The very nature of life company products, balance sheet usage, the mathematic and reporting complexities and associated tax implications, clearly distinguish them from the mutual fund industry as providers of investment products. More recently, margin pressures and regulatory change have been altering the way life companies do business and the products and services they offer. This article looks at the developments in the industry and how operational and technological requirements are changing to keep pace.
The complexities of the life business become clear when you consider actuaries’ attempts to estimate the future scale of liabilities and commitments based on uncertain events. Models are created that analyse current and future demographics, incorporate a huge variety of population statistics and potential healthcare outcomes, calculate likely payouts and then match that against the fund’s investment profile. It’s a task that has occupied some of the finest mathematical brains in the financial sector and, not surprisingly, many life firms have preferred to rely on their trusted in-house capabilities than search around for external providers.
On the asset side of the business, life companies have made use of complex unit-linked or ‘inter-funded’ investment structures to allow the use of large investment pools, known as general account or statutory funds, to service the needs of a wide range of investor and policyholder profiles, products and distribution channels efficiently.
Then there are the difficulties of managing both taxable and non-taxable transactions and dealing with fair apportionment of tax liabilities to products in accordance with product profiles and the company’s taxation requirements. And of course, life companies can also manage their portfolios from the perspective of an aggregated balance sheet, allowing them to manage their tax position and pass on some of that benefit to the end investor.
These challenges mark life companies out as different and as a result it has been hard for non-specialist technology providers to support them in these specific areas. But internal and external pressures have meant that things are changing and life companies are looking again at their operational and technology set-up to ensure success in this new and more fluid environment.
The changing nature of the life business
The pure life business now is very mature, and we are seeing a degree of diversification in products offered, particularly in the investment space. At the same time, life companies are having to be more innovative with their offerings. Apart from the challenges that life companies face competing with mutual funds on the assets they can invest in, they have the additional ability to compete leveraging the balance sheet basis of their offering. This allows them to add value through being able to take positions and risk on their balance sheet to give their investors a better deal.
As they diversify from traditional life insurance and endowment products, life companies have tended to open up their investment function to involve external managers to enhance returns. Similarly, the asset management arms of life companies have looked to extend their remit to include managing external funds or mandates for third parties. In the UK, as an example, it would not be unusual to see a life company’s funds representing only 50 to 70 percent of the associated asset manager’s assets under management.
Conversely life companies may establish investment platforms to distribute products from unrelated investment managers alongside their own, bringing with it the new requirements to ‘manage’ these external managers in areas such as processing fees and rebates. Life companies also need to service a range of different distribution channels including tied or independent investment advisors or financial planners (employee benefits consultants).
Life companies are becoming more adept at bringing new products and services on line: whereas ten years ago the product range was fairly static, there is now a greater level of product innovation targeting and competing for customers at various stages in their financial lives. Having said that, life companies are still in the long-term business of serving and protecting clients from both investment and risk management perspectives.
All this is happening alongside an abundance of merger activity within the sector which creates even more complexity. With different life companies needing to be administered through the intricate process of restructuring to achieve integration and resultant efficiency gains, there is an additional imperative for firms to source technology that is flexible enough to allow them to go on the acquisition trail.
However, as life companies move towards a more general investment model they face greater pressure for transparency and consistency throughout their product and investment pool structures, since the same underlying investment management function can now service both life and investment products.
Life funds are thus concerned about inefficiencies and lack of transparency in investment fund-pools and related processing, as well as processes involved in linking to internal or external funds management functions. But more than that, the complex unit linked fund structures that accommodate diverse retail and institutional investors, a multiplicity of channels and a variety of tax rules require the strongest degree of risk management.
This general evolution of the life industry has recently been given a speed injection thanks to a new wave of regulatory reform that places far greater urgency on risk management. In Europe, both Solvency II and the Retail Distribution Review increase the need for transparency and accountability to the investor. As with almost all recent regulation in the financial industry, similar legislation either already exists or is almost certain to appear in other, non-European markets, in the very near future.
Operational processes are working hard to keep pace but fortunately, as the challenges facing life companies develop, so the technology available to them has advanced significantly since the last generation of technology implementations which may have taken place 25 years ago.
The changing nature of life solutions
Firms are facing margin pressure that has restricted budget available for a system refresh: vendor-supplied systems with their proven implementation schedules, their demonstrable functionality and the economies of scale they offer are suddenly much more attractive from both a cost and risk perspective.
And so we are seeing a shift from the internal systems of the past. But more importantly, we are starting to see a move away from life-specific processes and technology solutions. Historically, firms have built systems for specific functions and a specific product set, and when looking for external systems to replace them they have been looking for a like-for-like replacement of the in-house functionality they always had. But this is one of the factors that makes these systems so prohibitively expensive in the first place and it does little to aid the risk management processes that are now so central to requirements.
More recent developments mean that solutions are now available that are designed from an operational or fund product perspective. They can offer transaction, accounting and process management capabilities that can be applied to any fund structure. The cost can certainly be amortised over many fund types across industry verticals, just as similar investments are managed in other areas of the financial services industry.
But more than that, a common fund technology platform can then be deployed across all business units and fund structures on a global basis achieving a greater level of transparency throughout the business, while also accommodating local requirements such as Box Management in the UK. These kinds of solutions offer a far more holistic approach that overcomes costly and opaque functional silos.
So, in addition to undertaking the business functions that relate to life product structures, they can reach out and connect with the market through the orders and information that flows both between the life company and its other business units, and the other market participants with which the firm interacts.
The world of technology has changed since many life companies first started to look for solutions that would help them manage the particular complexities of their business. The old arguments in favour of internal build no longer apply for life company product structures, and firms face realistic choices from external vendors.
But smart organisations are looking for a more multi-functional and efficient approach. They are no longer on the hunt for life market-specific solutions. Instead they are choosing providers that deliver a global capability that, for the first time, gives those organisations that want common technology across their business divisions exactly what they are looking for.
Phil Davies, is chief technology officer and Geoff Hodge is chief executive at Milestone Group, Sydney, Australia.