Life Insurer Confidence drops on Contracting Profits

Ernst & Young Financial Services Index Q1 2007

The latest Ernst & Young Life Insurance confidence Index shows that life insurance industry confidence took a knock during the first quarter of 2007, on the back of contracting profit growth, and despite a strong revival in premium income and stronger new business prospects.

The index findings furthermore show that life insurers have made strong progress in a number of key areas of their business, most notably, in addressing high surrender rates, and lowering lapse rates, which have historically eaten into their revenue flows and hence profits.  Despite these impressive signs, life-insurance confidence fell from 100 index points in the last quarter of 2006, to 83 index points in the first quarter of 2007.

                                                                               
These are the findings of the 21st quarterly Ernst & Young Financial Services Index released today. The research and analysis of the study was done in conjunction with the Bureau for Economic Research (BER) at Stellenbosch University.  Confidence is measured by satisfaction with prevailing business conditions.

Says Tim Rutherford, Director at Ernst & Young: "In 2006, life insurers confidence seemed to be rather resilient in light of their many challenges. They maintained a confidence reading of above 90 basis points throughout 2006, despite needing to make adjustments to some of their RA policies, and continuing to attract negative criticism regarding value-for-money in the press and from consumer lobby activists. In addition, they faced much greater competition for the declining share of the savings market, as unit trusts and linked products increasingly became the product choice of more and more investors."

Continues Rutherford: "To some extent, the life insurers have been very successful at transforming themselves from pure life assurers, and most have broadened their product range to provide the new generation products that consumers are increasingly demanding. This could provide some explanation as to why net profits growth are starting to decline these new generation products are typically far lower margin products than traditional life insurance ones." He points out that life companies reported a significant reduction in administrative expenses during the quarter, and believes that this may be due to restructuring their cost base in a drive to right-size their operations for changing market conditions.

The survey goes on to find that investment income growth was relatively flat in the first quarter of 2007, after rising throughout 2006. Furthermore, there is an expectation that investment income growth will contract in the quarter ahead. Comments Tim Rutherford: "To a large extent, the industry has offset some of the stagnation in its premium income book with gains from investment income returns through 2006. There may be a realisation that this will no longer be possible in 2007, and the operational side of the business thus becomes key to maintaining bottom-line profits growth."

On the plus side, there was a further noticeable improvement in lapses and surrender rates during the quarter, coupled with a positive turnaround in the new business premium growth trend. The sustained improvement in lapse rate trends follows strongly rising lapse rates through the first three quarters of 2006. Similarly, the value of surrenders contracted during the quarter. Says Tim Rutherford: "It appears that these improvements are now sustainable, and that most life companies have managed to conquer worsening lapse rates and growing surrenders. This is a change from past experience, where improvements in one quarter were not necessarily maintained in subsequent quarters."

The survey also found that net profits growth declined once again in the first quarter of 2007. In fact, net profits growth was basically flat, the first time in over two years that such nominal growth was recorded by the industry. This is at least partially due to continued worsening risk business profitability, which has faced increased competitive pressure through 2006 and into 2007.

Once again, the life insurance industry faced faster growing outflows than inflows, indicating that the net size of the life book continues to contract. Says Rutherford: "For only two quarters since the survey first ran, (3rd quarter of 2002), have we seen the rate of inflows into the industry exceed that of outflows. Over the longer term, this shows fewer savers are choosing life products as an ideal savings mechanism. The life insurance industry, in turn, continues to refocus its business to capture a greater share of the savings market."

Concludes Rutherford: "Despite improved trading conditions, sharply lower investment income growth has dampened life insurance industry confidence. Whilst total inflows have grown since Q406, outflows growth remains stubbornly high, exceeding inflows growth substantially, and illustrates a declining market size over the longer term. Whilst premium growth has risen to strong levels in early 2007, net profits were basically static. There is an expectation that profits will revive in the 2nd quarter, although life assurers are not sure about investment returns going forwards, anticipating that these may actually shrink."