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March 26, 2012updated 13 Apr 2017 8:45am

Many challenges, many opportunities

An industry founded on the principle ofrisk-avoidance, the US life insurance market might seem an odd choice for the venue for the next technological revolution Yet its data-rich, process-heavy pedigree presents an ideal opportunity for the armies of consultants that have proscribed waves of change through the years in core processing systems towards more nimble and less siloed architecture to have the last laugh. The demographics of life insurance in the US skew increasingly older, but a huge shift is inevitable, and insurers may well be in exactly the right place, at exactly the right time, as an industry once focused on manufacturing and selling product rides the technology to a more consultative future.

By Charles Davis

An industry founded on the principle ofrisk-avoidance, the US life insurance market might seem an odd choice for the venue for the next technological revolution.

Yet its data-rich, process-heavy pedigree presents an ideal opportunity for the armies of consultants that have proscribed waves of change through the years in core processing systems towards more nimble and less siloed architecture to have the last laugh.

The demographics of life insurance in the US skew increasingly older, but a huge shift is inevitable, and insurers may well be in exactly the right place, at exactly the right time, as an industry once focused on manufacturing and selling product rides the technology to a more consultative future.

It is all part of a long march towards product diversification and deeper client relationships

that agents in the field began nurturing decades ago; as recently as the early 1980s, life premiums dominated the industry as the largest source of revenue and the myopic focus of the carriers serving the producers in the field.

That began to shift with the expansion of the industry into the savings market through the growth engine of the annuity. In less than a decade, annuities overtook life insurance premiums and broadened the industry’s view of the customer relationship.

No longer would insurers merely pipeline product – they were financial consultants in an insurance setting, or aspired to be, at least.

bar chart for US life insurance industry

 

The broader financial planning conversation was vital to the expansion of the US life insurers’ product set. Client needs grew the disability and long-term care insurance market, for example, and began to influence the unbundling of life insurance products into universal life, variable and variable universal life chassis.

The same inertia ruled the rise of annuities, which long were sold as income annuities, often as a supplementary contract associated with the settlement of a death claim, only to emerge and diversify when insurance companies began promoting individual deferred annuities as a tax–advantaged savings vehicle, complementary to individual retirement arrangements (IRA) and other retirement plans. Today, of course, annuities may be fixed or variable, immediate or deferred.

Interest rate focus

The interest rate environment in the US dominateslife sales these days, as skittish customer have fled the equities markets in droves for the dull safety of whole life and universal life with a heavy dose of guarantees, says Steve Weisbart, vice-president and chief economist of the Life Insurance Institute.

“In these days, when getting investment income are the stuff of dreams, the opportunity to participate in the equities market through universal life is not as powerful, so whole life with its boring old 3% return now looks pretty attractive,” Weisbart says.

“The attractiveness of guarantees is helping, but on the annuities side, I would have thought that two stock market meltdowns would really have been felt a lot more on that side of the business.”

The great differentiator of annuities these days is the guarantees written on top of the products. In fact, it is safe to say that if it were not for the guarantees, there would be no real difference between variable annuities and mutual funds, except for the difference in tax treatment.

Thus guarantees are a fundamental area of product innovation, with a new design of the moment causing excitement in the marketplace seemingly every week. Do not let the noise fool you, though: guarantees all are a variation on the mechanism designed by the insurer to offer some type of mortality-contingent investment return guarantee.

In the current economic climate, such guarantees become crucial. Guarantees now are used to differentiate universal life, variable universal life and other types of insurance products as well. For life insurance products, there are guarantees with respect to mortality changes as well as investment returns.

They are durable, flexible, and incredibly effective: in the third quarter of 2011, for example, guaranteed living benefits riders were elected 88% of the time when offered, according to industry organisation, LIMRA.

Guaranteed minimum income benefit riders, guaranteed minimum accumulation benefit and guaranteed minimum withdrawal benefit are all vying with guaranteed life benefits for product space on the shelf.

LIMRA estimates that in the third quarter of 2011, guaranteed life benefits were elected in contracts representing $25.2bn, out of $28.7bn new deferred variable annuity premium where guaranteed life benefits was available.

 

Financial planning to the fore

Vera Dolan, president of VFD Consulting,  says that the life insurance market in the US has moved gradually from a sales-first pipeline toward a greater role in the financial planning market.

“In the go-go years before the 2008 meltdown, the life industry had moved toward aggressive, complex products aimed at maximising returns,” Dolan says. “We won’t return to that mindset. Instead I see whole life making a tremendous comeback. This is the best whole life market in 30 years.”

LIMRA’s research bears Dolan out. The insurance research firm reports that total individual life insurance grew four percent in new annualised premium in 2011, resulting in the second consecutive year of growth, propelled entirely by booming whole life sales.

For the year, whole life premium income increased by 9% compared with 2010. Overall in 2011, companies issued 2% more individual life policies than they did in 2010. This is only the fourth time individual life policy sales have increased in the past 30 years.

15 largest insurers 2010in US

 

Variable universal life also experienced a bit of resurgence in 2011. Variable universal life was the second biggest driver of total individual life insurance premium growth in 2011, increasing by 22% compared with 2010 and spurred on by a 36% jump in the fourth quarter of 2011.

Term life insurance was the only product line to experience declines in both premium and policy number count in 2011.

Term premium fell 6% in 2011 and the policy number count was down 4%. In the fourth quarter of 2011, term premium and policy number count dropped by 4%.

Despite the declines over the past few years, LIMRA research reveals that term life insurance continues to represent 65% of coverage and nearly 40% of all new individual life policies issued in the US are term policies.

“Term had quite a little run, but it has always been terribly cyclical and price-sensitive,” Dolan says. “It is really a product of its own.”

Changed risk landscape

So the US life insurance industry has moved from being mainly a provider of mortality protection to being a significant provider of complex savings products with investment guarantees. This changes the landscape of risk management.

Systematic market-return risk is now replacing diversifiable mortality risk as the most important product risk faced by many insurance companies, especially due to the fact that much of the mortality risk in recent years has been passed on to reinsurers.

That transformation toward complex savings vehicles is accompanied by the most fundamental industry trend – the declining demand for life insurance among middle income Americans, resulting in an industry shift in pursuit of the affluent market for specialised needs in life insurance as well as savings.

This narrows the customer base of the industry, exposes it to regulatory and legislative changes, and compresses its distribution force.

A constrained industry

Terence B Martin, director, Insurance Research & Consulting, Conning, says that the dominant issue facing the life industry in the US is the interest rate environment, which shows no signs of easing up anytime soon.

“It is hard to overstate just how constrained the life industry finds itself because of the cratering of interest rates,” Martin says.

“Life policies are long plays, and investment income is where the money comes from to make these policies work, so pricing of life is really being stressed.”

bar chart for US life insurance industry

Martin says that the yield curve is now so low that life insurers are bumping into the guaranteed minimum rates, so they are locked into paying interest rates they cannot earn.

The industry is persevering thanks to the product differentiation that began in the wake of the 2008 recession, he says. If it had not, things would be even more dire.

“Whole life has really helped, and the other product that took a huge jump was fixed annuities, which then jumped way back down as variable annuities came roaring back,” he says. “Indexed annuities have become a stronger mainstream offering than ever before.

“Initially there were some suitability issues, and consumer acceptance issues, but it seems that those have subsided and the agents sell it better as they grow more comfortable with the concept.”

Martin continues that combo products – especially those combining life coverage with an long term care rider – are ideally positioned for the aging US market.

“It is baffling to me that long term care has not done even better as a standalone product, but insurers face the inevitable question of ‘what happens if I pay for long term care for 10 years then die?’ so combo products really help insurers get over that hurdle.”

Bob Kerzner, president and CEO of LIMRA, stresses that the fact that the industry has “held its own” in such a low-interestrate environment is noteworthy.

“The question is, is this the new reality?” Kerzner says. “Is this the operating environment going forward, and if it is, what are the long-term implications? We have never even acknowledged the possibility of managing life insurance in such a low interest rate environment.”

New realities

Insurers have been ratcheting back guarantees to reflect the new realities of the marketplace, and thus far, Kerzner says LIMRA’s research shows little sign that sales are slowing as a result.

The huge numbers of Americans entering their retirement years could not be coming at a better time, he stresses. “Life sales overall increased by 4% in 2011, so we have now seen two years in a row of steady growth,” he says.

“And when you really look at it, whole life is the big story,” Kerzner continues. “Whole life was up 9% in 2011 over 2010, marking the sixth consecutive year of growth for whole life.

Across all products, policy count rose last year by 2 percent, and that seems like no big deal, but that’s only the fourth time in 30 years that it has increased.”

Kerzner emphasises that despite the solid numbers overall, the rocky economy has really taken its toll on smaller producers and financial advisers, who lack the economy of scale to weather a flat yield curve.

“Our research found that a third of producers said they were experiencing declining sales, so some are truly suffering, particularly at the smaller end of the market,” Kerzner says.

“Producers said they are changing to offer a more diversified product mix, or working in tandem with others in strategic alliances, in ways we have never seen before.

A lot of the fundamentals of the business are changing somewhat as the industry begins to normalise after the Great Recession.”

Substantial changes in the overall structure of competition in the insurance industry, including the scope of operations and the size and number of companies will depend to a large extent on changes in how the industry’s products are distributed, Kerzner observes.

If the traditional agency system declines considerably, the structure of competition in the life industry will probably undergo a transformation.

A silver lining

Despite the interest rate environment, the unsteady economic picture and heightened capital concerns, there is much to like about the long-term prospects for the US life insurance industry, not the least of which the trend toward personal responsibility for financial security.

An overextended federal government is sending an unmistakable signal to Americans that they must meet their own retirement needs.

Coupled with the equally powerful trend toward a lower level of employer responsibility

for the security of the workforce, the next generation of Americans already expects changes in the federal Social Security system to occur before they retire.

Their expectation is that benefits will be less generous. As this notion takes hold broadly, demand for insurance and savings products will strengthen.

“Any way you look at it, we have 75m people, who when they are all finished retiring, 20-plus years from now, will, for the first time, be at least partly, and for many mostly dependent on their own financial management skills,” the Life Insurance Institute’s Weisbart says.

“The more we can get people into fixed income products that they don’t have to manage, the better off they are, and the better off the life industry is,” Weisbart concludes.

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