Weak investment returns keep life insurance confidence subdued

Ernst & Young Financial Services Index Q3 2008

The 3rd quarter 2008 Ernst & Young Insurance confidence index continued declining, due to sustained weak investment income, which in turn kept profits growth subdued (albeit positive) during the quarter. The declining confidence is in line with weaker business confidence across most financial services segments. During the quarter, life insurance confidence fell to 57, from 63 in the previous quarter.

This is the 21st quarterly survey measuring confidence in the life insurance industry. The research is conducted by the Bureau for Economic Research in Stellenbosch.

Life insurance confidence remains the weakest of all financial services sectors, trailing the banking industry, (61 points), and investment managers (67 index points). Comments Tim Rutherford, insurance industry spokesperson at Ernst & Young; ‘Confidence among life insurers continues to fall, primarily on the back of weak investment income. Weak equity markets are not helpful for life companies, and across the globe, the sector is feeling the impact of volatile equity markets.’

Life Insurance Confidence Levels

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 Rutherford continues, ‘Confidence reached the lowest level yet in the five year history of the index, and it is a remarkable turnaround from the situation of last year, and into the first quarter of 2008. However, not all is doom and gloom. Operationally, premium incomes are providing some relief to the industry. Life insurers can take some comfort from their rising premium growth – other financial services segments are not reporting rising core revenue growth just yet.’

Another key finding of the survey relates to rising costs. All segments of financial services are being pressured by cost growth, which is not falling in line with slower revenue flows. Both banks and investment managers have experienced difficulties in getting their cost bases to slow in line with slowing revenues.

Rutherford adds, ‘ To a large extent, costs have been incurred by operational needs. Compliance costs have generally increased, as the degree and scope of regulation has intensified in the last few years. Whilst the industry was generally able to absorb these additional costs in a strong economy, it is proving difficult to slow the pace of cost rises in a slower economic growth environment.’

The survey also found that lapses and surrenders continue to rise. Says Rutherford, ‘ This is likely a symptom of the economic environment. Lapse rates are high when times are tough, particularly in the low end of the market, where the easiest debit order to bump has little impact on one’s day to day living. Surrenders may also be rising due to consumer squeeze, with a policy surrender used to provide for everyday general living expenses.’

He continues, ‘ General economic circumstances remain subdued in the household sector. Whilst overall GDP growth remains robust, consumers are still reeling from the impact of high interest rates, and high and rising inflation. Whilst it does appear that there is relief in terms of slowing oil and food prices, the middle and lower consumer segments are still feeling the pinch. In addition, GDP growth has not generated strong job growth yet

Net profits in the life insurance sector were only marginally positive in the 3rd quarter of 2008, the 3rd consecutive quarter that profits growth has remained subdued. Says Rutherford, ‘ Profit growth in life insurance continues to slow, in line with other financial services sectors and more broadly with the general economy. Higher premium income was insufficient to offset the impact of significantly lower investment income growth. We notice that in the interim reporting period to June 2008, the major life insurers collectively reported a 20% decline in headline earnings. This confirms that the trend which had already started in the first half is continuing into the latter half of 2008.

Rutherford also points out that the net pace of inflows growth into the sector continues to trail that of outflows. ‘This is a concern because it shows that over time, the life book is shrinking in size, i.e. there is no real growth in the market, and in fact, the market is shrinking. This is symptomatic of a mature life market (despite the need to extend the lower-income segment of the market). More worrying, is that it also indicates that product churn probably accounts for at least some of the new premium growth.’

In conclusion, says Rutherford, ‘ Life insurance industry confidence remains subdued in the 3rd quarter, but this is in line with many other sectors. Until there is household relief from financial pressures, confidence amongst retail banks, motor vehicle manufacturers and retailers are all likely to remain weak. Life insures have the double whammy of relying on (weaker) investment income for a large portion of their earnings, and it is thus understandable why their confidence levels are lower than that of their other financial services peers.’