The life insurance industry finds itself at a crossroads as a series of powerful forces – both secular and related to the financial crisis – reshape its competitive environment. Ageing societies and rising longevity are changing consumers’ retirement planning needs, as the trend from defined benefit (DB) to defined contribution (DC) plans shifts the investment risk onto individuals. The crisis has depleted balance sheets, heightened regulatory scrutiny, and led to an increased focus on absolute returns. Meanwhile, technology is transforming the way people make financial planning decisions and how organisations operate.
These forces have been a major catalyst for change. They are promoting the emergence of a long-term savings industry where life insurance and pensions converge. The challenge for life insurers is to retain and redefine their role in the value chain, particularly amid growing competition from DC pension providers. To that end, there is scope for significant ongoing innovation in the product space, as insurers seek products that find the optimal balance between risk and performance, and generate differentiated value for the end consumer. Those insurers that adapt to this new product paradigm will emerge as the winners.
The Challenge of Providing Retirement Income
Product innovation is happening in a number of areas. Demographic shifts, the pressures on private and public sector pension schemes, and the shift to DC have all increased the appetite for products that generate a more certain income stream in retirement, while ensuring that people do not outlive their assets.
At the same time, regulatory, tax and capital issues are influencing the type of retirement products that will be required in future. For example, the UK government is ending compulsory annuitisation at the age of 75. Planned tax changes will reduce the relief on pension contributions for higher earners and may discourage those affected from saving in a traditional pension. In addition, pressure on capital in the wake of the financial crisis, particularly with the advent of Solvency II in Europe in 2012, means that capital-intensive products, such as old-style annuities, may be on the way out. All of these factors are driving the search for new savings solutions.
Variable annuities may be part of the answer. Although well established in the US, they are relatively new to Europe. Like fixed annuities, they offer a guaranteed accumulation of interest and a payout in retirement, with the added death benefit of a life insurance policy. The primary difference is that the policyholder takes on investment risk. In addition to a fixed interest-rate account, the return on a variable annuity is tied to an underlying portfolio of assets such as equities. This means it can earn a higher rate of return but it is also riskier.
There is still more work to do on improving variable annuity products. These products hurt US insurers’ balance sheets during the crisis because of the high guarantees in place. Most are likely to adjust the guarantees to allow for greater downside protection on the insurer’s part. These and other investment products with guarantees are seeing increased interest on the part of bancassurers and financial advisors. The challenge in introducing and further expanding the use of variable and other annuities into new markets will be in educating sales forces to properly explain the benefits of these complicated products.
A Holistic Approach to Financial Planning
One way in which insurers are seeking to reassert their position in the value chain is by providing a holistic financial planning solution, incorporating both pension and non-pension products — the "corporate wrap" platform. Already well established in some markets, this concept is rising in importance in the UK and US, in line with consumers’ desire for greater transparency and cost effectiveness, and the shift away from individual product sales towards financial planning, as underscored by the Retail Distribution Review in the UK.
In some markets, wrap programmes have long been used by financial intermediaries working with individuals. Now they are gaining ground with corporations looking to provide integrated employee benefits, from investment for retirement right through to everyday financial planning. Wrap programmes offer a number of advantages, as more individuals take charge of their retirement planning and investing. Employees can transfer their existing financial assets, such as Individual Savings Accounts (ISAs), into the wrap. This allows them to manage their entire portfolio, including their DC scheme assets, through an online portal, so they can monitor it every day.
Wraps also provide an avenue to get financial advice, and offer greater choice and flexibility than some other benefits programmes. Options can include savings products (to narrow the savings gap and fund longer retirements), equity release schemes to pay for long-term care and variable annuities. Wraps can also be portable, if individuals move to a new employer. Importantly, these programmes help to maximise tax-advantaged investing by using "wrappers" such as the UK’s ISAs and Self-Invested Personal Pensions. With the shift away from product selling to financial planning, consumers will be less likely to pay for advice unless it significantly mitigates their tax bill.
Corporate wrap platforms require scale and a significant investment in technology to be successful. Yet they are fast becoming the best way for life insurers to compete in a crowded wealth management industry. By owning the holistic planning space through the wrap concept, life insurers can ensure their place in the value chain and, by extension, their future success.
Capital Usage and Efficiency are Also Critical
While developing the right products is key, life insurers also have other concerns. The financial crisis shrunk their balance sheets and Solvency II will increase the pressure on capital. Insurers’ business models will have to be much more efficient, starting with a new operating platform that is technology-dependent and globally consistent. To compete effectively, insurers will also need to take a hard look at which activities are core to their business and which should be outsourced to reduce costs and capital burden.
With a strong track record in providing solutions to the long-term savings industry, State Street can help life insurers meet these challenges. We are focused on being a global partner to life insurers, helping our clients to develop differentiated products and services, optimise their use of capital by outsourcing their non-core activities across the broadest functional spectrum, and leverage scale and investment in navigating regulatory and industry change.
