Many years of
tough-going face the UK’s life insurance industry.
This is the view of Antonello
Aquino, a vice-president and senior credit officer at rating agency
Moody’s Investor Services which recently confirmed its negative
credit outlook for the industry.
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Indicative of the problems facing
the UK life industry, it enjoyed the last period of robust growth
in terms of new business more than a decade ago. Growth began
slowing markedly in 2003 and went negative in 2006, 2008, 2009 and
2010.
To reverse this trend, Aquino said
the industry faces multiple problems, including the UK economy’s
muted growth prospects, debt-burdened consumers and looming
regulatory change.
The new regulation includes
Solvency II and the increased capital burden it will bring.
Insurers also face the Retail Distribution Review (RDR) which
threatens to disrupt insurers’ key distribution channel,
independent financial advisers (IFA).
Aquino pointed to a particularly
notable reaction by life insurers.
“The business model of UK life
insurers, predominately for the larger and more sophisticated
insurers, has been transformed over the past 12 to18 months,” he
said.
He explained that under the new
model insurers are focusing on maximising cash flow generation and
minimising new business capital strain.
They have been doing so by cutting
costs and focusing on high margin products (annuities and
protection), offering lower guarantees (so-called capital-light
products) and reducing up-front commission paid to IFAs.
In addition to Solvency II and the
RDR, Aquino said Moody’s believes insurers faced even greater
pressure from other factors to transform. These included
shareholder pressure to allocate capital more efficiently and
pressure of being viewed as a takeover target for industry
consolidators such as Resolution Life.
Aquino noted that although the
business model change benefits the life industry, it will require
careful balancing between short-term and long-term
profitability.
“In order to be successful,
insurers will have to strike a balance between the need to maximise
cash-flows in the short-term and the need to invest for the
future,” he stressed.
He continued that currently the
largest part of the cash flows generated by the industry are from
“monetisation” of the value of in force (VIF) business, thus
reflecting the profitability of the back book of business.
“The challenge for the industry is
to ensure that the new generation of capital-light products is able
to secure a solid cash flow pattern in the long term and replenish
the VIF monetised year after year by continuing to write
appropriate levels of new business.”
In essence, he stressed, UK life
insurers are increasingly shortening their cash payback periods –
meaning that meaningful future years’ cash generation has yet to be
created.
“In fact, only some UK insurers
reported a new business contribution to VIF higher than the VIF
monetised off the back book in 2010,” said Aquino.
“As a result, there is a risk of a structural reduction of VIF
for some UK players and, consequently, we believe a risk that
long-term cash flows would be impaired if not offset by either a
larger volume of lower-margin products or increasing margins.”
