life insurance industry has enjoyed several years of outstanding
growth, in reality this masks significant challenges. Not least of
these is a steep decline in persistency, an ongoing trend that has
prompted a radical reappraisal of commission-based adviser
remuneration.
The UK life insurance industry has enjoyed robust growth
following the tough period between 2000 and 2003, during which time
data from reinsurer Swiss Re reflects a 17 percent fall in total
premium income to £98.65 billion ($196 billion). Off this low base,
premium income rebounded and grew at a CAGR of 19.7 percent to
reach £169.13 billion in 2006. Though total premium income data for
2007 is unavailable, new annual premium equivalent (APE) business
written in that year was up 14.4 percent to £15.12 billion,
according to industry body the Association of British Insurers
(ABI).
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However, published data alone does not tell the full story. Though
premium numbers are impressive, much of the growth in recent years
has been attributed to the transfer of existing business between
insurers, often referred to as churning. This was among points of
concern relating to life insurers raised by the Financial Services
Authority (FSA) in a review of the country’s financial services
industry, Financial Outlook 2008.
Focusing on the life insurance industry’s pensions business, the
FSA observed that in 2006 the net flow of funds into the pensions
industry appeared to be negligible, with new regular and single
premium income almost exactly matched by outflows. The FSA noted
that in 2006 the industry reported £22.9 billion in single premium
new pensions business, up 36.3 percent compared with 2005, while
new recurring pensions business increased by only 4.8 percent to
£12.9 billion.
The ABI has itself highlighted the impact of business churn, noting
in its most recent annual statistical review that pension transfers
from one pension provider to another accounted for £72.7 billion of
the £141.4 billion in total benefits paid out to policyholders in
the UK in 2006. However, the ABI stressed that changes in pension
regulations from April 2006 “contributed significantly to this
movement for individual pension contracts”. The changes that
occurred on what was dubbed A-Day enhanced the range of assets
available for investment through self-invested personal pension
plans, prompting many customers to shift assets into other
products.
In-force business in decline
While A-Day no doubt influenced the level of churning in 2006, it
was far from a one-off example of poor persistency in the industry.
For example, professional services firm KPMG observed that in 2004
life insurers paid out £93.5 billion in claims and received £87
billion in net premiums. Of the claims paid, £57 billion was in
respect of surrenders and refunds. “As a result the in-force value
of their business has been reduced,” noted KPMG.
KPMG’s reference to the value of in-force business is confirmed by
data from the ABI. Between 2002 and 2006 total in-force business
declined by 8.1 percent from £86.721 billion to £79.732 billion,
while new business APE increased by 53.5 percent from £8.612
billion to £13.219 billion.
In its most recent study on persistency in the life insurance
industry, published in November 2007, the FSA highlighted
deterioration in persistency in most classes of business, based on
data gathered on policies written between 2002 and 2005. The FSA’s
key measure of persistency is business that remains in force four
years after being written.
One of the most significant declines in persistency observed by the
FSA since its previous study in 2003 was in the area of regular
premium personal pensions sold by independent financial advisers
(IFAs). In its latest survey the FSA found that the four-year
persistency of IFA personal pensions was 42.3 percent in 2007, down
from 45.9 percent in 2003 and 70.5 percent in 1997. According to
the ABI, in 2005 IFAs accounted for 80 percent of regular premium
personal pensions sales that totalled £1.86 billion.
In the single premium sector the most significant decline in
persistency was recorded in pension products sold via IFAs. In its
survey the FSA found that the four-year persistency of personal
pensions sold via the IFA channel was 82.3 percent in 2007, down
from 87.6 percent in 2003 and 94.6 percent in 1997. According to
the ABI, in 2005 IFAs accounted for 86 percent of single premium
personal pensions sales that totalled £16.3 billion.
However, four years is a very short period in what is essentially a
long-term market. According to consultancy Cazlet Consulting, the
financial break-even point for product providers for the typical
pension plan, for instance, is 16 years for a 25-year policy into
which money was paid on a regular basis, and 14 years for a 15-year
policy into which a lump sum was paid.
On the issue of persistency, pensions specialist Scottish Life, a
unit of mutual insurer Royal London Group, has made its view
crystal clear: current pension pricing structures are
unsustainable. Scottish Life stresses that under the current
structure if customers do not maintain regular contributions into
their plan, providers can end up facing a significant loss. The
loss is greatest for lapses in the early years, especially if the
traditional form of initial commission has been paid by the
provider.
Encouraging switching
The current structure, the stakeholder pricing model, was
introduced in April 2001 and operates with just an annual
management charge , and with the policyholder able to stop
contributions or switch to another provider, at any time on a
penalty-free basis. Clearly it provides an ideal environment to
encourage switching between providers.
Commenting on the FSA’s 2007 persistency survey, John Deane, CEO of
Royal London’s Intermediary Division, said: “We have been
emphasising for some time now the importance of writing new
business profitably and not just pushing for increased business
volumes and market share on any terms. However, there are still a
number of competitor companies who are operating in a way that just
makes no sense to us. As long as this continues, the market will be
distorted.” However, Deane predicted that following the publication
of the latest FSA persistency survey, it is likely that analysts
and institutional shareholders will put pressure on companies that
make market share their main objective to review their strategies
and move to sustainable pricing structures.
In 2003 Scottish Life introduced what it believes is a sustainable
pricing option, the Financial Adviser’s Fee (FAF), which is a form
of customer-agreed remuneration for IFAs. “It [FAF] means that
providers can compete on their products’ merits rather than on the
commission levels they pay,” stressed Deane. In the second half of
2007, 91 percent of Scottish Life’s individual regular premium new
business was written using a fee-based structure and the balance
using the traditional initial commission basis.
Underscoring Scottish Life’s concerns relating to the current
pricing structure, the FSA in its Financial Outlook 2008 review
noted that deteriorating persistency levels occurred during a
period when the UK’s economic growth was above its long-term trend.
Given the deteriorating economic climate, including rising interest
rates and inflationary pressures, persistency could be further
adversely affected “should more households struggle to repay their
debts”, cautioned the FSA.
Indeed, recent data suggests that if persistency will not be
negatively impacted by the economic climate, new business will. For
example, in the first half of 2007 the ABI reported single premium
retirement income product sales of £7.09 billion, up 44.4 percent
compared with the first half of 2006. In the second half of 2007
sales of £6.98 billion were recorded, 3.8 percent down compared
with the second half of 2006.
Further indicating that UK insurers are in for a difficult period,
research published by UK insurer Prudential in March this year
reflects a sharp fall in voluntary pension contributions. According
to Prudential, non-retired UK adults surveyed were contributing an
average £144.57 a month in March to private and company pension
schemes, equivalent to £1,734 a year. This is down 48 percent from
an average monthly contribution of £279.38 a month (£3,353 per
year) made into private and company pension schemes in April
2007.
Commenting, Prudential’s Retail Life & Pensions MD, Gary
Shaughnessy, said: “It is deeply concerning to see that the amount
UK adults are personally paying into pension schemes has fallen so
dramatically in the past year.” He attributed the fall to a
reaction by some consumers to rising prices and a squeeze on
savings.
Consumers under pressure
Indicative of pressures facing British consumers, non-profit
organisation Credit Action reports that at the end of January 2008
average household debt excluding mortgages was £9,052. This
increases to £21,051 if the average is based on the number of
households who have some form of unsecured loan. In addition,
compared with 12 months earlier, total personal interest payments
had increased by 13.2 percent to £93.9 billion.
The Prudential report also revealed that 55 percent of non-retired
UK adults said they are not contributing at all to a private or
company pension scheme compared with 54 percent of adults who said
they did not contribute to a pension scheme in 2007. Currently 63
percent of women and 44 percent of men do not pay into a private or
occupational pension plan. This finding by Prudential supports the
FSA’s view that there is a lack of planning for retirement among
individuals and employers.
The FSA believes this situation may improve over the longer term
with the introduction of the government’s personal account
proposal. The proposal is that from 2012 all employers will have to
provide a workplace pension and automatically enrol all of their
employees who meet the required criteria. However, the FSA
cautioned, until the proposal is finalised, there is a risk that
increased uncertainty around pension planning will result in
consumers or employers delaying decisions about retirement
saving.
Overall there is a general view in the UK life insurance industry
that change has become essential. At the core of the debate as to
which direction change should proceed is the FSA’s Retail
Distribution Review (RDR) discussion paper championing consumers,
published in June 2007. A key theme of the RDR paper was that many
consumers rely on advisers, a situation in which commission-driven
sales can result in what the FSA termed “inappropriate advice” to
switch between different products in order to generate income for
advisers.
The FSA’s paper has set in motion a hot debate around the issue of
commissions versus fee-based customer-agreed remuneration (CAR) of
advisers. One of the strongest views on this issue has come from
the Financial Consumer Services Panel (FCSP), an independent body
representing consumer interests. The FCSP stressed in a statement:
“The Panel believes that the paying of advisers directly through
commission must stop – provider firms should not be able to buy
market share in this manner, and competition must be based on the
quality of the financial product itself.” The panel is strongly in
favour of CAR as an alternative to commissions.
Whatever course the industry takes, a sobering comment came from
Mike Kellard, CEO of insurer AXA’s UK unit AXA & Winterthur
Wealth Management. Delivering the keynote speech at a conference,
Rethinking Life Insurance 2008 – Generating and Preserving Value,
he warned that the life insurance industry could “self-destruct in
the next five years” if it does not back the core aim of the RDR–
that of putting the customer first.
