Insights Report Life Risk Australia 2010 NMG Financial Services Consulting

Insights Report Life Risk Australia 2010

NMG Financial Services Consulting

2

Introduction

2009 has been a watershed year for the life risk (protection)

From 2004 – 2007 retail and group new business growth

segment in many of the geographies we cover. Declining equity

accelerated, and profitability steadily improved (with an average

markets in 2008 and into 2009 reduced consumer appetite for

return on equity of over 15% for the period). In 2008 and through

risk even as institutions and distributors were forced to look to

2009 new retail sales continued to grow (albeit less rapidly than

alternative products to offset lower investment sales; life risk new

in prior years, and supported by one-off external stimulants) but

business and revenue growth accelerated even as investment

product margins deteriorated particularly in trauma and income

revenues declined. As a result we have seen a marked and

protection. Aggregate industry profits were dragged down by

positive shift in sentiment towards life risk from insurers as well

investment losses (Figure 2) and insurers quickly moved to report

as distributors, and are hopeful that this will stick as investment

on a normalised basis despite having previously been happy to

markets and sales bounce back.

take the credit for investment income. Still, relatively stable headline

This general observation applies as much to Australia as to other markets. Australian life insurers were already focused on standalone risk or protection products (unlike insurers in the UK,

results were in stark contrast to wealth management, where the impact of the global financial crisis (GFC) on volumes and on profitability was far more pronounced.

South Africa or Asia where investment-linked or bundled products

As this disparity between life risk and wealth results became

are the norm) but life insurance was still widely seen as a poor

apparent, we witnessed a rapid change in sentiment: media and

cousin to wealth management. 2009 marked a turning point, with

analyst coverage of the life risk sector became progressively more

a noticeable shift in mainstream institutional and media attitudes

upbeat while domestic financial institutions reversed years of under-

to life insurance and to life insurers.

investment in their own insurance businesses to kick off the wave of life insurance consolidation we predicted in our last Insights report.

Figure 1: Historical Life Risk Sales and Profit Growth Retail Life Risk New Sales, 2007 - 2009 - A$m Growth

Total Retail Sales

Life Risk Industry Profitability, 2007-2009 - A$b -

>30%

19%

18%

ROE

16%

12%

12-15%

656

781

920

Profit

1.1

0.9

1.0 - 1.1

2007

2008

2009E

85 56 372 37

333

294

Direct



Bank



IFA

325

2007

Source: NMG Risk Distribution Monitor

392

2008

464

2009

Source: NMG analysis of company accounts, management interviews and estimates



Insights Report – Life Risk Australia 2010

3

We would note that this newfound enthusiasm was not shared by

We have noted already that insurers benefited from external

all industry participants. A number of multinationals voted with their

stimulants in recent years, while increased enthusiasm for life risk

feet, with Aviva and ING exiting in 2009 and AXA SA apparently set

is due at least in part to the perceived scope for demand expansion

to follow suit in 2010. These multinationals will have been driven

driving future premium growth. Many insurers are therefore

by capital and currency considerations as well as the availability

(understandably) focused on external and demand-side issues as

of growth options outside Australia, but contrasting perspectives

a basis for strategy development, planning and prioritisation. We

on industry outlook and valuation must also have played a part.

acknowledge the prominent demand themes facing the industry;

We know that some of the remaining second-tier and specialist

on the other hand we could point to supply-side issues that are

insurers are re-considering whether and how they compete, and

equally important, and that individual insurers might be better able

in the short-term it seems likely there will be more transactions

to analyse and manage, but that attract far less attention. Given

and at prices that reflect the limited supply of quality franchises.

uncertain external dynamics over the next 12 - 24 months our

But looking beyond the immediate future we are more interested

feeling is that insurers would be well advised to focus more on the

in how consolidation will impact industry growth and competitive

supply-side and on strategies providing a basis for competitive

dynamics, and the implications for insurers (whether consolidation

advantage in all future scenarios:

participants or non-participants), distributors and customers. We have been advocates of the attractiveness of the life risk

Build a broader portfolio of incremental investments

segment since the publication of our first Life Risk Insights report in 2005. We have pointed to relatively stable growth and profitability, as well as to the role for capital and scope for



institutional profit participation. We were not alone in that regard,

Re-think insurer value chain participation

and it was frankly not difficult to forecast improvements in growth and profitability even without predicting the impact of external demand stimulants (a rising tide that lifted all ships). But we are

Consider alternative organisational and ownership models

Improve cost transparency and management disciplines

increasingly cautious about the near-term outlook, and concerned that expectations of future growth and profitability are now out of line with long-term industry fundamentals. At best we think that insurers face a period of considerable uncertainty based on the interplay between three key dynamics: First, the implications of whether consolidation (particularly integration of successful specialists into non-specialist insurers) is effectively executed and benefits realised and rationally distributed between customers, distributors and insurers. Second, the extent to which non-specialist new entrants into IFA, group and (particularly) direct marketing channels compromise segment profitability and reputation. Third and most critically, the impact of supply-side regulatory change (including APRA’s attitude to new life licenses, offshoring and outsourcing, prospective accounting changes and legal developments impacting claims management) on profitability, competitive dynamics and the pace and pattern of new entrant activity.

4



Investigate a broader range of risk pooling opportunities

Build a broader portfolio of incremental investments

We have considered a number of feasible future scenarios based on identified change dynamics, each presenting radically different outcomes in terms of growth and profitability, channel and product dynamics and competition. We are confident only that insurers face an extended period of uncertainty, and we are accordingly advising our clients to avoid big bets (large-scale, fixed investments with limited optionality) over the next 12 – 24 months. That is not to say that we think insurers should scale back investment activity. The minimum cost of maintaining competitive position is higher than ever with so many insurers positioned on the boundary between ‘competitive’ and ‘differentiated’ (Figure 2) and if anything we feel that uncertainty creates opportunity for those willing and able to invest. However we question whether the kind of large-scale technology or product investments (or major acquisitions for that matter) that may have found favour in recent years are prudent in the current environment. We suggest insurers build broader portfolios of smaller, incremental investments around those themes (cost efficiency, multi-channel participation and lead relationships/shareof-wallet) that are most likely to play well in all future scenarios. Shifting focus from big bets may be easier said than done. We have identified in past reports that insurers seem to prefer large-scale technology and operations initiatives over incremental investments in marketing and relationship management, and we suspect the current trend toward fewer, bigger insurers owned by diversified institutions will only exacerbate this tendency. Looking forward insurers may

need to re-think how they develop and manage smaller-scale initiatives aligned to those factors that are known to drive share-ofwallet (Figure 3). They may also need to reconsider initiatives that offer little value in the insurer’s preferred or central future scenario, but provide significant upside or risk mitigation in alternative scenarios. Finally it may be necessary to consider alternative (lower cost, lower risk) approaches to pursuing big opportunities where there is little scope for incremental improvement: for example, partnering with international specialists to deliver genuine product innovation at lower risk and cost. Figure 3: Factors Driving Share-of-Wallet Improvements 1. Gathering u/w information 2. Underwriter relationships 3. Staff empowerment 4. Processing non-standard cases 5. Usability of application forms 6. Underwriting non-standard cases 7. Knowledge of adviser’s business 8. Tailoring product & service 9. New business idea flow Source: NMG Life Risk Adviser Programme 2008/2009

Figure 2: Life Risk Adviser Programme, 2009 Business Capability Index 100%

Competitive

Uncompetitive

Differentiated

90% 80%

Market penetration

70% 60%

TOW ING

50%

AIA

AST AVI

COM

AXA

40%

ZUR

30%

MAC

MLC

20% 10% 0%

55





60



65



70

Business Capability Index Source: NMG Life Risk Adviser Programme 2009



Insights Report – Life Risk Australia 2010

5

Consider alternative organisational and ownership models

While alternative organisational and ownership structures have

We believe there are a range of options for insurers willing to

proliferated in asset management, and even in the general insurance

challenge the status quo (Figure 5). Of course different models will

industry, life insurers have in general preferred to stick with a more

suit different segments, and all imply execution risks as well as

traditional, internally homogenous model: a single licence and

trade-offs. For example our analysis of multi-boutique businesses in

brand, wholly institutional ownership and with very limited scope

asset management suggests that complexity and dilution of scale

for divisional autonomy, identity or broader economic participation.

economies may in some cases outweigh the benefits associated

Looking forward we think that insurers have good reason to consider alternatives: First, in a consolidating market, measures helping large, multi-

with greater expense transparency and participation, resulting in higher expense ratios. These models may not be immediately suitable for established channels or operations; on the other hand they may help incumbents or new entrants to support inorganic

channel insurers to maintain divisional specialisation and channel/

growth prospects, to facilitate entry into new distribution channels

segment alignment driving competitive advantage (particularly in

or segments, or simply to combat the entry of specialists and new

the IFA channel as illustrated in Figure 4, and more generally for

entrants once the current round of consolidation has played out.

those multi-channel insurers that acquire channel specialists) will be increasingly important. Second, as insurers become more cost-focused they must

Figure 4: Characteristics of IFA Focused vs Aligned/Multi-Channel Insurers

seek to increase divisional visibility of, accountability for and IFA Focused

Aligned/MultiChannel

BCI (capability index)

66

64

RMCI (Relationship Index)

63

60

% Lead Relationships

20 – 35%

15 – 30%

Forecast Increase in New Business

15 – 25%

10 – 20%

participation in cost outcomes (provided measures to achieve these goals do not dilute cost efficiency). Third, as insurers begin to emphasise key-person differentiators (for example in relationship management and marketing) or grow in expertise-intensive channels (for example direct marketing) they will need to think differently about how they recruit, incentivise and retain staff, moving away from traditionally hierarchical ‘command and control’ structures to more progressive organisational models.

Source: NMG Life Risk Adviser Programme 2009

6

Figure 5: Alternative Business Models Multi-Boutique

Characteristics

Distinct branding and target markets

Multi-Specialist

Multiline

Monoline

Distinct branding and target markets

Common branding across markets

Single brand and target market

Multiple business units (one licence)

Multiple divisions (one business)

Single division

Limited/no common infrastructure

Shared infrastructure (arm’s length pricing)

Shared infrastructure (non-arm’s length pricing)

Channel/segment alignment

Channel/segment alignment

Consumer brand awareness

Segment focus

Direct staff economic alignment and participation

Balance alignment and scale benefits

Economies of scale

Economies of scope

Support acquisition or lift-out strategies

Support lift-out strategies

Strengths/ Weaknesses

Cost impact of complexity and dilution of scale

Balance staff alignment and scale benefits

Limited specialisation or alignment

Examples

Royal London (UK), Aegon (AsiaPac), Hollard (South Africa)

Promina, Budget/AIH

Australian life insurers

Multiple specialist insurers/licences

Strengths

Single infrastructure (internal or sourced)

Institutional partnerships (eg with banks or retailers)



Segment exposures

Key staff participation & retention

St Andrews Life (UK bancassurance), Cigna (direct)

Insights Report – Life Risk Australia 2010

7

Re-think insurer value chain participation

While the Australian wealth management value chain has become

As alternative distribution channels expand, the demand from

increasingly fragmented, life insurers have for the most part

powerful distributors (retailers, industry superannuation schemes)

resisted disaggregating functions or pricing. This makes sense

for increased participation and control will ultimately favour

given recent industry context (a supportive demand environment,

insurers and reinsurers willing and able to cede distribution and

limited focus on costs, and historically narrow industry scope

servicing functions and focus on risk pooling.

in terms of product and channel) but going forward we expect insurers to look harder at where and how they participate along the value chain:

It is worth pointing out that this is one area where Australia still lags peer markets. In the UK, mainstream insurers have exited policy administration and servicing to specialist local administrators and

Consolidation (and the potential fall-out from large-scale

through offshoring, while in South Africa insurers have moved

integrations) may create opportunities for new entrants; we are

to variabilise sales and marketing cost by franchising business

already aware of several multinationals variously progressed in

development activities. Even in Asia distribution, product and risk

entering the Australian market, and all would prefer to ‘rent’ a

pooling activities are segregated in certain segments, including

licence and operations from a local partner while focusing on

private banking and direct marketing. In Australia we have seen

product development, risk management and/or distribution

incipient moves toward fragmentation in emerging channels

functions.

(with Hannover Re acting as issuer/underwriter for Hollard’s Real

Australia is a high-cost location with respect to generic processing, and capacity constrained with respect to technical functions. As cost pressures build the case for insurers to outsource functions (including technical functions, to markets such as South Africa or New Zealand) or even to establish utilities, will become more compelling.

Insurance brand and TOWER for ALI) and product categories (variable annuities and longevity products). Regulatory and competitive dynamics may limit the extent to which mainstream insurers are willing or able to disaggregate core functions at least in the short term. Still we do expect a gradual evolution of thinking around which functions are truly critical, and would encourage insurers to think more broadly about value chain participation as they frame their competitive strategy.

Figure 6: Value Chain Fragmentation Examples

Administration

Comments

Risk Management

Product

Sales & Marketing

NB processing

Pricing

Product development

Marketing and advertising

Policy administration

Underwriting

Product manufacturing

Claims administration

Claims management

Product issuance

Distribution sales and service

Distribution

Customer advice, sales and service

Capital management Revenue Attribution