Outlook on Life
by Carolyn S. Ellis As managing principal of Ernst & Youngs insurance consulting business in the U.S. Doug French is well positioned to comment on the outlook for 2011. A life actuary by profession, French has been a consultant for 26 years, the last 11 with Ernst & Young. His experience includes all aspects of actuarial risk and finance.
L&HA Features Editor
L&HA: Your years of consulting have given you a broad perspective on todays life insurance industry.
DF: I have learned a great deal from working with clients over the years here and overseas. In the past 12 months our Ernst & Young insurance consulting division has worked for 15 of the largest 20 insurance groups in America. We focus on the key tenets of our business, risk, finance, regulatory agenda, and standard transactions work and operations improvement.
L&HA: Can we talk about the complex global landscape that insurers face today?
DF: Starting with the economy, the last couple of years have been challenging for life companies with regard to premium income and growth and the balance sheet. Entering 2010 we predicted a challenging year and an uptick in 2011. Early in 2011 that uptick is still not being seen. We might officially be out of recession, but unemployment remains high and payrolls are down which means premium income for group products is even or slightly down. On the retail side, protection and savings products get put on the backburner when competing with mortgage payments and food. The uptick in equity markets and interest rates helps life companies, but interest rate spread compression is a very real issue.
L&HA: And the regulatory environment is heating up.
DF: Life companies have to pay attention to three regulatory issues: Dodd-Frank financial reform, the insurance contract financial reporting proposals by FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board), and the NAIC Solvency Modernization Initiative. In the best of times one of those issues could be challenging. Then you have the Federal Insurance Office that has 12-18 months to write a report around suggested enhancements to the regulatory environment in the US.
The NAIC Solvency Modernization Initiative is about getting to a point of equivalency between the European and US solvency regimes. That will unfold in 2011, with recommendations in 2012. There are fundamental differences: in our state regulatory system we focus on each insurance subsidiary where it is domiciled. Solvency II is a top-down approach, starting with the holding company. We are telling clients to be engaged with the regulatory process but it is too early to know how things will evolve.
L&HA: How will agents feel the pinch?
DF: Under the European Solvency II rules there is a Pillar 2 requirement around risk management. Changes may raise the cost of doing business for the manufacturer. Additional capital requirements and compliance expenses, or a financial reporting framework that increases the volatility of financial results, those will be imbedded in product pricing. Somebody will pay, either through lower commissions to the agent, higher prices to the consumer, or lower returns to the insurance company. On the positive side, estate taxation is coming back, so that should help a few players short-term. But then they will be looking everywhere for ways to raise tax revenue and that will include the insurance industry.
L&HA: Do you expect growth in annuity sales?
DF: There are two demographic groups that matter in the US for the next ten years. Baby Boomers are all about the orderly liquidation of assets, i.e., longevity products. The opportunity there is huge. Agents and advisors need to move from the accumulation of assets which they have been doing for the last 20 years to liquidation. Most people do not want to give their big chunk of money to an insurance company in exchange for a monthly income stream. It’s a behavioral and educational issue. Even if you show that rates of return in those products are pretty attractive, especially today compared to equity returns, there is still a reluctance to give up your money. That has got to change. How? Maybe tax incentives that push behavior in the right direction. Or you get your financial planning population to make that part of their planning approach. As we saw with 401ks, as consumers get educated, things will change.
L&HA: Mature consumers have lived through dramatic economic changes and they expect to live 10-20-30 more years, so they hesitate to tie up their money.
DF: You can have your cake and eat it, too. We are talking about setting yourself up with a basic cost-of-living, inflation-protected income beyond Social Security locked into place at age 65. With your pot of gold in excess of that you can take your cruises, hang glide, and do all the other things 65-year-olds do. Your kids are not going to look out for you. They will be off doing something else, like paying taxes.
L&HA: What is the other important demographic?
DF: The next demographic that matters is the under 35 group, Generation Y. That group is growing and has some protection needs and some savings needs because they see what ishappening to their parents. However, they are not responsive to traditional, face-to-face distribution methods. Gen Y wants to transact over the Internet not the kitchen table. We are not sophisticated enough now to deal with that population. That is the challenge for insurance underwriters.
L&HA: Many agents and advisors would say that insurance is part of a total financial plan not a commodity.
DF: The guy or girl who has to have an agent is in a different world from Joe Six-pack and Sally Brown-bag that need ten times their salary so if one of them dies, the other can carry on and raise the kids. Wealth transfer, that’s less than 5 percent of the population. That is where agents hunt because that’s where the money is. For 95 percent of the population, you can educate and make that transaction on the Internet. Agents are aging and young people do not want to be insurance agents any more, so eventually underwriters will have to deal.
LHA: Is it time for cost reductions in operations or distribution?
DF: Both. When you have little or no revenue growth, you have to look at operational efficiencies. You usually mess with manufacturing first and leave the distribution channel alone. But eventually you have to look at the field, whether it is management layers, technology, or number of offices. Banks have been cutting expenses for decades. Insurers will have to behave more like banks.
LHA: What is most important for the future of the life industry?
DF: Customer analytics and data to underwrite life insurance policies. Somebody will crack that code. Life insurance will open to a huge swath of population when you can buy a meaningful-size policy without giving fluids or blood or having a para-medical exam. This could involve transactions like monthly health club fees and the restaurants where you eat (or do not), or annual doctor visits and motor vehicle records. If you can make the friction of buying life insurance go away you will sell lots of policies.
At Ernst & Young we are bullish about the insurance industry. It provides great benefits for society and it’s not going away. But with todays challenges, it’s not easy running one of these companies.