Insurance has a way to go before it reaches the maturity of the investment industry
by Michael GordonMr. Gordon is Group Chief Operating Officer & US Chief Executive Officer with Lombard International Group, a global wealth structuring provider at the intersection of asset management and insurance. Please visit http://www.lombardinternational.com/ for more details. Prior to joining Lombard International, Mr. Gordon served as the Global Head of Insurance Solutions at BNY Mellon Investment Management. Prior to BNY Mellon, he was an executive at New York Life Insurance Company, leading investment and insurance product management, including sales and marketing, actuarial, operational, and technology functions, as well as overseeing the Broker Dealer and the Registered Investment Advisor for the U.S. life insurance business. Mr. Gordon earned his B.A. in Philosophy from Colgate University and also completed heavy coursework in mathematics.
While the concept of insurance has been around for millennia, and while the life and annuity industry is indeed a behemoth, it is still somewhat immature in terms of reaching its full potential, a point which is best understood by comparison with the investment industry.
In general, insurance is sold in one of two ways.
The most traditional sale is a “needs-based” sale, i.e., motivating a policyholder to identify a need and building a plan by comparing the amount of coverage needed with what the client can afford.
The second most common way to sell insurance, typically used for larger insurance policies, is by “disqualifying alternatives” to insurance in the context of a contingency plan. For example, consider a business buyout plan, a plan used by two business partners to ensure that, if one of the partners were to die, the deceased partner’s heirs would be bought out of the business. This enables the heirs to realize the financial benefit of the business while still allowing the original partner to continue to run the business going forward without interference. Business partners could fund this plan with cash, but that would require a very large cash infusion up front.
Alternatively, the partners could initially only partially fund the plan, and invest the capital to grow over time; but, in that scenario, if one of the partners were to die before the investment account grew to a sufficient size to buy out the business, the plan would not work. It is only with an insurance policy that the two partners can create funding for the plan in an efficient manner, and in a manner that will work irrespective of when one of them dies. That basic logic is the basis for most “advanced” insurance sales.
Planning For Economic Outcomes
In order to truly mature to the level of the investment management industry, however, the insurance industry needs to develop a third way to engage with clients: focus on the role insurance and annuities can play in optimizing economic outcomes, as well as constructing portfolios that are resilient against the full range of risks consumers face, including but not limited to market risk.
To take that step, there are four key traits the industry will need to develop and adopt. These are:
- An agreement on how to select insurance products, and how to incorporate them into portfolios and plans;
- A simple, streamlined process to present that intellectual capital to intermediaries and clients, similar to an investment risk tolerance questionnaire and model portfolios;
- The technology infrastructure to integrate insurance into the broader financial ecosystem; and
- The ability to disaggregate the options embedded inside insurance products, allowing consumers to purchase just the parts they need.
In the investment management industry, there are widely understood and agreed upon frameworks that detail how portfolios should be constructed to optimize risk-adjusted investment returns. One such example is modern portfolio theory, which posits that one can design a portfolio that will provide maximum returns for a given level of risk. The insurance industry, however, suffers from a lack of such intellectual frameworks. As such, individual brokers each apply their own philosophy for how insurance should be utilized in the interest of the end consumer or institution.
This idiosyncratic approach has resulted in a systemic lack of consensus about what insurance is ultimately for, and how it can and should be utilized in the context of a broader wealth portfolio. The industry lacks (but requires) agreed upon frameworks, models, and best practices that allow a policyholder or broker to explore different types of insurance from a wealth management perspective. Without these frameworks, insurance will not be able to scale at a geometric rate, and will not fully mature as an industry.
A More Streamlined Process
Once intellectual capital is agreed upon to more clearly establish an optimal solution set for policyholders and their advisors, a more streamlined process is required to make that intellectual capital more accessible. In investment management, advisors utilize questionnaires to match a risk tolerance with compatible portfolios, asset classes, and investment vehicles in a standardized, scalable, and rigorous process. An appropriate, pre-constructed model portfolio that incorporates the tenets of modern portfolio theory can often be presented quickly following the completion of the questionnaire.
In the insurance industry, such a process is lacking, and brokers cannot effectively compare the available products and structures as a means of effectively exploring options suitable for a policy-holder’s desired risk/return. The insurance industry needs a more uniform process that better leverages academic research to, for example, formulate its own version of a standardized questionnaire; and, indeed, to extend existing investment questionnaires to incorporate insurance and annuities as asset classes or containers for asset classes.
Robust technology infrastructures are also required to help prospective policyholders more efficiently monitor performance of portfolios they are invested in through insurance contracts. We know that in the investment management industry, these platforms are in place and have become increasingly automated and highly sophisticated. Meanwhile, the insurance industry is still treated as a lower priority, when it can and should be considered an asset like any other, with agreed upon reporting frameworks that detail performance metrics and policy characteristics, and that fit easily into broader planning and portfolio frameworks. Leveraging modern technology will improve insurance companies’ ability to price risk, will generally enable an integration of insurance into the policyholder’s broader investment portfolio, and will even make it possible to construct custom insurance products on the fly.
Ultimately, insurance products do five things. They can provide tax benefits, accounting benefits, economic benefits associated with risk pooling, access to investment return streams, and guarantees. Unbundling these benefits would allow policyholders to select only those aspects they need—that is, to buy just one part or another part, instead of a full bundled product.
Consider an investment universe where mutual funds were the only tradeable vehicle, with individual stocks unavailable. Or one where mutual fund wrap accounts and unified managed accounts did not exist. It would be much smaller- and the insurance industry still mostly operates in this way, and for the most part, does not offer disaggregated, unbundled solutions, or solutions easily incorporated into broader portfolio construction. Until that situation changes, insurance is likely to be left out of the asset management planning process altogether, and it is unlikely to scale to its full potential because it will not be considered in every portfolio the way other, more flexible asset classes are.
But it does not have to be this way. The insurance industry provides tremendous value to consumers. If the life insurance and annuity markets are to grow to their full potential, the insurance industry must put in place the foundation for that growth: consensus on intellectual capital, streamlined process, technology and networking to integrate into the broader financial system, and disaggregation of real options embedded inside the contracts. With those changes, consumers and their advisors will be able to approach the industry with more confidence, along with a greater sense of how insurance products fit into broader financial objectives; and the industry will be set to scale at a geometric pace.