables. We also believe that a dedicated TSP can be successful if it can

1 We value all companies referred to in this report that are under our coverage on a sum-of-the-parts basis (relative rating system).

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achieve the necessary scale to determine the direction of the market.

If there are winners within the insurance industry then we expect these to be the early movers in the space, those with the advantages of scale and those with strong relationships with strategically-placed companies. Many of the smaller insurers that we spoke to are waiting for their larger peers to assume the lead in this space and to bear the development costs. Indeed, it is notable how many players want to be a fast follower of the technology. We believe that there is ultimately a danger that these smaller players could be left behind and that the larger insurers will benefit from achieving a first-mover advantage. We show in Figure 1, roughly in order of commitment to telematics, the progress made by those companies under our coverage which have made significant steps.