U.K. Life Insurers. Getting Back on Track. White Paper. April Miguel Ortiz Ed Bradshaw -6-

Transcription

1 U.K. Life Insurers Getting Back on Track White Paper April 28 Miguel Ortiz Ed Bradshaw -6-

2 U.K. Life Insurers Getting Back on Track April 28 A 2-year period of diversification into investments and wealth management has threatened to bring the U.K. life-insurance industry to its knees. Insurers, once in a position of dominance in an industry with seemingly unassailable barriers to entry, have suffered greatly under general economic pressures and the burden of compliance with consumer protection measures. Now is the time to take a fresh look at the industry and identify areas where U.K. life-insurance companies can succeed and those where they cannot. A False Sense of Security Statistics from the Association of British Insurers show a consistent annual increase in new business for U.K. life insurers in recent years. (See Exhibit 1.) And until the past 12 months or so, this positive trend was sufficient to keep investment markets and policyholders happy. Yet when the issue of increasing churn in new business is considered, that rather sunny picture clouds over. Indeed, persistency rates have fallen annually since 1998, and stimuli such as Pensions A-Day, while bringing in net new money, have also created a storm of churn. In fact, statistics for insurance assets under management (AuM) reveal that in recent years, stock market growth has o en shored up an industry that is actually in net decline. (See Exhibit 2.) For example, net premiums in the industry have historically run at 12 to 14 percent of the previous year s total AuM. Between 2 and 21, however, this figure declined to about 1 percent, where it has essentially remained. Yet the percentage of AuM paid out in claims, surrenders, and maturities has risen from between 8 and 9 percent in 1999 to about 12 percent more recently. The lines on the graph crossed in around 23. (See Exhibit 3.) These dynamics are reflected by the downward trend in the number of in-force policies. (See Exhibit 4.) The impact of this overall reversal is compounded when the average margin of new business sold today is compared with that of, say, five years ago. Clearly, overall profit margins are sensitive to the rate at which the back book of in-force business runs off. It has been estimated that between 24 and 26, worse-than-expected operational results and assump- -1- Exhibit 1. New Business Has Risen in Recent Years millions 18, 16, 14, 12, 1, 8, 6, 4, 2, U.K. Life Insurers APE, % CAGR Note: APE = annual premium equivalent.

3 Exhibit 2. In Recent Years, the Stock Market Has Propped Up the Industry millions 1,25, U.K. Life Insurers Long-term assets under management (AuM), ,982 tion changes to the embedded value of existing policies offset 6 to 7 percent of new-business profits for two of the United Kingdom s leading insurers. 1 Ultimately, the combination of increasing churn, declining margins and net AuM, higher costs (brought on by regulation), and a creaking technology infrastructure has led the U.K. life-insurance industry to the brink of structural decay. 1,2, 1,15, 93,26 1,179,686 In a series of brief articles, of which this is the first, BCG plans to assess the challenges that the U.K. lifeinsurance industry is facing and to explore some of the opportunities that exist for insurers to build a new, sustainable business model for the future. Roots of the Malaise 1,1, 1,14,858 AuM, 25 Premium income (NWP) 141,361 Benefits paid Capital appreciation AuM, 26 Note: NWP = net written premiums; AuM numbers have been rounded. Exhibit 3. Fund Flows Have Reversed Course % U.K. Life Insurers Illustrative fund flows, NWP as a percentage of the previous year s AuM Benefits paid as a percentage of the previous year s AuM Note: NWP = net written premiums; AuM = assets under management. The U.K. life-insurance company of 2 years ago had a number of sharp competitive edges. For example, consumer trust in insurance providers and brand loyalty were both high. Distribution was secured through large direct sales forces. Life insurance companies wrote guarantees within a mutual structure. This framework provided a unique, smoothed savings product for customers, one with little or no shareholder capital committed or exposed. What is more, barriers to entry for potential competitors were formidable. Then the unraveling began. Miss-selling scandals damaged confidence in the industry, raised the cost of regulatory compliance, and made home-service productivity levels and then direct-sales-force productivity levels uneconomical. Guarantees built into savings products became untenable during periods of equity market volatility. A number of companies ceased writing new business, and some well-established brands were lost or irreparably tarnished. Understandably, life insurance companies ran for the comparative shelter of wealth management, where margins were thought to be fat, risks relatively low, and potential assets to be managed far more substantial than those within reach of most existing customers. With-profits became suspect, and consumers 1. Credit Suisse, UK Life Insurance: Back-Book Problems (November 26). -2-

4 Exhibit 4. The Number of In-Force Policies Has Declined In-force life and pension policies in the United Kingdom, Number of policies (millions) 12, 1, 8, 6, began to recognize the value of simple tracker-based investment products such as index funds. At the same time, the government removed some of the fiscal advantages of pensions. Today we have a value chain in which distribution is mostly independent. Insurance savings assets are unitized and overseen by fund management companies, some of which are owned by insurers but many of which are not. Overall product margins are tighter. To make matters worse, many links in the value chain are no longer controlled by, nor provide income for, insurers. Tax wrappers have become commodities, and investment risk has been passed on to the consumer. 4, 2, Some players have tried new strategies, including investing in distribution and wrap platforms, in an effort to regain lost ground and revive volume and margin streams. But such initiatives are not substantive enough to truly turn the tide. In our view, a strategy that could help U.K. life insurers construct a solid foundation for future market leadership would begin with providing high-quality asset-management services but also with building investment guarantees back into savings products, thereby leveraging insurers core competence in risk management. What Is Needed Today? What must the U.K. life-insurance industry do to get back on track? The answer, in one sense, is simply to provide what consumers have always needed: high-quality products and superior performance, and a level of service that will renew public confidence in the industry. Consumers have far more performance information and fundtracking tools at their disposal now than ever before, and their tolerance for mediocre products and services is at a historic low. Granted, it may still be possible to pay high commissions or to push branded products through the advisor channel or even to promote uncompetitive in-house asset-management products. But these strategies are neither sustainable nor particularly profitable given tightening regulatory regimes and increasing consumer sophistication. In our view, the first strategic response from insurance companies seeking to blaze a trail to renewed prosperity should be to compete head-on with asset managers in the savings space. Insurers need to focus on performance, on innovative product development, and on creating the type of high-energy, fast-moving culture embodied by a number of successful asset-management firms. Clearly, strict discipline will be needed to get the best results from in-house fund managers; the focus on performance and product innovation applies to them even more than to managers of external funds. The traditional culture and complexity of life insurance companies, along with the internal politics that o en surround in-house fund managers, can make such discipline difficult to achieve, but insurers must persevere. We also see opportunities for a second strategic response, one that takes insurance companies back to their original advantage in savings: offering guarantees. To be sure, it is no longer feasible to offer the traditional with-profits -3-

5 fund. Yet guarantees can be written directly by the insurer, which can then hedge and manage the investment risk. This capability represents a unique source of competitive advantage for insurers, which possess balance-sheet and risk-management skills that relatively few asset-management firms can match. For consumers, these guarantees are highly attractive especially following periods of equity market volatility, which have reminded them of the real dangers of downside risk. Of course, these strategies constitute potentially major initiatives for U.K. life-insurance companies, many of which spent the period between 21 and 23 trying to significantly reduce investment exposure on their balance sheets. However, in adopting these approaches, they would in effect simply be applying their current annuitybusiness practices to the savings market writing risk and managing it over time, essentially replacing mortality risk with investment risk. The opportunities for dynamic hedging are far greater in investment markets than in the mortality market, so in many ways they represent an easier milieu in which to write and manage risk. Insurers third strategic response should be to reposition themselves in the distribution link of the value chain. Few positions being built by insurers today are truly differentiated and economically sustainable, and many positions will simply accelerate the commoditization of the underlying insurance business. For example, we doubt whether large investments in wrap platforms can truly change the economics of distribution for financial advisors, and thereby create winning positions for insurers in the medium term. We also see challenges in high-net-worth distribution. To make money, insurers need an employment model that attracts the best talent, and an investment offering that is truly differentiated not just open-architecture in nature. Where else should bets be placed in distribution? Clearly, consumers are beginning to realize that good advice about a simple range of fit-for-purpose products offers more value than infinite choice. The big challenge for insurers in controlling distribution will be to redefine their value proposition along these lines and, in so doing, to reintegrate the value chain. This approach remains the most profitable for the sale of long-term savings products whether aimed at the affluent or the mass-market end of the spectrum and creates an opportunity for insurers to move away from the role of commoditized product provider. Succeeding, however, will require actions that not all insurers are capable of: designing an effective industrialized employment model; building a simple, low-cost sales platform; managing partner relationships; and, most important, developing a proposition that fosters consumer trust. None of these challenges will be easy, but they do need to be tackled directly. To summarize, we would recommend that U.K. life insurers pursue the following strategic initiatives: Build a performance-based, innovative, fast-moving savings operation to compete head-on with asset managers Develop an investment-guarantee capability Design a sustainable distribution model The first step will get insurance companies back into the savings space in a competitive way. The second will give insurers a unique capability that will reestablish them as differentiated providers in the savings marketplace. The third will help insurers achieve self-determination. -4-

6 About the Authors Miguel Ortiz is a partner and managing director in the London office of The Boston Consulting Group. Ed Bradshaw is a principal in the firm s London office. For Further Contact At BCG, we always welcome the opportunity to sit down with clients to discuss their successes, their challenges, and the ways in which they can build competitive advantage. If you would like to discuss your insurance business with BCG, please contact the authors of this paper or Heiner Leisten, a senior partner and managing director in BCG s Cologne office and the leader of our global Insurance practice: ortiz.miguel@bcg.com bradshaw.ed@bcg.com leisten.heiner@bcg.com The Boston Consulting Group, Inc. 28. All rights reserved. -5-