After nearly half a decade of ten-year Bund yields below 1 percent, and about six months of negative ten-year yields across most of continental Europe, the expectation of continued extremely low interest rates poses major challenges for life insurance companies in Europe and—to varying extents—around the world.
The impact will be multifold: financial revenues will decline across products, the capital requirements of guarantees will skyrocket, and the value proposition of life insurers in savings products will be increasingly questioned. New regulations such as IFRS 17 will add further challenges. Life insurers with large guaranteed savings books will be particularly affected, as their landscape has been shaped by a three-decade bull market for bonds.
In this context, some life insurance executives are tempted to focus their efforts only on unit-linked products. The complication is that savers continue to express a strong appetite for capital protection, while the Insurance Distribution Directive (IDD) and the markets in financial instruments directive (MiFID) form a demanding framework for product adequacy.
By leaving customer demands unanswered, distribution channels in this environment run the risk of losing relevance. In addition, the value proposition for pure unit-linked products can seem weaker by measures such as customer costs and payoffs compared with asset-management products.
The new normal: Where to go?
Reviewing how the Swiss and Japanese markets have addressed similar environments can provide insurers with a source of inspiration. In addition, the tax and regulatory context is being adjusted in several European markets, opening new paths for technical adjustments and product innovation.
In taking stock of these changes and looking at the road ahead, life insurers should structure their strategic agendas around four measures.
1. Pulling tactical levers to bring short-term relief to the current situation
2. Evolving the product range to better address customer needs
3. Reshaping customer journeys to ensure high-quality advice and experience
4. Taking structural action to radically reshape in-force business
While the fourth measure may only apply to some companies, all four must be considered both to bring short-term relief to life insurers’ performance and also to set the basis for long-term success.
1. Pulling tactical levers to bring short-term relief to the current situation
Life insurers should consider several tactical levers when addressing the most pressing aspects of the low-rate challenge. Most prominently, these levers include the following:
- Applying additional criteria to regulate underwriting of new guaranteed products
- Reviewing pricing policies to better account for capital-guarantee and liquidity options
- Better aligning distributor remunerations with the economy of the products—for example, capital-guaranteed products that require very limited after-sale service should carry lower remunerations than products that require regular advice
- Revisiting investment possibilities and asset-allocation policy as well as considering an updated view of credit risk and liquidity premiums
- Selectively protecting the balance sheet through reinsurance contracts, derivatives, and swaps
Since the third quarter of 2014, low interest rates, combined with the imminent implementation of Solvency II, have generated steep drops in the capital ratios of European life insurers, often reaching levels just above 100 percent. However, insurers that pulled these tactical levers have often regained 40 to 70 percent of such drops—even though their impact depends on interest-rate fluctuations, portfolio characteristics, and insurers’ effectiveness in executing such levers.
Going forward, we consider these measures necessary, but in many cases insufficient, to keep healthy solvency levels without new capital raises. Consequently, they are also necessary to achieve ROE close to the target cost of capital.
2. Evolving the product range to better address customer needs
Because they provided healthy returns with no risks in the previous era of higher and decreasing rates, traditional with-profit products could be deemed the single and proper answer to a variety of customer needs.
However, the situation now requires a much broader range of savings solutions to address specific time horizons, levels of risk appetite, liquidity profiles, and investment objectives.1 This includes the following:
- Investment products with capital-protection solutions, including partial capital guarantees, structured UCITS,2 and commercial package policies that cover short- and long-term needs (see sidebar 1 “Unit-linked with protection”, at the bottom of the page)
- Existing and new retirement-savings vehicles
- Alternatives to purely financial payoffs through bundling of savings products with in-kind (protection) benefits, which already proved successful in China (see sidebar 2 “Accumulation products with in-kind decumulation benefits”, at the bottom of the page)
Exploring new, nontraditional risk coverages, such as divorce or unemployment, might help to develop distinctive value propositions targeting specific, yet sizable, customer segments. A few specialist insurers and innovators have already tested the waters, particularly in the United Kingdom, despite limited commercial traction to date.
Both unit-linked with protection and in-kind decumulation benefits are typically targeted at affluent customers, a segment that makes up 50 to 70 percent of business for most life insurers. This underlines the necessity to develop segmented solutions that address different parts of the market.
3. Reshaping customer journeys to ensure high-quality advice and experience
The shift toward a more diverse range of value propositions designed to answer the variety of customer needs—and away from the simplicity of guaranteed products—represents a major challenge for distribution. It requires a careful rethinking of sales and advisory processes, including an adoption of hybrid digital sales formats and greater personalization.
Our research finds that remote and video-based advice platforms can be two and one-half times more productive than traditional face-to-face meetings. In addition, while agent interactions are still at the core of selling complex products, chatbots and other automation tools can add tremendous value to the overall hybrid online and offline customer journeys.
By segmenting customer groups, insurers can increase the number of personalized offerings that might address, and even predict, a specific need. Among agents and sales representatives, specializations—such as in retirement—will allow for further efficiencies. As these agents and representatives develop deeper expertise that is focused on specific customer segments and offers, they can provide more personalized advice.
Technology will likely play a crucial role in driving these changes and fostering efficiency across the advisory and reporting process. Thus, technology could enable growth in the part of the market where small-ticket sales and low margins make traditional, physical advisory nonviable.
Fundamentally, a digital front end and connected tech capabilities must provide the backbone that upholds various distinctive customer journeys and helps ensure compliance with the IDD. Providing visual aid and explanations to agents and sales representatives could increase their productivity as well as their advisory effectiveness.
4. Taking structural actions to radically reshape in-force business
Some life insurers will not be able to sustain traditional business models in the new normal. These players will have to explore other, more radical levers to fundamentally address the challenges they face. Such measures could include the following:
- Transferring traditional life portfolios to other life insurers, reinsurers, or specialized players in closed–book runoff deals (the emergence and subsequent success of many life runoff players demonstrates the appetite for this type of transaction)
- Splitting segregated funds—for example, by level of guarantees—to better match maturity profiles but particularly to limit the yield dilution of existing customers (to the advantage of new policyholders)
- Pooling IT infrastructure and operations with other players or outsourcing certain business processes to seek economies of scale and expertise
The time to act is now
An era is ending. For a long time, the high inertia of large life books, supported by tactical and strategic adjustments, allowed many life insurers to remain profitable without having to adapt. However, complacency will not ensure survival in a protracted, extremely low-interest-rate scenario. Life insurers must fully address the new normal.
This means profound change, affecting all parts of the life business model. Those that realize the need to act and embrace the breadth of measures required are more likely to both succeed in the long term and play a role in shaping the life industry over the next decade.
1Product innovation is constrained by local regulations.
2Undertakings for the Collective Investment in Transferable Securities.
Sidebar 1: Unit-linked with protection
Differentiating the value of life insurance from more cost-effective asset-management products is crucial for future growth as well as the sustainability of the industry. As low interest rates force insurers to focus on capital-light products, bundled risk coverages can be an attractive source of differentiation for insurers—and riders related to term life or disability risks can satisfy customer demand for capital protection. More sophisticated solutions tailored to specific customer needs, such as educational benefits, can constitute additional value-added services.
Sidebar 2: Accumulation products with in-kind decumulation benefits
While not typically considered compelling for European customers, residential and healthcare benefits have grown into real alternatives to traditional financial payoffs—for example, annuities or lump sums paid at maturity—for Chinese insurers. These in-kind benefits are structured as a retirement ecosystem that policyholders can access with a policy subscription. They can also opt in on personal needs and health conditions during the decumulation phase. Offering these new benefits allows life carriers to diversify both their sources of business income and, if they own the companies operating the ecosystem, their investment portfolios. As a result, insurers will be less exposed to interest-rate swings.