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January 9, 2012updated 13 Apr 2017 8:46am

Tough times ahead for US insurers

Future growth in the US life insurance is a matter of managing capital and risk in an uncertain environment, Ernst & Young (E&Y) has emphasised in their new Global Insurance Center US Outlook Those life insurers that manage the associated multiple variables will be the winners of the tumultuous years ahead, predicts the professional services firm. Laying the groundwork for future growth while wrestling with low interest rates and volatile equities markets presents a significant challenge for insurers, but it is critical they begin to size up opportunities ahead, E&Y advised.

By LII editorial

Future growth in the US life insurance is a matter of managing capital and risk in an uncertain environment, Ernst & Young (E&Y) has emphasised in their new Global Insurance Center US Outlook.

Those life insurers that manage the associated multiple variables will be the winners of the tumultuous years ahead, predicts the professional services firm.

Laying the groundwork for future growth while wrestling with low interest rates and volatile equities markets presents a significant challenge for insurers, but it is critical they begin to size up opportunities ahead, E&Y advised.

They stressed that the probability of a great deal of organic growth for life insurers is very low given the chronically high unemployment rates dogging the market for new policy sales.

Putting further limits on organic growth is the reality that retirement account assets are still recovering from losses suffered in 2008, delaying further development of the retirement income market.

Even variable annuity sales, which increased in the first half of 2011, saw heightened volatility in the second half of the year that has darkened the outlook for 2012.

Throw in the potential for regulatory changes and looming capital requirement changes, and it is safe to say that organic growth rates will be miniscule.

In its report, E&Y explained that US life insurers might need to improve earnings through such non-organic means as an opportunistic acquisition, while building the foundation for organic growth after 2012.

“Larger and well-capitalised insurers may explore options outside the US for both organic growth and strategic acquisitions, although some foreign markets are becoming less attractive due to increased competition and their own changing economic circumstances,” stated E&Y.

“Multinationals with operations in the US may continue to feel ongoing impacts from the eurozone crisis, and there could be secondary effects for US-based insurers as well.”

 

Low interest rates a certainty

The only thing that is certain these days, it seems, is that insurers will be operating in a low interest rate environment. The Federal Open Market Committee’s unprecedented decision in August 2011 to lock in a low interest rate environment until 2013 ensures that life insurers must manage through nearly two years of guaranteed low interest rates at the short end of the yield curve.

E&Y also stressed that the very low interest rate environment increases the risk of spread compression for existing products, while also dampening enthusiasm for fixed annuities and universal life insurance.

The same conditions earlier in the decade led some insurers to chase yield thus assuming greater risk which resulted in losses during the credit crisis of 2008.

The result, noted E&Y, is that risk-adverse, insurers may now avoid some of the simpler ways of improving performance, such as increasing the asset portfolio duration [average maturity] of their general account.

E&Y suggested that a more sophisticated approach to interest rate and market risks to possibly protect an insurer’s surplus position and simultaneously promote growth, is to improve the asset and liability matching and management process.

This, according to E&Y, can reduce variability in surplus and prepare for possible future interest rate changes.

E&Y warned that if interest rates climb rapidly in 2013 when the Federal Reserve Board’s freeze ends, disintermediation risk could become a concern, as policyholders may lapse existing policies in favour of investing in new policies with higher credited rates.

Understanding the interaction of the asset and liability cash flows under a variety of scenarios will help prepare insurers to weather these uncertain financial times, E&Y emphasised.

E&Y believes that life insurers may also be challenged by future Congressional efforts to reform the federal tax code, and US budget deficits and revenue generation are serious concerns.

The health of the economy will be a central political issue in the 2012 general election. That could lead to structural changes to the tax code, which may have significant repercussions for the life insurance industry.

“In order to avoid the dangers seen in the recent financial crisis, insurers need to more fully comprehend the structure and safeguards among their assets,” E&Y stressed. “Utilising a variety of stress scenarios to understand counterparty risks, correlations in credit risk, capital requirements and cash flows can help insurers better evaluate investment opportunities. Looking through the lens of risk-adjusted returns can give confidence as to whether or not the insurer is receiving a sufficient return for the asset risks being absorbed.”

 

Go online, advises E&Y

E&Y also urges insurers to more fully embrace internet distribution. While other sectors have been nimble in adapting to the internet and leveraging its opportunities, life insurance companies have lagged behind.

The extent of life insurer presence on the internet largely consists of financial calculators of insurance needs, sales lead-generating activity like educational materials and product information and proprietary internet applications that support the sales force through online insurance application forms and illustrations.

This, notes E&Y, may be due to the nature of the sector’s products and services, and the complexities and subjectivity of underwriting, but the time has come for the industry to move past its hesitance and embrace online sales and distribution.

However, E&Y pointed out that the newest generation of insurance buyers is young, internet savvy and what it describes as “transactionally self-sufficient”.

Such consumers have grown up in a self-service culture, and spend a significant portion of their time transacting online. While insurance in its current form does not lend itself well to internet sales, it can be better leveraged to develop stronger ties to customers and build a better brand.

“In the future, it will be possible for a consumer to submit applications to several insurers, receive competitive quotes, and be educated by web-based information on the insurers, decide which insurer best suits his or her needs and wallet,” noted E&Y.

“Creating incentives for consumers to transact online, much in the way many airlines do, could guide lower premium options, versus purchasing insurance solely through an agent.”

E&Y also urges insurers to make effective use of analytic and predictive modelling techniques to improve speed and accuracy of underwriting. Ultimately, the faster applications are processed and accepted, the more policies are issued, E&Y observed.

Predictive modelling also brings with it the ability to analyse policyholder behaviour and target marketing at individuals most likely to buy specific products. Banks, notes E&Y, have long aimed their products at people who have recently purchased a home, and producers of baby products are especially adept at putting advertising material in the hands of new parents.

“Insurers can learn from these experiences,” E&Y concludes.

Charles Davis

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