Mr. Wan Feng Executive Director, Vice President May 2007, Nan Ning
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1 The distinctive characteristics of life insurance operation Mr. Wan Feng Executive Director, Vice President May 2007, Nan Ning
2 Foreword The characteristics Why we need to understand them How we analyze them
3 The distinctive characteristics of life insurance operatoin 1. Products 2. Premiums 3. Marketing and sales 4. Business operations
4 Products: 1. Life insurance is an intangible product Insurance policies are the product A contract in nature Related to birth, aging, illness, death and injuries. Conclusion: A life insurance product is an intangible risk protection obligation. The business of a life insurance company involves risks related to birth, aging, illness, death and injuries. However, these risks may or may not materialize. How do we understand risks may or may not materialize?
5 Products: 1. Life insurance is an intangible product The meaning of Intangible product : Insurance companies sell promises. An insurance policy is a proof of this promise. Therefore, credibility is the foundation of the business of an insurance company. A A customer experiences the benefit of insurance products through the service of the insurance company. Customer service is, therefore, the core business of an insurance company.
6 Products: 2. The need for insurance is not obvious to buyers. The insured risks involve events that may or may not happen. Therefore, buyers can choose to buy or not to buy such products. The risks borne by an insurance company will materialize.
7 Products: 2. The need for insurance products is not obvious to buyers. Implications: Most buyers are reactive. Since risks may or may not occur, sales is more difficult. Adverse selection may occur.
8 Products: 3. Sales of insurance products rely on sales people. The needs are not obvious. And the risk involved birth, aging, illness, death and injuries are not something people want to talk about. Life insurance products need to be marketed by sales people.
9 Products: 3. Sales of insurance products rely on sales people. The meaning of marketed by sales people : A life insurance company needs sales people. In the primary market, the number of sales people is in proportion to sales. A unique sales team management model Making the primary market a seller s s market The targets of promotional activities are salespeople, not the actual consumer. Misrepresentation may occur.
10 Products: 4. Life insurance products are not consumer products. Insurance covers life and health, which are not commodities. An insurer buys a policy for financial compensation, not for consumption.
11 Products: 4. Life insurance products are not consumer products. Implications: Life insurance is not considered a basic necessity by many. Only people who have achieved a certain living standard feel the need. Development of the industry is closely linked to market environment.
12 Premiums: 1. The difference between first-year premiums and renewal premiums First-year premiums the value of output of an insurance company The number of first-year policies the quantity of output of an insurance company
13 Premiums: 1. The difference between first-year premiums and renewal premiums The significance of first-year premiums : Measures the sales capability of an insurance company. Renewal premiums First-year premiums Total 1st year nd year % change (50%) 40% First-year premiums are a key performance indicator for an insurance company and a comparable among peers.
14 Premiums: 1. The difference between first-year premiums and renewal premiums The significance of the first-year premiums : First-year premiums are a growth driver for the following year s business. Year FYP regular-premiums Renewal premiums Gross premiums Driving factor 50% 33% 25% 20% There is no increase of FYP, but gross premiums increase every year.
15 Premiums: 1. The difference between first-year premiums and renewal premiums The significance of the renewal premiums : Measures the sustainability of an insurance company. Determines the long-term nature of an insurance company s s business.
16 Companies A and B: Assuming a renewal rate of 100%, different amounts of renewal premiums will lead to different gross premiums. Year Company A Gross premiums Single premiums account for 50% of the FYP First-year premiums First-year regularpremiums Renewal premiums Company B Regular premiums account for 100% of FYP Gross premiums First-year premiums First-year regular premium Renewal Premiums GP of A / GP of B 2/2 3/4 4/6 5/8 6/10 7/ 12 8/ 14 Market share 50% /50% /57 /60 /62 /63 36 /64 36 /64
17 Premiums: 2. Premium income is accumulative. How do premiums accumulate? Gross premiums New business Year Gross premium income tends to grow arithmetically. Why do premiums accumulate?
18 Premiums: 2. Premium income is accumulative. * Regular premiums are accumulative. Single premiums are not. Gross premiums Single premiums Year
19 Premiums: 2. Premium income are accumulative. How do premiums accumulate? N/G 100% 50% 33% 25% 20% 17% Gross premiums (G) New Business (N) Year Longer payment periods result in higher premiums accumulated and higher sustainability for an insurance company. The higher the proportion of the accumulative part, the better the premium structure is. Short-term regular premiums are not fully accumulative.
20 Premiums: 3. Organic growth of premiums Organic growth of premiums Annual premium 5 * Pm 12 * Pm Monthly premium Pm Pm Pm Pm Pm Pm Pm Pm Year / First-year premium income: 5 * Pm Second-year Premium Income: 12 * Pm (+140%)
21 Premiums: 3. Organic growth of premiums Why do premiums grow organically? Financial year Policy anniversary 1/1 31/12 Since the policy anniversary and financial year are usually different, most policies would straddle two financial years. Therefore, there will be a situation where premiums received in the current financial year will be less than the amount for the next premium renewal year. Hence, there is a natural increase in premiums in the second year.
22 Premiums: 3. Organic growth of premiums Organic growth of premiums: Annual premium 5 * Pm 12 * Pm (+140%) Monthly premium Pm Pm Pm Pm Pm Pm Pm Pm Month / The more premiums paid on a regular basis (except one-off annual payments) in an insured year, the more natural growth of the premiums in the next financial year. The more regular premiums paid (except one-off annual payments) in the second half of an insured year, the more natural growth of premiums in the next financial year.
23 Premiums: 4. Cost of premiums Property insurance company Life insurance company Customers Investment income Investment income Company Company Guaranteed interest rates and guaranteed policy dividend payments are the cost of premiums of a life insurance company.
24 Premiums: 4. Cost of premiums Implications: Since premiums come with a cost, the use of capital has a very significant impact on the business operations of a life insurance company. The cost is deducted from the tax a life insurance company pays.
25 Sales: 1. Sales of new policies need proper control Sales Sales Profit Profit Companies in general Volume Volume Life insurance companies
26 Sales: 1. Sales of new policies need proper control Why do we need proper control? * Costs in the first year of life insurance policies are higher than in renewal years * Insurance companies nowadays use level premiums schemes
27 Sales: 1. Sales of new policies need proper control Natural premium vs level premium Premium Natural premium Level premium Insurance cost (Expense loading) 0 Period
28 Sales: 1. Sales of new policies need proper control How do insurance companies control sales? Premium 1) Two-year principle: 1st year:120% 130% 2nd year:70% 80% Two-year premium income Level premium Insurance cost 1 2 Period Therefore, if reserves are not set aside for two years, the policy will have no
29 Sales: 1. Sales of new policies need proper control How do insurance companies control sales? 2) Budget management: Example: Cost of new policy (assumption) 130% Annual profit plan 80 million Realizable profit 110 million New policy premium plan 100 million What would happen if the new policy premium reaches 120 million?
30 Sales: 1. Sales of new policies need proper control Why do we need proper control? * First-year premiums do not generate profit * Premiums from policy renewal generate profit * More resources should be allocated to new first-year policies These features are yet to be reflected in China s life insurance industry.
31 Sales: 2. Careful selection of customers is essential Companies in general Life insurance companies All customers are welcome Increase premiums, accept with conditions or even reject applications
32 Sales: 2. Careful selection of customers is essential Why be selective: * Not everyone can be a customer of a life insurance company * Key to success: look for those who match our criteria * Application underwriting is essential in the life insurance business
33 Business operations: 1. Production comes after sales Companies in general: Purchase of raw materials Production Sales ServiceS Insurance companies: Sale of policy Management (production) Service PaymentP
34 Business operations: 1. Production comes after sales Implications: * Sales has the leading role in the company s operational chain * The company s s development is driven by sales * Think about production before selling; never sell any product that is unable to deliver * Rules can be violated * Underscore the important role of sales agents
35 Business operations: 2. Risk declines over the years Net risk of Insurance? Sum insured Reserve Year Net risk of insurance = Sum insured reserve Net risk of insurance is the actual risk borne by an insurance company
36 Business operations: 2. Risk declines over the years Example: A = 1000, N = 10, Rs for each year below: V1 = 0 R = = 1000 V2 = 200 R = = 800 V3 = 450 R = = 550 V9 = 890 R = = 110 V10 = 1000 R = = 0
37 Business operations: 2. Risk declines over the years Implications: The longer an insurance policy has been in force, the less risky it is for an insurance company. Therefore, after-sales service to long-term customers is extremely important.
38 Business operations: 3. Profitability hinges on anticipated costs Companies in general: Actual cost of raw materials Actual cost of production Actual cost of sales Estimated profits Product prices Product sold, profits realized Life insurance companies: Estimated mortality rate Estimated interest rate Estimated additional costs Estimated profit Premium rates Insurance policies terminated, profits realized
39 Business operations: 3. Profitability hinges on anticipated costs Implications: Operating risks for a life insurance company are potential in nature. Cost control is essential. The actuary has a very special position and duties. Use of embedded value (EV) to evaluate the value of a life insurance company.
40 Business operations: 4. Reserves are an obligation to customers A property insurance company s s reserve is the cash reserve for the company to pay against natural risks A life insurance company s s reserve is the cash reserve for the company to pay against obligations to customers at certain points of time Belongs to the company Belongs to customers
41 Business operations: 4. Reserves are an obligation to customers Implications: A life insurance company operates with liabilities. A life insurance company s financial stability is very important. Prudent business operations are the fundamental management principle of a life insurance company.
42 Business structure and profitability of a life insurance company In general: Product nature: For protection > Savings> Dividend-paying > Derivative Duration: long term > short term Payment method: Regular > Single Distribution channel: agents > Bancassurance > group direct sales Conclusion: For protection, long-term, regular premium, agent distributed channel
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