14 April 2021

 

The life insurance industry has been evolving in recent years, and it will need to keep changing under the joint pressure of market trends and regulators worldwide. Interestingly, most or all of these drivers for change are global. For example, the Singapore and Hong Kong regulators keep an eye on regulatory and government-driven reforms in the UK and tend to follow suit. Market trends are global as well. A large company like HSBC has even implemented a set of Global Standards that all products in all regions must comply with.

Five market trends:

1 - Demographics:

• Ageing population (e.g. in Western countries or China).
• Increasing longevity.

 

2 - Consumer behaviour:

• Limited trust in mainstream financial providers.
• Greater awareness of the retirement savings gap (and much greater scrutiny of the value for money of retirement propositions, e.g. annuities).
• Delaying retirement.

 

3 - Economic environment

• Low interest-rate environment impacting the profitability of traditional long term investment products. It also drives investing behaviours when searching for returns.
• The Covid ‘curve ball’ and the associated uncertainty for the future.

 

4 - Technology:

• Better access to information (internet, mobile, etc.): it makes it easier to monitor and raise uncomfortable questions on fees and commissions, on the performance of investment products (whether in an insurance wrapper or not), or the value for money of some propositions (e.g. annuity).
• Digital transformation, e.g. digital distribution and “Big Data”. Mainstream players are slowly evolving – possibly using the wrong angle of attack and primarily searching for cost-savings rather than ‘better serving & delighting customers’.
• Emergence of ‘Insuretech’ players. To date, they seem primarily focused on General Insurance as the products are more straightforward, easier to sell, and less regulation-heavy.

 

5 - Regulation

Regulators worldwide are stepping up efforts leading to extra operating costs for Life insurers (e.g. risk, compliance teams). After the great financial crisis, authorities have been trying to:

• Ensure that insurance companies remain robust (e.g. solvency 2).
• Ensure that customers get a good (better?) deal. In the UK, this included the Retail Distribution Review, or the pensions reforms announced in 2014, allowing the consumers to choose what to do with their pension pot freely.

 

 

A look at the inner workings of the life insurance industry:

I would argue that the industry has been relatively complacent thanks to the opacity surrounding it. It has effectively permitted the emergence and subsistence of poor practices, i.e. products that offer low value for money, excessive distribution commission levels, etc.

 

The regulatory pressure and the market trends highlighted above bring these practices to light and force change. For example, if customers knew how much insurance brokers get paid in commission fees in the UAE or other emerging markets, they would take their business elsewhere.

 

While many of the above challenges are also valid for the asset management industry, there is an additional specific question on the added value for customers of investment products placed into life insurance wrappers. They come loaded with extra fees or penalties of all kinds.

 

For example, these additional costs are particularly opaque for consumers in the case of unit-linked funds:

• A customer owns ‘units’ of the fund. To be very precise, he holds a contract (the policy) with a right to a benefit. The value of that benefit is determined by the number of units he has in each unit-linked fund multiplied by each fund’s unit price. He does not own the underlying assets, e.g. stocks, or bonds.
• The value of a unit depends on the value of the underlying assets - as one would expect. However, it also depends on the life insurer's cost structure and how much cost is apportioned to this unit-linked fund (and this is opaque!). This cost-apportionment reduces the value of a unit. As a simple test, one can plot, say, ten years of a unit-linked fund tracking a well-known index versus a low-cost ETF of the same index. Be sure to track in currency value (e.g. $, £, EUR) and not in ‘units’. The difference goes towards covering the life insurer cost structure.

 

In summary, customers of unit-linked funds face two layers of fees in their units (in addition to one-off fees for withdrawals, ad-hoc requests etc.):

1. The fees charged by the asset managers of the underlying funds in which the unit-linked product is invested, and
2. The fees of the unit-linked insurance wrapper placed around the underlying investment vehicles (and charged by the life insurance firm).

 

There are sometimes good solid reasons to take investment products placed in insurance wrappers (e.g. tax shield in some jurisdictions like France, portability for expatriate products, and a few others). However, a customer could (should?) instead consider splitting his needs and taking specific protection products to meet protection needs, along with pure investment products with no life-insurance wrappers to meet savings/investment needs. An amusing test is to ask a financial advisor or the product teams of insurers and bancassurers for their opinion comparing these two approaches.

 

 

The (simplified) economics of the life insurance business:

In the end, the equation of the life insurance industry is simple:

• The primary source of revenue = premium from customers (and –possibly- return on AuM invested) and…
• There are three parties to share that revenue: the distributor (broker, sales advisor, financial advisor, etc.), the shareholder (= profit), or the customer ( = claims/redemption).

 

Bluntly, if one party gets a larger share of the revenues, the others get less. Ultimately, insurers and bancassurers will need to make a choice. Note that increasing online/digital distribution effectively means giving -on average- less to the distribution, therefore leaving more to shareholders and customers.

 

 

 

Examples of tactical and practical remedial actions:

Short of reinventing the business model, most players can take several tactical actions as a first step. Here are three examples, among others:

• The Bancassurers sales force is not trained enough and often does not know or understand the products. I have personally seen that in countries as diverse as the UK, France or Malaysia. For some brokers, the issue I observed is the drive for profit via commission payments. It comes at the customer’s expense, whereby the product fit to the customer’s needs tends to come after the commission amount. For other brokers, a similar poor customer outcome can result from a lack of knowledge, particularly in emerging markets where the certification required is quite basic. In summary, actions such as proper training can be taken and result in both sales increase and sales quality increase.

 

• Extracting value from the in-force book is often an unknown skill. Ultimately, it is about the sustained generation of free cash flow from the customer/asset base and comes from significant operational efficiency. There is also usually a lack of knowledge or infrastructure to perform data insight and enable retention or cross-selling activities. Specialized players like Phoenix in the UK have emerged to plug the gap.  

 

• In general, there is ample opportunity to remove costs in the sale process, back-office and administration processes, etc. Removing costs can then permit the creation of simpler and less opaque products, thereby enabling a virtuous circle with customers (e.g. simpler / clearer marketing, etc.). Products would be more straightforward and less opaque as there would be no need to add multiple subtle fees to cover a high-cost base.

 

 

Wrap-up:

The Life insurance industry faces five key trends: evolving demographics, consumer behaviour change, harsh economic environment, technological shift, and regulations tightening.

 

Consequently, some profit pools have disappeared, and others will disappear, forcing life insurers to adapt. On the whole, one could expect customers to benefit from these changes. In particular, they should benefit from the transition away from the most opaque practices to fairer and better products, albeit at a pace that could be faster.