Point of View. Taking Risks in Life Insurance. Financial Services

Transcription

1 Financial Services Point of View Taking Risks in Life Insurance Authors: Bernhard Kotanko, Head of EMEA Insurance Simon Grout, Partner Rouget Pletziger, Senior Manager

2 Risk is back in fashion. We have seen a common message emerging from our discussions with senior European insurance executives, and from their investor communications: we want to take more life insurance risk. The growth case is easy to make, as although life insurance risk (especially term assurance) accounts for only a relatively small proportion of sector premiums, underlying profitability is strong in most markets, and profits are much more defensible against competition from banks and asset managers than elsewhere in the sector. Risk capital consumption is relatively low, and Solvency II has reinforced this by placing high charges on market and ALM risks. However, succeeding as a provider of life risk protection is not a slam dunk. Growth rates in most Western European countries are at best moderate, penetration rates are low and distribution is challenging. Some competitors are also deterred by weak understanding of the underlying biometric risks and their contribution to portfolio economics. And even where they have ambitions to grow the business, insurers often struggle with implementation. In our experience there are five main imperatives for insurers wanting to push further into risk: Exhibit 1: Five imperatives for insurers wanting to push risk Strategic imperatives Top line and bottom line impact Margin improvement 1 Build a culture of innovation around customers needs Demand-led innovation and advanced customer segmentation Creative design and smart bundling A balanced product mix and pipeline considering life cycle patterns 2 Deliver a consistent emotional message towards the customer Emotionalising the customer facing proposition Aligned branding, communication and sales pitch per channel Convenient sales support services for distribution partners 3 Develop advanced pricing and underwriting capabilities More granular perspective of risk drivers and customer elasticity Considering profitability skews in customer targeting and pricing Special underwriting terms 4 Increase automation in administration and underwriting Straight-through processing Smart and automated underwriting to increase pass rates 5 Capture maximum value in risk intermediation Clear appetite for insurance risks on own balance sheet Integrated risk and capital management Economic approach to reinsurance optimisation 2 Copyright 2011 Oliver Wyman

3 1. Build a culture of innovation around customers needs Many people are risk averse and in principle a proposition around life insurance risk protection should be easy to sell. In practice, however, many consumers still perceive protection insurance as either unnecessary or unaffordable, or suffer from apathy when faced with the purchase decision. Hence providers face two distinct challenges: How to meet customer-specific needs for risk protection in a standardised way. It remains challenging to aspire to deliver a tailored proposition and a customer centric delivery model while still retaining scale advantages. How to generate a consistent stream of proposition innovation, and how to manage the broader insurance product life cycle. Typically the biggest challenges are in maintaining a good flow of new ideas but also in being able to flexibly and quickly test these ideas in the market. When the challenge to growth is consumer resistance or apathy, innovation has to start on the demand side. Products, bundles, price schedules and channel strategies need to be built around a deep understanding of customers concerns, preferences and behavioural tendencies. Best practice players understand customers underlying concerns and apply technical insurance capabilities to deliver an applicable and easy-to-understand solution. Two good examples of this in the market are PruProtect s Vitality programme in the UK and Allianz s living expense coverage ( Fixkostenpension ) in Austria. 2. Deliver a consistent emotional message towards the customer Analytics can help insurers to understand and segment consumer needs. However, analytics can never be enough on their own. It is clear that in the mind of the consumer, insurance risks touch on some of the deepest underlying concerns about life s uncertainty. To succeed insurers need to engage emotions not just intellects. While many insurers recognise this challenge in principle, most still have severe difficulty finding the right level of emotionalisation for their products in practice. Copyright 2011 Oliver Wyman 3

4 To take a real world example, Exhibit 2 highlights the relevance of proper risk protection from a customer perspective using Alzheimer s as an example of critical illness risk. The analysis makes it clear that people face a severe financial risk from contracting the disease, and at the same time there is typically a strong emotional reaction to the future prospect of the disease (evident from discussions on any relevant blog or discussion group). Nonetheless insurers have found it difficult to address and to communicate an effective proposition around these needs. Exhibit 2: Financial impact of Alzheimer s Income and expenses Net worth $K Insolvency age: with Alzheimer's, 75 yrs Insolvency at base case: 79 yrs With Alzheimer s $K 450 Total assets Insolvency age: with Alzheimer's, 75 yrs Insolvency at base case: 79 yrs 150 Life expectancy: 81 yrs Life expectancy: 81 yrs 100 Expenses Base case 200 Financial assets 150 Base case With Alzheimer s Income Age 50 Total debt Age Notes: Alzheimer s costs account for the increase in expenses at age 70; annual cost of $36,132 for treatment until death based on American Health Assistance Foundation data for the average cost of caring for a patient with severe symptoms (17% of the population in the age group and 20% of the population in the group have severe symptoms); no change in life expectancy assumed. Liquidation of real estate assets that are converted to income-bearing liquid financial assets accounts for the increase in income at age 70. Expected retirement age at 65 accounts for drop in income and expenses at that age. The challenge is to come up with an integrated blend of product/ service features, communication strategy and distribution approach, that delivers a consistent emotional message. As yet, no insurer has managed to completely solve this issue. Nonetheless, there are some early encouraging signs: for example, some insurers now claim to have customer centricity at the heart of their strategy statements; surveys suggest customers trust in insurance has increased in many European markets through the course of the financial crisis; and a few insurers have managed to create innovative propositions (for example, UK risk protection specialist Bright Grey, who have created an effective mix of technical risk product expertise, customer value proposition and appealing communication). 4 Copyright 2011 Oliver Wyman

5 However the jury is still out, and insurers have a long way to go to achieve true emotionalisation of their proposition. 3. Develop advanced pricing and underwriting capabilities Advanced technical pricing differentiation can provide great economic benefit and can also be a way to differentiate the value proposition to different customer segments. The UK is usually seen as the most advanced European market in actually moving actuarial insight into differentiated pricing. Typical parameters include postal codes, professions and education, gender, family status, income and wealth and some new products include also parameters like the Body Mass Index (BMI) and specific critical illness clauses ( Alzheimer s). An example of this granularity is shown below. Exhibit 3: Differentiated biometric risk profiles by geography (UK example) There are large skews in mortality risk across the UK population leading to considerable profitability skews and customer cross subsidies 1 % of population Illustrative EEV new business margin as % premium 40% 9% 35% 30% 25% 20% 15% Population of England and Wales split according to the Standardised Ratio of their local Unitary Authority 8% 7% 6% 5% 4% 3% -42% -27% -13% +12% +23% +34% 10% 2% 5% 1% 0% 0% 30% lower 20% lower Islington Kensington New Forest 10% lower York National average Stockport 10% higher Bradfor 20% higher 30% higher Liverpool 30% lower 20% lower 10% lower Current market average 10% higher 20% higher 30% higher Males Females 1. Profitability based on level annuity sold to male age 65 Source: ONS and Oliver Wyman analysis However, improved analytics is not the only area for best practice: leading competitors are able to continuously experiment with and improve their technical pricing bases, and can translate these price changes into a consistently communicated value proposition (undiluted by rebates and discounts). In addition, some leading edge players have also applied statistical techniques to marketing in order to understand and leverage price elasticity at customer segment level. Copyright 2011 Oliver Wyman 5

6 4. Increase automation in administration and underwriting Risk products have low levels of premium and assets per policy but are distributed in large volumes, hence it almost goes without saying that there is a strong need for efficient processing and lean operations. But efficient manufacturing and administration of risk products requires a continuous effort to drive cost and efficiency out of the value chain, including openness to outsourcing or cooperation where beneficial. At the same time given risk products are often sold as riders or annexes to other products the front-end interface into distribution and product sales systems is crucial for effective selling and efficient processing. The most successful bancassurance specialists invest heavily on maintaining a perfectly functioning link into their bank partners sales and processing systems. The principle is not complex, but is extremely hard to deliver consistently in reality. The low cost leaders (such as Legal & General in the UK) manage to deliver highly automated integrated pricing and processing to channel partners, and at the same time leverage scale (in a virtuous circle) to negotiate the best possible terms from reinsurers. 5. Capture maximum value in risk intermediation At the heart of life insurance manufacturing is the process for managing and mitigating the portfolio s exposure to life insurance risk. Most insurers already claim to manage this through a combination of business strategy, enterprise risk appetite statement, risk management practices, and a regular review of reinsurance programmes. However, our experience from working with many life insurers suggests some surprising outcomes in practice. For example, misperceptions about the true level of biometric risk exposure (such as longevity) and the economics of credit protection, or limited translation of nuances in underwriting risk parameters into distribution and marketing execution. In practice this may lead to outcomes such as over-conservatism in portfolio exposure to life insurance risks for example in overly defensive reinsurance programmes if looked at under economic risk/ return parameters. 6 Copyright 2011 Oliver Wyman

7 A properly constructed strategy for life insurance risk should not necessarily be a defensive one. We believe that insurers who understand the true contribution of life insurance risk to the portfolio, and have the appropriate tools and processes to manage it rigorously, can go on the offensive and actively seek out additional life insurance risk. * * * In summary, we believe that life insurance risk is an under-exploited opportunity for European insurers. But execution is not easy and will depend on the five key success factors described above. This may mean fundamental organisational and process changes for some insurers, for example, a stronger dedicated risk product management responsibility, or a clearer link between technical pricing and front end marketing. But we believe the pain is worth the gain, and that a bold push into life insurance risk could pay significant dividends. Copyright 2011 Oliver Wyman 7

8 Oliver Wyman is an international management consulting firm that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, organisational transformation, and leadership development. About the authors: Bernhard Kotanko is Head of Oliver Wyman s EMEA Insurance Practice, based in Zurich SImon Grout is a Partner in Oliver Wyman s London Office Rouget Pletziger is a Senior Manager in Oliver Wyman s Frankfurt Office For more information please contact the marketing department by at info-fs@oliverwyman.com or by phone at one of the following locations: EMEA North America Asia Pacific Copyright 2011 Oliver Wyman. All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The opinions in this report represent the views of the author(s) and may not necessarily reflect the views of other partners within Oliver Wyman or the company. This report is not a substitute for tailored professional advice on how a specific financial institution should execute its strategy. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisers. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. This report may not be sold without the written consent of Oliver Wyman.