ROLAND BERGER STRATEGY CONSULTANTS CONTENT Fresh thinking for decision makers Restoring profitability in life insurance Go and win a EUR 5 bn prize Dynamic in-force optimization is the key for success But rigorous action is needed MARCH 2013
5 A EUR BN PRIZE BY RESTORING PROFITABILITY IN LIFE INSURANCE With EUR 5 bn in reserves in European insurance companies, profit potential depends on the level of an insurer's maturity and competences. But we have seen that active in-force management can generate anywhere bet ween 5 to 20 bp of additional margins. From a conservative outlook, a 10 bp gain will generate up to EUR 5 bn for life insurers a prize well worth the effort. 5 E U R O potential profit generation
CONTENT Life Insurance Can the European life insurance sector be resuscitated? Several years of deteriorating profits would suggest that the sector is on its last legs. Margins have not improved despite intense and increasing efforts to generate new business, and continued unrest in the macroeconomic environment makes the situation look pretty grim. To counter the downturn, most life insurers are not only stepping up acquisition efforts but are also going back to their books to boost margins. But attention to them remains largely superficial and generalized, implying that most insurers do not yet realize how much potential lies in improved in-force management. Best-in-class insurance players are demonstrating the benefits of a more rounded and targeted approach to the optimization of their book, but most players on the market have yet to take up the challenge. A typical in-force optimization program digs down, in a programmatic way, into an insurance portfolio to uncover its varying characteristics, difficulties and potential. Through a systematic approach, all elements of the portfolio are analyzed. Where most insurers make changes based on an average view of their contracts, this method looks for and at the differences, breaking the portfolio into clear parts that can be managed accordingly. A life insurance portfolio is many things: different types of products, runoff contracts, distribution networks, heterogeneous groups of clients; it is also legacy policies and IT systems, varying lapse ratios, costs and operations. The key to optimizing it starts with a view that takes its various characteristics into account, and does so cross-functionally within the organization an ongoing and methodical program that brings several departments together to examine, segment, reassess and optimize the full range of the in-force. The life insurance market as a whole can improve significantly if insurers take a threedimensional and in-depth view of their in-force. And the stakes are high with EUR 5 bn in reserves in Europe, profit potential truly depends on the level of an insurer's maturity and competences. But we have seen that active in-force management can generate anywhere between 5 to 20 bp of additional margins. From a conservative outlook, a 10 bp gain in the European market as a whole will generate up to EUR 5 bn for life insurers a prize well worth the effort. TURBULENT ECONOMICS FOR LIFE INSURANCE IN EUROPE Profitability within the life insurance sector has been weakening for several years. A threefold hit first the financial crisis, then dropping interest rates and now sovereign debt unrest has made it difficult for life insurance companies to turn a profit. This deterioration is particularly severe in markets dominated by with-profits policies: Germany, France, Italy, Spain and Portugal, among others. "GROSS LIFE" PROVISIONS IN EUROPE ARE SLOWLY RECOVERING 2001-2010 [EUR bn] 6 4 2 0 Gross Life Provisions 2001 Source: FFSA; Roland Berger analysis % of Unit Linked 2002 2005 2007 2008 2010
ROLAND BERGER STRATEGY CONSULTANTS PROFITABILITY ON RESERVES HAS HALVED WITHIN ONLY SIX YEARS In-force profitability in France (bp) 46 34 28 23 2006 2008 2010 2012* * estimate Source: FFSA; Roland Berger analysis The life insurance market's characteristically low excess returns and intense competition continue to put pressure on profitability. But now, with the destruction of most hidden reserves through the financial crisis and the ensuing drop in long-term interest rates, it is even more difficult to earn the minimum guaranteed rate, or simply to offer decent remuneration to policyholders. In many cases, long-term rates are lower than average rates on the portfolio. The true economic costs of guarantees are being thrown in stark light with the advent of Solvency II and when measured from a market-consistent perspective like the value of new business expected shareholder values are falling while the costs of guarantees are rising. These results call for companies to free up capital if the solvency calculations required by Solvency II are to be adequate. Combined with the depletion of reserves buffers, with-profit insurance companies face a profitability stand-still or worse. BUT THE EUROPEAN LIFE INSURANCE MARKET IS NOT DEAD YET For now at least, as high-value old contracts lapse and low-value new contracts join the portfolio, insurers are pressed for profit. But there is no need to pronounce the life insurance market dead yet. The situation may be difficult, but it is by no means desperate. Profitability and value creation in the life insurance sector mainly come from the in-force, where old contracts generate most of the margins, not from new accounts where initial margins are low. With EUR 5 bn in reserves in play, and in this difficult economic landscape, more value can be created by optimizing them than by acquiring new contracts. This figure alone demonstrates why insurers should place more and more attention on the profitability of their Portfolio policies. Strategies should be consistent with the market context, which is currently seeing low margins in a low return environment. As such, insurers should focus less on shuffling investments and resources (HR, sales and finance) towards new product and client development and more on working on their in-force. Accelerating and refocusing their attention on the in-force will not only rejuvenate in-force margins, it will also improve them: a 10 bp increase means EUR 5 bn in additional margins. Most insurers are doing a bit of this work already, but investments and deployed resources for new business development outnumber the in-force management business, on average, by 15 to 1. Portfolio responsibility and management are often diluted within the organization, mainly handled by technical departments, and with limited investment. When new business was profitable, with attractive economics, favorable rates, hidden reserves and buffers constituted, this made sense. But in the current landscape, these balances need to be revisited perhaps even reversed. Our experience with insurers has demonstrated that in-force management is not only a matter for the technical or financial department, but also for the marketing, distribution, legal and tax departments as in-force dynamics cross several functional lines.
CONTENT Life Insurance IN-FORCE OPTIMIZATION ACROSS THREE DIMENSIONS Looking hard at the economics of the in-force means first analyzing its accounts in fine detail, drilling down to the dynamics at play and the profitability patterns that exist between contracts and groups of contracts. A multifaceted and three-dimensional view of the book is vital to in-force improvement: all of its dynamics must be taken into account. But this is no easy task, as portfolios are complex and highly various, often characterized by numerous types of contracts (e.g. with-profit, pensions, protections) and requisite IT systems, several statuses (e.g. runoff, active), and different levels of profitability, capital requirements, legacy costs, lapse ratios, etc. By unraveling and classifying this differentiation, insurers can develop a rounded, encompassing and systematic portfolio management program that is flexible to in-force dynamics and which goes beyond the usual often over-generalized improvement levers. The many layers and facets require that its optimization take a cross-functional, comprehensive approach. This means looking at margins, as well as at IT challenges and financial issues. In other words, revamping and enhancing the margin yield on the in-force occurs in three dimensions: 1. Value and persistency management 2. IT and OPS rationalization 3. Financial and capital management ENHANCING THE MARGIN YIELD IN THREE DIMENSIONS Value and persistency management Financial and capital management IT and OPS rationalization Value and persistency management targets policies in the portfolio to improve account returns. There are several potential measures which can be taken here. A company could develop a migration campaign to transition lower value contracts to bigger value ones, or reactivate old policies via cross-sell or up-sell campaigns. It could differentiate crediting rate levels based on contract value or accelerate the termination of contracts that hold little to no (or negative) value. Eventually, the ability to develop value-driven lapse management should probably be considered. In any case, the goal of this first dimension is to boost the value yield of the existing portfolio. Once actions have been taken to increase actual in-force returns, measures must be implemented to reduce in-force costs. IT and OPS often represent significant potential here. Most insurers have several IT systems and lots of different management systems, running very heterogeneous types of contracts at different costs. The situation, often inherited over several decades, makes it difficult for insurers to keep a handle on the in-force from a technical standpoint. As a matter of fact, maintenance and legacy costs may often differ between these systems thanks to scale effects or simply system agility. Three measures can thus be taken to get these costs down. First, simplification (e.g. reducing the number of IT systems or software used) will often reduce administrative and managerial costs associated with poli-
ROLAND BERGER STRATEGY CONSULTANTS WHAT A LEVER 25 E U R O Total IT cost, 2011 KEEP THE RYTHM PHASE 1 Understanding the book and identification key levers for optimisation PHASE 2 What actions to consider and how to implement them PHASE 3 Action plan and road map cies. Second, scale effects can lead to efficiency gains and thus lowered costs, for example by outsourcing administration of one or several systems or of specific policies (e.g. runoffs). Finally, reducing the level of services offered will reduce administrative costs. These three measures, together or individually, will often lead to lower in-force costs and thus to higher margin yield. The last dimension of margin optimization comes in the form of financial and capital management: the ability to optimize ALM policy and gain additional bp financial margins. Here the crux is to find the right balance between the generation of additional margins from the in-force, the costs of guarantees, and capital consumption. Several avenues can be considered or reconsidered in this context: de-risking the largest contract group, reviewing profit sharing with asset managers, adapting the reinsurance strategy, or originating new classes of assets. TACKLING IN-FORCE OPTIMIZATION HEAD-ON Dynamic in-force management is complex. It requires a number of prerequisites be fulfilled, conditions that are not always easily met. Successful in-force optimization programs are thus structured around three main phases. The three phases aim to uncover the varying characteristics, difficulties and potential within an insurer's in-force and subsequently to set up a corresponding management system. Phase 1: Understand the in-force and identify key optimization levers This first step provides the basis for optimization. Though most insurers are already working on in-force profitability, measures remain limited. One of the main reasons behind this is that in general, insurers do not have a dynamic vision of their in-force, and thus manage it without taking its strong disparities and minute specificities into account. As mentioned above, the in-force sees a range of contract types and the IT systems handling them, and contracts stand at different statuses. The first phase should reveal their different levels of profitability, consumption of capital, IT legacy costs and durations. The in-force can then be broken down into several categories of contracts, providing an accurate picture of the in-force dynamics and an understanding of the in-force along the three dimensions of value and persistency, IT and OPS, and financial and capital concerns. In doing so, this phase identifies and defines not only the many contract groups and patterns in the in-force, but also profit potential. Though a complex step requiring substantial analysis across various angles (e.g. IT costs, operation links, margin and capital consumption per contracts), the dynamic picture it paints will visualize and reinforce what is at stake. This phase is thus key to creating buy-in across the company that will ultimately build a culture of dynamic in-force management, while simultaneously making it clear where the in-force optimization can align (or where it does not align) with the company's existing strategy and initiatives.
CONTENT Life Insurance Phase 2: Identify actions Once this dynamic vision of the in-force is defined and shared with the main stakeholders, the next step is to set up a comprehensive program that covers all aspects of the in-force and which is structured around cross-functional workgroups. Each workgroup focuses on one of the three optimization dimensions (value and persistency management, IT and OPS rationalization, or financial and capital management). The workgroups address and test the initially identified opportunities from phase 1, but also consider additional ones that arise during workshops, through continued analysis, or from lessons learned from other players in the industry. Phase 3 : Develop implementation roadmap Business cases are then made for each of the improvement opportunities to support go/ no go decisions for their implementation. Building the business case itself has proven, in our experience, to uncover additional sources of profit within the in-force, and thus represents an important step during phase 2. With clear governance and expert teams dedicated to in-force optimization, the business cases can then be turned into a comprehensive implementation roadmap that will ultimately lead to sustained in-force management within the company. IN-FORCE OPTIMIZATION STAKEHOLDER DEDICATION IS KEY When all is said and done, the implementation of a life insurance in-force optimization program is complex but potentially very lucrative. Realistic targets range around 10 bp. But even so, the main goal of in-force optimization is to progressively and sustainably implement a genuine culture of dynamic in-force management within the organization. The process must be rigorous and thorough for it to be effective, but more importantly, perhaps, it must be led, acknowledged and taken up by key stakeholders. Stakeholder buy-in On-boarding and mobilization of the key stakeholders at the group level as well as in business units is key to the success of such an initiative. Sponsorship from senior executives ensures that solid understanding of different stakeholders is developed, and that these stakeholders are dedicated to the ambition of the program and to their own participation in the improvements. Total buy-in from various stakeholders throughout the business is a key driver behind the success of both optimization phases. Dedicated teams The in-force and its many dimensions cross functional lines within an insurer. In order to implement an in-force optimization program, the dedication of a cross-functional, specialized team is crucial. In addition to its analytical role, the team can advance the crossfunctional process and workgroups and thus build the foundations for continuous inforce management across the organization. IF YOU HAVE ANY QUESTIONS, PLEASE FEEL FREE TO CONTACT US: Christophe Angoulvant, Senior Partner christophe.angoulvant@rolandberger.com Cyril Gay Belan, Partner cyril.gaybelan@rolandberger.com think:act CONTENT THE GOOD ADVISE BE DYNAMIC Shift from static to dynamic management of the in-force BE DEDICATED Set up a dedicated and senior team led by a Head of In-Force who reports directly to top management BE CROSS-FUNCTIONAL Manage the necessary cross functionality, involving different parties and competencies from within the organization BE CONSISTENT Integrate in-force gains/improvement in the remuneration scheme of your organization BE SYSTEMATIC Tackle all levers proactively BE PROGRAMMATIC Address all components of the in-force progressively ditors: Dr. Martin C. Wittig, Charles- douard Bouée Overall responsibility: Dr. Torsten Oltmanns Project management: Dr. Katherine Nölling Design: Roland Berger Media Design Roland Berger Strategy Consultants GmbH Am Sandtorkai 41 20457 Hamburg +49 40 37631-4421 news@rolandberger.com www.think-act.com
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