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 <10% 40% – 50% <10% 10% – 20% 20% – 30% Local No Limited* Limited (Hollard/Real, ALI) Imminent All IFA, DM insurers UK (Various/Capita) UK (PruProtect/ Discovery) UK (Royal Liver /Munich Re) SA (Altrisk) SA (Liberty) All IFA, DM insurers Fragmentation International Examples * Scope of reinsurer involvement is much lower than in peer markets such as the UK 8 Improving cost transparency and management disciplines In our discussions with Australian insurers we continue to be Our analysis suggests that some major insurers could boost surprised by how little informed debate exists around costs. profitability by 10 - 25% by bringing operating costs in line with Few insurers have an accurate perspective on whether they are industry averages. Of course in the current environment and given more or less cost efficient than peers, fewer have robust processes the industry’s track record we are not advocating large-scale for effective segment-based cost measurement or management, (top-down) cost cutting but rather management and organisational and there is little credible industry benchmark data on cost changes supporting better incremental decision-making: efficiency or operational metrics. In contrast to the banking or general insurance sectors, life insurer investor presentations rarely A culture of cost transparency both externally and internally, reflected in communications to institutional owners and end- call out cost ratios by line of business or product, or positioning shareholders relative to local or international peers. In some cases life risk results are still substantially grouped in with non-risk or trans- A willingness to develop and utilise financial benchmarks as a Tasman results, or with wealth management even where insurance directional guide (along with an understanding of the limitations generates a meaningful proportion of profits (and particularly where of such metrics) life insurance dynamics flatter aggregate cost metrics). Of course even in a MoS environment, cost ratios are complicated by new Linked to the above, a shift away from allocation-based budgeting to driver-based budgeting and planning business and lapse dynamics as well as cost allocations, but this is equally true in banking or general insurance. We suspect that Finally a move away from command-and-control cost disciplines limited cost focus reflects a lack of informed, external scrutiny of to line management direct accountability for and participation in insurance businesses, as well as the relatively benign competitive cost outcomes environment that has prevailed in Australia. In the absence of good internal or external data, many insurers fall back on (apparently) logical rules of thumb: that higher Figure 7: Cost (OpEx) Curve – Retail Insurance, 2008-09 product margins are evidence of lower unit costs, or that scale drives cost efficiency. Unfortunately our analysis of insurer results Expense ratio since 1999 shows that franchise quality (supporting selection and pricing advantage) is the only consistent driver of life insurer +1 std deviation -1 std deviation >25% returns on equity. And as illustrated in Figure 7, scale economies do exist but only up to a threshold level; above this point larger insurers tend to have higher costs, reflecting in part the history 23.0% of growth through acquisition and the industry’s remarkably poor 21.1% integration track record. 19.6% The Rest <150m Other 4 150 - 450m Next 4 250 - 450m Top 4 >450m Insurers Ranked by Retail Premium (A$m) Source: NMG analysis of company accounts, management interviews and estimates Insights Report – Life Risk Australia 2010 9 Investigate a broader range of risk pooling opportunities We view life insurance as being concerned with the transfer and On the other hand we suspect that in 10-years insurers may pooling of mortality, morbidity, longevity and investment risks. wonder why they did not pay more attention to these opportunities, Australia is unique among developed markets: the insurance and we would point to alternative (lower risk and lower cost) industry is focused overwhelmingly on standalone life risk products, development paths for local insurers. on mortality risk (with morbidity risk a distant second, and unlike the US with no specialist insurers focused on this segment) and on yearly renewable product structures. By contrast when we look at peer developed markets (in North America, in South Africa and across Europe) we see a much broader range of products including whole-of-life (UK and Singapore), modernised with-profits and guaranteed return products (South Africa, Europe), variable annuities and universal life (North America and increasingly in Asia) as well as niche mortality and morbidity covers (including broken-bones and cancer via direct channels). While investment accumulation products may be less relevant in Australia, we see considerable opportunity around longevity and investment risk products that support retirement income needs (Figure 8) and around niche mortality and morbidity products as long-term care Unfortunately our interviews with Australian insurance executives in 2009 suggest that few are thinking beyond the status quo in prioritising product development investments (Figure 9). Even where we have seen appetite to look beyond existing risk pools, this has been driven from the broader wealth management business, and focused on the most complex available products (the rush to develop variable annuities being a case in point) limiting risk participation for the local insurer. Still we are optimistic that we will see a gradual expansion of the scope of the domestic insurance industry, and from 2010 we intend to cover the broader range of life risk products (including annuities) in our BQM Life Risk Adviser programme. Figure 9: Insurer Product Development Focus Term/ CI/IP Participating Investments Life Annuities Long-Term Care HNW 23% 3% 10% 3% (licence and franchise). We would note that of our five highlighted Premium 37% 7% 10% 3% themes, this is the most speculative (at least in the short-term and Affluent 43% 3% 7% 0% given regulatory dependencies) and could be considered at odds Mass Market 60% 3% 7% 0% and health policy agendas evolve and direct (affinity) channels grow. Additional risk pools offer insurers a means of expanding revenue participation while leveraging existing fixed costs and assets with our general preference for small, incremental bets. Source: NMG A&NZ Reinsurance programme 2009/10 Figure 8: Product Opportunities vs Risk Pools Current mainstream products Niche/new products Severity based trauma Preferred Lives Non-Tied Advisers New product opportunities Term Insurance IP TPD, trauma Tied Advisers Longevity Plans Long term care and risk rated health Variable annuities Life annuities Group Non-Advice Sales Simple Term Direct Marketing (inc. bank direct) Funeral Plans Mortality Consumer Credit Insurance Broken bones, cancer... Morbidity Investment Risk Pools 10 Smoothed return and fixed rate products Longevity About NMG NMG is a specialist multinational consultancy focused on the insurance and investments industries. NMG provides strategy, actuarial and research consulting services to financial institutions including insurers, reinsurers and wealth managers. NMG’s Business Quality Management (BQM) practice runs evidence-based consulting programmes, using annual cycles of interviews with key clients and intermediaries to analyse industry trends, competitive positioning and drivers of business allocations. Established BQM programmes exist in reinsurance, life insurance and wealth management, and across North America, the UK, Europe, Asia, Australia and South Africa. This Insights report draws on results from the 2009 BQM Life Risk Adviser programme in Australia, 2009 BQM A&NZ Reinsurance programme as well NMG’s Australian Risk Distribution Monitor and local and international case experience. Janar Weerasingam Director Business Quality Management Sydney NMG Financial Services Consulting Level 27, Grosvenor Place 225 George Street Sydney NSW 2000 Australia P.O.Box R1863, Royal Exchange Sydney NSW 1225 Australia Tel: +61 2 9251 7888 Fax: +61 2 9251 2888 London NMG Financial Services Consulting 23 Charlotte Street London W1T 1RN Tel: +44 207 631 3087 Fax: +44 207 462 5719 Ashwin Field Principal Consultant Strategy Consulting Montreal NMG Financial Services Consulting 6795 Des Coquelicots St-Hubert Quebec J3Y 8P1 Canada Tel: 1 450 656 4694 Fax: 1 450 462 8358 Hong Kong NMG Financial Services Consulting Suite 2207-9 Tower Two, Lippo Centre Admiralty Hong Kong Tel: +85 2 2530 8888 Fax: +85 2 2530 8100 Mark Prichard Executive Director NMG Group Jane Cheng Consultant Strategy Consulting Milan NMG Financial Services Consulting Plaza Liberty 8 20121 Milano Italy Tel: +39 2 7631 7567 Fax: +39 2 7600 1653 Singapore NMG Financial Services Consulting 141 Market Street #11-05/08 International Factors Building Singapore 048944 Tel: 65 6325 9855 Fax: 65 6325 4700 www.NMG-Group.com NMG Financial Services Consulting