Marcus Bowser explains how life insurers can emerge from a challenging era by reinventing their business models
Do life insurers have a future? I think so. Equally, it's clear that their future looks very different to their past. Quite simply, if they're to survive they will need to dismantle and reassemble their business models. Otherwise, in the same way that Uber is disrupting the taxi and private car hire market globally, someone will come along and do the job for them.
It's fair to say that UK life insurers have not had an easy ride, thanks to an increasingly unsupportive regulatory and tax environment. Tax changes that removed the incentive to repay a mortgage with an endowment policy were just the start of a catalogue of changes.
More recently, changes to pensions have dramatically reduced the numbers purchasing annuities. And while the government has introduced auto enrolment, substantially increasing the numbers saving into pensions, this has been partially offset by the erosion of yearly and lifetime saving limits, leaving pension savings less attractive for those with larger incomes and pots.
But many of the industry's problems are self-inflicted. The public's trust in life insurers dropped significantly after the Equitable Life court case, which shone a light on the complex and obscure nature of with-profits management. Insurers' reputations took a further knock after with-profits and pension mis-selling scandals.
The demand from companies for buy outs of their defined benefit schemes should be a bright spot, but annuity business is now subject to much more stringent regulatory capital requirements. As a result, insurers have begun to pull back from the annuity market, which can only lead to higher prices and consequently further pressure on annuity sales.
Where do we go from here?
How will winners emerge from this disruption? Four areas commonly top the CEO's agenda:
- Back book optimisation
- Consolidation
- Customer centricity
- Digital and big data.
CEOs are clearly betting that focusing on these will help to ensure their organisations remain relevant and progressively more successful.
Back book optimisation is often viewed as a product area in its own right, with senior insurance industry specialists brought in to squeeze out extra value, whether that be from more efficient policy administration, outsourcing, rethinking investment strategy or applying capital management techniques.
More efficient policy administration, whether executed internally or externally, is to be commended and should lead to an increase in the earnings associated with the back book. However, most insurers have been active in this space for years, meaning that optimisation is increasingly about investment, particularly for insurers with large annuity books, and better capital management.
The low interest rate environment has left insurers, along with every other investor, searching for yield. Yet the illiquid nature of insurers' annuity books allows them to turn to increasingly illiquid assets, such as lifetime mortgages, commercial mortgages and infrastructure investments, in an attempt to increase the performance of the asset side of their balance sheet.
Capital management can help to ensure a business is managed efficiently under Solvency II, including reducing the volatility of the surplus. Common techniques include: Part VII transfers combining legal entities; establishing reinsurance captives; notional hedging of unit linked business; and actions to manage transitional arrangements and the risk margin.
However, many of these actions lead to one off increases to the free capital and hence, do not lead to a sustainable increase in earnings. Indeed, some bring forward earning recognition to the detriment of longer-term earnings.
Solvency II favours larger insurers with diversified balance sheets, rewarding them with lower capital requirements. This provides an incentive to act as a consolidator, while also offering an opportunity to apply one insurer's expertise in back book optimisation to another.
But neither back book optimisation nor consolidation are likely to secure the future of the life insurance industry in the UK. This will require rethinking how insurers interact with customers to remain relevant and investment in the use of big data and digital platforms.
Investing to win?
Some insurers have already taken the requisite steps. For some this has meant reinventing themselves as investment managers, slowly running off, transforming or even divesting their traditional insurance businesses. But with the charges levied being driven ever lower in a race for volume, efficiency of management, differentiation through branding and improved digital access are likely to be key success factors. Those that fall behind are likely to become further consolidation fodder.
Others remain committed to operating as an insurer with a focus on the protection market, albeit this is unlikely to ever sustain a market of the current scale and diversity. Critically, those insurers with strong survival instincts are recognising the need to excel at costing through enhanced underwriting, pricing through optimising the amount charged, and differentiating themselves through their brand and values. This means significant investment in data analytics accessing ever larger pools of information on customers to both better understand their risks and behaviours.
All of which plays to the strengths of the big players. Could it be that bigger really is better?
Marcus Bowser is the sales and practice leader for UK life consulting, Willis Towers Watson