The Universe of Life Products Is Growing

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1 The Universe of Life Products Is Growing Reaching High Net Worth Clients By Steve Kean The growth of the high net worth market is creating new opportunities for product providers that effectively develop customized products and propositions to meet its specific needs. Life insurance is an effective way to meet the many needs of high net worth (HNW) clients. Clearly, these wealthy individuals require more than a one-size-fitsall strategy to best serve their present and future circumstances. Product providers can identify new insurance opportunities that will differentiate these individuals and help capture market share. Identifying High Net Worth Clients The definition of HNW is difficult to pin down. A quick web search shows multiple definitions of HNW. In some cases, HNW is used to include a very broad spectrum of wealth, and many services are offered as a single solution under the title wealth management. To effectively capture the opportunities presented by a rapidly growing client segment, clearly defined propositions should be crafted that target specific client needs. Towers Watson distinguishes wealthier client segments by using the Wealth Management Ladder. Once the worth of HNWs is identified using the ladder, additional nonfinancial features of this group can be added to create a full profile. HNWs tend to be successful entrepreneurs or recipients of inherited wealth. Typically in their 40s and 50s, HNWs may still have wealth accumulation and protection needs. Meeting Complex Needs In general, HNWs tend to look for a contradictory mix of guarantees and leveraging when considering insurance. Protection is a lower priority. In Asia, business and personal assets are often comingled. Assets are often held in multiple jurisdictions and may include a range of asset classes. And as clients progress through the life cycle, their wealth management needs can become increasingly blurred. Together this creates an often unique challenge for life insurers in meeting HNW clients family, personal and legacy requirements. Buying Life Insurance Many HNWs already use life insurance to address their needs. According to one broker who specializes in the HNW segment, Typical HNW clients that buy life insurance are between 50 and 60 years old, depending on the jurisdiction in which they reside. Most are probably close to age 55. He continued, The most common reason a client buys life insurance is for liquidity planning. 2 towerswatson.com

2 Figure 1. Reasons for buying life insurance Hong Kong 6 Thailand 4 Indonesia Liquidity may be required for any number of reasons: Creating a pool of wealth outside the client s principal domicile as a form of wealth and risk diversification Building sufficient funds to ensure assets aren t force sold to divide an estate between beneficiaries or to meet estate taxes* Debt protection ensuring an estate can pass unencumbered to beneficiaries Key-person protection or to fund a buy/sell agreement as part of business continuity planning The drivers for buying life insurance also change depending upon the jurisdiction in which clients are domiciled and where the majority of their assets are located. The reasons for clients buying life insurance outlined in Figure 1 are not unique to the HNW segment. It could be argued that clients across a range of wealth segments may be concerned with issues such as providing for their family s future lifestyle (family security planning or legacy planning) or other needs. What is interesting is to see how these reasons for using life insurance as part of their wealth structuring change depending on their location. HNW clients are not a homogeneous group. Business continuity, for example, features as a key driver in a number of markets, but is not entirely consistent, which may be somewhat of a surprise given the high number of entrepreneurs flourishing across Asia. What is, perhaps, more at issue is the increasing level of complexity the clients financial situation and wealth location present, and the solutions that need to be deployed to properly address meeting their financial objectives. And this raises the question about the products that are currently available to HNW clients to address their needs and achieve their objectives. * Estate taxes have been subject to a significant overhaul in Asia over the past few years. These taxes have less relevance for clients with Asia-domiciled assets, but can still have a significant effect on assets located elsewhere. Taiwan Today s Life Insurance Choices Anecdotal information suggests that traditional universal life (UL) products represent over 90% of all life insurance policies sold to HNW clients in Asia. However, there is growing interest in investmentlinked products. As one insurer who works solely in the HNW market said, The days of UL as the sole solution for HNW clients must be numbered. Increasing sophistication and competition will demand alternate products. Once the current investment market turbulence is over, I think PPLI [private placement life insurance, a more customized variable life contract for wealthy clients with very broad investment content] and VUL [variable universal life] products will be more attractive. New Competition Singapore Asset diversification Family legacy planning Estate equalization Estate tax planning The number of product providers has grown over the last few years. The historic dominance of offshore providers, typically located in Bermuda, is now being challenged by domestic providers, such as HSBC. The field of foreign providers is also growing. Swiss Life s entry into the Singapore market in 2008 brought a new dimension to locally available solutions. The company s early success with VUL 2 0 Philippines Malaysia Family security planning Debt protection planning Business continuity U.S. tax and beneficiary planning HNWs tend to be successful entrepreneurs or recipients of inherited wealth. Typically in their 40s and 50s, HNWs may still have wealth accumulation and protection needs. Emphasis 2011/2 3

3 Steve Kean Specializes in market analysis, strategy development and distribution optimization. Towers Watson, Hong Kong products through its private placement operation raised industry interest. Even so, UL remains the leader by far. UL is also the dominant product offering despite distributors frustration (primarily private banks and wealth management arms of the big U.S. brokerage houses) over insurance providers and intermediaries heavy reliance on a single product. UL Under the Magnifying Glass UL offers some clear liquidity benefits, and has additional financial planning and wealth structuring uses. It is sometimes sold as a risk transfer solution, often sold as a low-risk even a guaranteed solution and very often sold as an investment solution. Many of the HNW UL providers recently repriced their products to reflect lower bond yields. To better understand the risks and issues facing both insurer and client, it is worth looking at how these bonds may perform over the next few years. The Client s Perspective Let s look at the benefits of UL from the perspective of a client considering a UL purchase. Towers Watson projects the return on U.S. corporate bonds to be around 2% per annum over the next five years. This projection increases to 3.2% over 10 years. Our models show only slight changes to these projections when looking forward 20 and 30 years. If we take a simplistic view, we see some interesting issues developing for insurers. The Wealth Management Ladder A broad definition of HNW blurs prospects and leads to missed opportunities. To avoid this blurring, a definition shouldn t encompass the affluent and those considered wealthier. A refined segmentation is needed to avoid this misstep. Starting from the lower wealth levels, the Wealth Management Ladder includes the mass affluent cluster, which includes the affluent segment (US$500,000 to US$1 million of liquid assets) and the emerging affluent segment (US$100,000 to US$500,000 of liquid assets). HNW is then defined as those individuals with US$1 million of investable (liquid) assets and above. This is further capped off by the ultra-high net worth client segment, whose assets start around US$20 million. These definitions make it easier to develop relevant propositions, and determine appropriate marketing and distribution strategies. They also allow providers to better serve an increasingly educated, sophisticated and demanding client base. Mass (Mass) < US$100,000 Mass Affluent (MAff) US$100,000 $1 million High Net Worth (HNW) US$1 million $20 million Ultra-High Net Worth (UHNW) > US$20 million Affluent (AFF) US$500,000 $1 million Emerging Affluent (EA) US$100,000 $500, million HNW individuals control US$3.8 trillion (2009), rising to 2.7 million HNWIs with US$7.3 trillion of wealth by million MAff individuals control US$7.7 trillion (2009), rising to 64.4 million MAffs with US$13.6 trillion of wealth by 2014 Source: Towers Watson estimates and analysis; Datamonitor Asia Pacific Wealth Market Database 2008; Credit Suisse Global Wealth Databook 2011; Cap Gemini/Merrill Lynch World Wealth Report 4 towerswatson.com

4 Figure 2. Projected asset class returns 10% 8% 6% 4% 2% 0% U.S. corporate bond Global corporate bond hedged to US$ Global equity Global listed real estate (REITs) Fund of hedge funds Commodity Expected five-year return Expected 10-year return A client who buys a single premium UL policy today may be offered a minimum guarantee of 3% and a nonguaranteed crediting rate of 4% or a little over. An immediate question is raised. How can the insurer sustainably meet these rates and pay commission and provide mortality cover (often a significant multiple of the premium) through the next few years if bonds really do return at these low projections? The investment portfolio backing the policy is outside the client s control. In this case, there is little choice but to rely on improving bond returns to maintain policy benefits. This represents a risk to the client. Mortality charges tend to increase as the insured ages. Although the sum at risk (the difference between the underlying policy value and the sum assured) typically decreases as the policy value increases, low yields in the early years risk creating a funding shortfall in the policy. As a result, the client will have to find additional liquidity to pump into the policy to sustain coverage. No-lapse guarantees being withdrawn from these products is an additional concern. These contract features keep a policy in force even if the cash value is zero. Their withdrawal increases the client s risk that a policy will not provide the long-term cover throughout a policyholder s life that it is, arguably, meant to accomplish. Other Options Term insurance There is little evidence that term insurance is being sold in significant volumes to meet HNW client needs, as part of a portfolio sale with a separate investment strategy or as a stand-alone product. A senior wealth manager said, I find it strange that clients who have needs like key man [insurance] are offered only universal life products as the optimum solution. There must be cases out there where a client would be better served by other products, such as term insurance. He then compared today s UL rates for a 50-year-old client with term rates. There may be some basis for his argument, given the costs and charges of the products, the return of premium term option and the returns that could be achieved by other asset classes. VUL VUL detractors argue that the client bears the policy risks and that the sum assured cannot be guaranteed in the event of a critical failure of the policy s net asset value (NAV). This argument is often supported by the fact that UL carries a minimum guarantee, while VUL carries no guarantees. A high-level look at projected returns from global equities or funds of hedge funds indicates that higher returns are forecast. Global equities projected five-year returns of 9% per annum come with significantly higher volatility. The 10-year projection of 9% also represents higher risk and volatility than a bond portfolio (Figure 2). HNWs tend to look for a contradictory mix of guarantees and leveraging when considering insurance. Protection is a lower priority. Emphasis 2011/2 5

5 Life Stages as Drivers HNW client life stages are broadly similar to other wealth segments. But key needs of HNW clients create specific, significant opportunities for product and solution providers. Need ($) 0 20 Accumulation Preservation Decumulation Single Age DINK Provider Empty nester Enjoyer Accumulation Accumulation seems a counterintuitive driver for people who already have wealth. However, wealth is increasing rapidly, and it remains a continued and core focus of many HNW clients strategies. Preservation It is natural to want to preserve what we have accumulated. Accumulation and preservation are strongly linked, and not discrete from each other. This natural next step can take place in a number of ways. For instance, a client may want to incrementally move a proportion of a portfolio toward more conservative strategies. Simultaneously, by investing in diverse, aggressive strategies, other parts of the portfolio can continue to act as wealth accumulators. Certain pieces of a portfolio may allow clients to take advantage of tactical opportunities. To feel more comfortable making these types of decisions, the client will need risk management tools. These tools are not static since attitudes toward risk change at different points in clients lives. And it does not mean that a client is risk-averse. Decumulation Decumulation allows clients to benefit from efforts to invest. They can pass down wealth or engage in philanthropic endeavors. However, it does not mean that the accumulation phase is over. If the projections are right, then the NAV of the policy will rise steeply; the sum at risk will decline sharply, and the overall costs will diminish relative to UL. Even with increasing mortality costs per dollar of premium as the insured ages, the increased value in the policy due to better returns can make a huge difference in what the contract holder pays to keep the policy in force. The risk of paying mortality charges longer than anticipated is offset by the potential for the policy to achieve its target earlier than the typical UL s target endowment age of 99. VUL doubters add that UL transfers more of the risk away from the client and onto the insurer, saying that UL is a better tool for risk management. We would agree if one looks solely at the nature of investment risk over time. Equities are more volatile than bonds, presenting risks to the policyholder. However, risk is also created by low bond returns, as described earlier. VUL offers the client the opportunity to benefit from investment upside as long as they understand the associated risks. Meeting Needs HNW clients need tailored insurance propositions. In an HNW client universe of increased customer sophistication and complex needs, there are any number of opportunities to offer a range of products. A customized approach benefits the HNW client and also allows providers to both capture increased business and differentiate themselves. For comments or questions, call or Steve Kean at , steve.kean@towerswatson.com. In many client circumstances, there may be a very thin line between the need to accumulate and decumulate wealth. Consequently, HNW clients need flexible products and solutions to reflect their changing circumstances. 6 towerswatson.com