Category Life Insurance

As good as it gets

30 November 2004 Bob Stein

Although different to South African circumstances, the global life insurance industry is leisurely savouring the fruits of vastly improved results.

But, it's important to note thatthe strategic direction responsible for this change in fortunes is posing challenges that threaten to end the celebrations prematurely and possibly send the industry in a tailspin.

So cautions Ernst & Young chairman for global financial services Bob Stein.

Writing in the autumn edition of CrossCurrents – an Ernst & Young
publication for financial services executives – Stein notes that the
inability of the life insurance industry to generate any growth in total life premium income has necessitated a shift in the operational direction of the industry.

Stein says globally, a shift in strategic direction has borne fruit in the last 10 years as evidenced by a 6% growth in total asset growth between 1993 and 2003 on the back of increased investments in annuity products.

“Today, about two thirds of industry assets are in annuity products, with this concentration expected to rise to about 70% by 2005. Despite the stock market’s turmoil, variable assets continue to rise and are expected to approximate 35% of total assets by 2005,” says Stein.

Stein continues: “The message in all this is quite clear: the industry is fundamentally an asset gatherer and investment manager.”

However, Stein cautioned that the evolving nature of the industry poses new challenges for the sector as it calls for a significant change in its business model.

“Without a significant change in the business model, the life industry will have trouble overcoming its characterisation as a mature, low-growth business that is challenged to compete with the best financial institutions,” Stein cautioned.

Looking at the cost levels of the life insurance industry, Stein says
despite efforts to whittle down operating expenses, relatively high
operating expenses will seriously hamper the competitiveness of the industry.

“Based on the expense levels of top quartile performers, insurers will need to reduce cost levels at least another 40 basis points to assure competitive and profitable products. Clearly a lot of excess cost still needs to be wrung out of the system,” he says.

Stein points out that the daunting cost issue, which has long been the Achilles Heel of the industry, will continue to derail the profitability of the industry going forward.

“Can a business model that is encumbered by high-cost acquisition methods, heavy back office cost burdens support effective competition with pure investment managers over the long term?

“Or should life insurers instead build on their insurance risk management skills and focus on growing the life business and other underwritten products,” Stein asks.

Examining the prospects of the industry, Stein says the options are not clear-cut, as the industry has to strike a delicate balance between growing the assets under management and widening profit margins.

Acquisition successes, Stein points out, are more likely in the specialised or niche product and market area and in transactions that emphasise the acquisition of quality, low cost distribution.

“A well thought-out and perfectly executed acquisition strategy may proveto be the right answer for some. But this risky strategy will succeed only if companies can convince investors that the acquisitions being considered will produce major operational consolidation and cost reductions,” he says.

Looking ahead, Stein urged the industry to ensure that the reputational damage sustained by other financial institutions is not visited upon the industry.

“The industry should use its time in the sun to establish a solid
foundation for future growth and profitability by aggressively tackling the many strategic and operating challenges it faces.

“The next few years will tell us whether the life insurers will remain a critical part of our financial system or will fade in importance as the financial products and services demanded by the market are dominated by market-savvy offerings of competitors,” says Stein.

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