Significant market forces will confront U.S. life insurers in 2013, challenging all aspects of their business models and operations. Although these trials are expected to continue beyond the year, successful companies will be those that proactively address these forces now, rather than postpone action and be compelled to react in a more competitive future environment.
Macroeconomic challenges derive from the persistently sluggish recovery. Real GDP is expected to grow only modestly, although the unemployment rate could improve during the year. Given current low interest rates and the Federal Reserve’s pledge to keep them low, U.S. life insurers should anticipate an enduring low interest rate environment.
Equity markets are likely to remain volatile in 2013, directly impacting insurers’ financial positions through management and expense fee instability. This volatility is causing reluctance among consumers to purchase variable products, and the low crediting rates on fixed products are not perceived as a particularly attractive alternative.
Regulatory forces also are challenging. At the federal level, life insurers with banking operations, or those designated to be a Systemically Important Financial Institution (SIFI), confront increasing regulation by the Federal Reserve. Life insurers also must prepare to respond to possible actions taken by the Consumer Financial Protection Bureau (CFPB), as it begins in 2013 to review assorted financial services transactions like insurance sales.
At the state level, life insurers continue to adapt to current and prospective NAIC regulations, such as the Risk Management and Own Risk and Solvency Assessment (ORSA) model act.
Against this backdrop, life insurers also are competing against financial products from outside the insurance industry, in an economic environment when many consumers are increasingly questioning the value proposition of life insurance. Indeed, the average household expenditure on life insurance has declined 50 percent over the past decade. Consequently, the U.S. life insurance industry must cope with a shrinking share of the consumer wallet.
In this uncertain climate, life insurance companies will need to address the following issues:
- Prepare for a scenario of long-term low interest rates.
Now that the Federal Reserve has announced its third official program to attempt quantitative easing, there is little possibility of returning to a higher interest rate environment in the near future. While interest rates have been decreasing since the early 1980s, the required interest rate to maintain policyholder reserves and profitability was low enough compared to prevailing rates that margin squeeze came primarily from competition. Now the margin squeeze is coming from the interest rate environment itself.
Insurers must move from managing this environment purely as a short-term crisis, as it now appears to be a long-term operating challenge. To obtain greater yield, insurers may need to increase risk-taking in their asset portfolios, with an understanding that they will have to be adequately compensated in yield for taking on the additional risk. And insurers may be able to mitigate the impact of lower interest rates by adjusting liabilities and pursuing stronger enterprise risk management and asset liability management practices.
- Intensify cost-reduction efforts to improve margins.
Not surprisingly, the low interest rate environment and reduced demand for insurance products are squeezing profit margins, making future success highly dependent on expense efficiency and reduction. This challenging environment increases the need for sustainable cost reductions.
Typical cost reduction techniques such as outsourcing and the shedding of non-core businesses can still be effective, but to attain long-range gains more fundamental changes in processes are required, such as investments in predictive modeling and consumer analytics. Companies that have invested in these areas have improved the efficiency and cost-effectiveness of their underwriting and sales processes.
- Organize and plan for accounting change.
Both the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are revisiting areas of insurance contracts accounting in U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). Current exposure drafts indicate that approaches to insurance contracts accounting will change under both standards, with the final standards from both bodies arriving in second quarter 2013 with an effective date of Jan. 1, 2016.
Although final standards have not yet been determined, insurers should begin preparing as soon as possible — reviewing policies, processes and controls; examining the reporting of financial results; educating staff and management; pilot-testing of a model office; and participating in discussions during the comment period, which is to end mid-2013.
Market conduct is another issue in the regulatory crosshairs. For instance, the NAIC adopted updated annuity suitability and disclosure model regulations. The creation of the CFPB further enhances market conduct scrutiny, as the bureau is also tasked with examining the transparency and fairness of diverse financial products and services. The CFPB has typically focused on banking and consumer loans, but it will soon be studying insurance products.
- De-risk and redesign products.
Equity and credit market volatility is increasing awareness of the risks that underlie the optionality provided in insurance products. Prior to the financial crisis, these risks were thought to be well understood and adequately priced. In hindsight; the industry erred on both counts. The income from products that depend on asset-based management fees has been volatile, decreasing earnings. Hedging programs also are less effective and more expensive. As a result, the life industry must decrease risk exposure and enhance product appeal.
Insurance companies are paid to bear risks that customers are unable or unwilling to bear on their own. Therefore, decreasing the amount of risk transferred to the company is seemingly at odds with the idea of enhanced product value.
Basic products like whole life insurance and term life insurance are more popular because of their straightforward value. Companies must continue to design similarly comprehensible products that are flexible enough in a broad range of environments.
- Respond to consumer needs and changing distribution to grow.
Increasingly strained by the country’s current financial situation, the average household expenditure on insurance has declined over the past decade. Although a 2012 industry study indicates that life insurance premium growth has kept pace with inflation over the past 45 years, the growth in the number of policies over that period is zero. In 2013, insurers need to reexamine the value proposition they offer consumers, while further addressing the converging forces of changing demographics, consumer needs and product distribution.
Demographics lie at the heart of an insurer’s business. Many companies struggle with continuously providing to baby boomers while also targeting younger consumers, who typically have less interest in life insurance products. It is sensible to begin this journey by evaluating current distribution channels to desired customers. While many life insurers rely on independent agents, brokers and representatives to sell products, more consumers (regardless of age) are increasingly looking to the Internet to research and purchase insurance.
For more on the year ahead, see: