Category Archives: Life Insurance Industry

The Future For The Life Insurance Industry Is Simple

The path to success in a competitive market full of twists and turns is to identify the simple things to do and simply, do them.

Looking back on almost 50 years in the life insurance industry, the most striking observation is how the products and process have gone from simple to complicated. Back in the day, agents bounded out of the office in search of those folks who were worried about what would happen to their family or business, “if something happened to them.” The paradigm was neat, clean and simple: Consumers were most concerned about the economic cost of dying young and there was no shortage of insurance companies ready to offer a product to meet that need.

In fact, hundreds of insurance companies vied to capitalize on this need, and the market appeared to be saturated with competition. But because banks and investment firms were prohibited by federal law (Glass-Steagall Act of 1933) from competing in the insurance industry, the truth is that Insurance_Stabilitythe industry was, in fact, competing only with itself. This meant that the insurance companies were free to offer virtually the same products. And they did. The agents selling the products may have competed fiercely against each another, but the companies were in reality competing with – not against – each other to divide up the business.

This situation created a symmetry of simplicity that functioned well for the companies, consumers and agents. Once the agent had worked with the customer to identify, quantify and accept the financial need, the solution was simple. There were only two options: Buy either whole life or term insurance. And since all companies offered basically the same products, “shopping around” for best values was as meaningful as shopping around for a best quart of milk.

The insurance landscape was so harmonious, in fact, that the environment was devoid of product confusion and consternation for both agents and consumers. There were no class-action lawsuits claiming deception, no company departments dedicated to determining suitability or the requirement for Biblically-long disclosure statements. There didn’t have to be, because the products were simple, easy to explain and understand, and targeted to meet a specific need.

Changing Times have changed the Basic Insurance Equation

Certainly the times, consumer needs and their options have changed dramatically in the past half-century, and that has forced the industry to change as well. For individuals, extended longevity has reduced the concern for the economic cost of dying too soon, but it has increased the worry about the economic cost of living too long. At the same time, the competitive ground rules for the insurance industry have changed. No longer do insurance companies have the field to themselves to simply contend with each other for the business; now they have to compete against banks and investment firms that are now free to offer products designed to meet the same consumer needs.

One upshot of this new environment is that the life insurance industry has forfeited what had been its strength and superiority in the market: the ability to offer simple solutions to complicated problems. And yet, although consumer needs may have changed over the years, they are still just as simple. But instead of fretting about what will happen when they die, the consumer is now concerned about what will happen if they live.

Unfortunately, instead of playing to its strength, the insurance industry has fallen into the trap of developing products designed to meet what the competition is doing, rather than what the consumer needs, wants and can understand. Instead of being the competition, insurance companies are following the competition by developing products that seek to mimic those offered by banks and investment firms. And even worse, insurance companies are putting themselves at the mercy of the banks and investment companies by coming to them to distribute the products. This is never a winning proposition.

Products once intended to respond to a basic need are now structured in an effort to meet every need. The byzantine products now being offered by insurance companies are akin to selling a battery-powered Swiss Army knife to someone who simply wants to butter his bread. This leads to complexity, confusion, dissatisfaction and delusion for both those selling and buying the products. One company recently introduced a new product described as, “An indexed annuity equipped with a stacking roll-up feature plus interest credits and bonuses with the goal to maximize the death benefit.” How simple is that for an agent to explain and for a consumer to understand?

The company that introduced the aforementioned product is attempting to touch all the bases by including elements of an annuity, variable annuity and life insurance all in one policy, only to end up convolution and confusion.

But they are not alone. The variations of products offered by insurance companies have now become so prolific, complex and complicated it is doubtful that even the chief marketing officer could list and explain all of them from memory. It is telling to note that in the past, agent-training focused on teaching agents how to prospect, identify the need and close the sale; today’s training tends to be nothing more than a long, PowerPoint presentation trying to explain what the product is and how it works; leaving little time to teach agents the right way to sell it.

Certainly the changed consumer needs and increased competition from banks and investment firms call for product innovation on the part of insurance companies, but real innovation makes things simpler, not more complex. All too often insurance companies seem to have confused product innovation with complexity. The truth is that products developed to meet every need end up meeting no one’s need.

Is it any wonder that the muddled approach to product development employed by insurance companies has led to confusion and frustration for both agents and consumers? Why should the industry be surprised that agents bungle the sales process and consumers are, at the very least confused, and most often dissatisfied?

Simple is as Simple does

At the risk of repetitiveness, the dominant financial concern of the consumer today is: Will I have enough income at retirement and will it last as long as I live? Just as the life insurance industry was best positioned 50 years ago to protect people in the event of death, so too, it is best positioned to protect those who live. For the industry to take advantage of this opportunity, however, it has to return to the idea doing simple things and SSI_1_business_desksimply doing them; developing simple solutions to complicated problems.

Admittedly, simplicity is the best, but hardest thing to do, and yet the effort is worth it. Remember, true innovation is not defined as inventing new things – that is creativity – but by making things simpler to do. Putting wheels on luggage was a great innovation, because it solved a need and was so simple.

The truth is that the companies and the agents are both more enamored with the complicated and confusing “bells and whistles” added to the products than is the consumer. These “special features” serve only to confound the customer who, deep down, is only anxious for their money to be safe and that they can count on the income for as long as they live. A focus on the “unique features” of the product, rather than the solution it can provide, runs the risk of the consumer feeling they have been bamboozled. And then the problems really start.

The consumer can and will adjust their standard of living to the amount of income received, but what the consumer can’t adjust to is having their income expire before they do. It is this attitude and economic fear on the part of the consumer that gives the life insurance industry an advantage; but only if the industry offers a simple solution to this complicated problem.

Looking for Real Answers

Is it still possible to develop an innovative product that is targeted to meet the income needs of the consumer and yet be simple to understand and sell? To answer that question, think about Social Security. When it comes to income needs, Social Security is probably the simplest product one could imagine: You put in money till you retire and then you receive money till you die. The product offers few options, no hedging, indexing or “stacking roll-up” features. A simple solution to a complicated problem.

Sure, people are required to “buy” Social Security, but in every survey taken, over 80 percent of the respondents say they are happy with the program. Social Security may not provide all the income people need, but you don’t see recipients rebel against Social Security although they do mutiny against any attempt to take it away. The life insurance industry could develop and market safe, simple products the consumer and agents can understand; that simply meets the needs of the consumer. That would be real innovation.

The great opportunity for the life insurance industry is the same as it was 50 years ago – to meet the long-term financial needs of the consumer. The more simplicity the industry can bring to the process, the more successful it will be.

And the Moral of the Story …

In a changing and competitive world, it is a widely held belief that complicated problems require complicated solutions, but that is not true. Success comes with simplicity. Successful people and companies attack complicated problems with simple solutions.

The appearance of complexity in a process is often the result of a simple failure to understand the real objective. The first step to making what is complicated simple is to focus on the desired result and then work back to identify the simple actions needed to accomplish the goal and simply do them.

The life insurance industry created a grand record of success by developing products that offered a simple solution to a complicated problem. The industry began to forfeit this success when it lost focus on the changed needs of the consumer and began to offer complicated solutions for a simple problem. The life insurance industry must understand that its path to a successful future is simple.


The Curse Of Longevity Is The Cost To Enjoy It

Are Longevity Insurance Policies a Smart Buy? Maybe Someday, But Not Now

It used to be that our grandparents worried about what would happen to their kids if they died too soon. Nowadays, our kids worry about what will happen to them, if we live too long.

Extended longevity is both a blessing and a curse. The blessings are well known and innumerable. But we are also cursed with extra time to fear death and more time to worry about our added longevity stripping us of the cash required to comfortably support those “bonus” years. In short, most folks are Longevitynow more concerned about the cost of living too long, than they are about the cost of dying too soon.

A New Opportunity is Waiting

The life insurance industry achieved exceptional success and became comfortable offering products that protected against the cost of dying too soon. But it has taken the industry several decades and a number of fits and failures to (grudgingly) recognize and accept this fundamental change in consumer needs.

Despite the admonitions of some within the industry, the idea of accepting – even acknowledging – change has not been easy for the life insurance industry. Historically accustomed as it was to selling the products it wanted to sell versus products the consumer sought to buy, the life insurance industry’s initial response to the threats posed by this change was a call to “get back to the basics.” The problem for the life insurance industry was that the basics had changed and clinging to the past simply exacerbated the problems.

The Writing on the Wall was not in Invisible Ink

It’s not like the life insurance industry was not warned. As long as three decades ago, the signs of change – for those who were open to seeing them – were clearly evident. Life expectancy at the start of the 20th century was a mere 42 years; by the end of the century it had dramatically increased to age 74; with predictions that it would soon extend well into the 80s.

These remarkable statistics and a number of other factors signaled the need for change, but it was this extension of longevity that led the consumer to conclude that the fundamental products offered by the life insurance industry had become outmoded.

The life insurance industry has finally been dragged kicking and screaming into the future, but because of its intransigent allegiance to the past, it may be too late to recover what it has lost. Now that the life insurance industry has accepted the premise that it must change – if it is to survive – and offer products that protect against the cost of longevity, it is struggling with just how to do so.

Many believe that the business of insurance companies is to take risks, but that is not the case. (At least that’s not the approach for those companies that survive.) The path to success in the insurance industry is not to assume the risk of loss, but to manage the risk of loss faced by others. In order to do this, the insurance company must fully understand all aspects of the risk, so it can be managed.

The life insurance industry has more than 150 years of experience designing products that cover the costs of dying. This experience enables the industry to comfortably manage the risk of dying, without assuming much risk. Given any group of insureds, the life insurance industry can forecast – with virtual prescient certainty – when and how many in that group will die during any given period of time.

On the other hand, the life insurance industry has only a smidgeon of experience understanding the risks inherent in what could be called the “longevity market”:  offering income products that meet the costs of living. An insurance company can use life expectancy tables to determine when people will die, but it has no experience projecting how many individuals in a group will live beyond – and for how long – the moving target of life expectancy.

This means the insurance company is, in effect, making a guess (taking a risk) as to how many insureds will live longer than expected and what the duration of those claims – life income – will be. In addition, interest rates have a dramatic effect on the amount and cost of income benefits. And since interest rates, another moving target, cannot be predicted for even the next year, it is a significant risk for insurance companies to try to project interest rates over decades.

The Unwelcome Upshot of All This

Faced with this dual conundrum, the prudent insurance company will tend to develop products for the “longevity market” that are loaded with hedges, protections and benefits for the company, but not so many for the consumer. This is to be expected, because insurance companies do not (and should not) assume risks they don’t understand or can’t manage. As a result, the tactic taken by insurance companies in the design of these first-generation longevity products is to transfer as much risk as possible to the insured. And this will continue to be the approach until the industry gains experience and confidence in the management of those risks. In the meantime, it’s buyer beware.

The concept and objective of these longevity policies is fine, but they are so loaded with protections for the insurance company, they don’t yet offer good value for the consumer and should be avoided. It’s not that these products are bad, it’s that they are not as good as they could or will be and the cost benefit for the consumer is not well balanced.

These products are the insurance industry’s first response to meet the concerns an individual may have that they will “outlive” their assets and income. They may have enough money to get to age 75, but what if they live to 95? The basic structure of “longevity insurance” is for the Retirementpurchaser to deposit a lump-sum amount with the insurance company, with the understanding that no benefits will be paid unless and until a person lives to a predetermined age. For example, a 55-year-old deposits $50,000 with the insurance company to buy a longevity policy. The policy would pay no benefits whatsoever until age 85. At that time, the company would begin to pay about $50,000 a year, for as long as the insured lived.

This type of policy certainly solves the “longevity problem,” but it comes at a very high price with few options for the insured. For one thing, once the deposit is paid to the insurance company, it belongs to the insurance company and may never be returned. The insured gives up all control and access to the money and if they change their mind or have an emergency need for cash, they are out of luck.

That means an individual age 55 could deposit $50,000 or more with an insurance company and if they don’t live to age 85, they lose all the money deposited. The only chance they have to get their money back is to live. Even then, if the insured does live to 85, and dies a year or two later, the funds are lost. In fact, insurance companies anticipate that so many of those who buy the policy will not live to collect any benefits they count on using these forfeited funds to pay those who do live. (In fairness, some companies do offer the insured options that would, under certain circumstances, allow for a return of this premium, but the costs are so prohibitive they virtually eliminate the basic value of these policies.)

There are other problems with the policy as well. For one thing, benefits are set and guaranteed at the time the policy is purchased. With current interest rates at such low levels, this may be the worst time to buy a policy that locks in current rates for, what could be, 30 years or more. Any increase in investment rates between now and when benefit payments commence (if they ever do) would benefit the company, not the policyholder. Another concern for the policyholder could be inflation. A guarantee of $50,000 a year income may seem good today, but what will its value in purchasing power be in 30 years?

There is another issue a potential purchaser of these longevity policies should consider. It is what investors call the “credit risk.” When buyers deposit their funds with the insurance company, they are taking the credit risk that the company will be around in 30 years and will be able to meet its obligations. This is a relatively low risk decision, but if the insurance company mismanages the investments backing these policies, if more people live than anticipated live to receive benefits and those receiving income live longer than planned, the insurance company could be squeezed to meet its promises.

So what is someone who is concerned about the economic costs of living too long to do?

Well truth be told, these “longevity insurance” policies are not all that revolutionary and are not worth the cost or the risk the insured must assume in order to receive benefits. In effect, the core of these policies is a single premium deferred annuity. In a single premium deferred annuity the insured makes a single deposit of funds, allows those funds to accumulate over time and then, at a later date, can elect to receive an income for as long as they live. The risk the insured is taking by purchasing this type of policy is that it is impossible to know exactly what the income will be when they elect to receive it.

What makes the longevity policy unique is that the insurance company will guarantee what that income will be. That’s great. But the costs applied by the insurance company to receive this benefit are just not worth it. The insured must give up the right to get their funds refunded if their needs change. If they need cash for unexpected purchases or emergencies, they must find it elsewhere. If they die before receiving any benefits, their family receives nothing. They have only one chance to receive income and that is they must hang on until they reach 85 and if they die a month before or a month after income starts, that’s the end of the income stream. All these costs and limitations outweigh the value of the insurance company’s guarantee as to what the income will be at age 85.

In the Meantime, Here’s the Smart Choice

Until the insurance companies gain the experience and desire to develop improved iterations of longevity insurance, the consumer is better served by purchasing a traditional single premium deferred annuity. This keeps all the options on the side of the consumer, while still offering a guaranteed income to cover the cost of longevity. The only risk for the consumer has is not knowing exactly what that income will be when they elect it, but that risk is slight and is a fair exchange for the high costs of current longevity insurance policies. This is the best way, at least for now, to enjoy your longevity, for as long as it lasts.


Hot Money May Cause the Life Insurance Industry to Crash and Burn

Cash is God in the life insurance business and some companies seem to be willing to sell their soul to the Devil to get it.

The appeal, power and profitability of the life and annuity insurance industry have eroded almost to the point that the industry has not only lost its prominence, but its very viability as an independent competitor in the Insurance_Stabilityfinancial services market also is being questioned. These dire circumstances are forcing insurance companies to seek capital infusions from sources they would never have previously considered and to take actions that are an anathema to traditional insurance financial management. Both actions may, in the end, threaten the very survival of the companies, but even worse is the risk that these activities may leave policyholders holding the bag and cost the taxpayers billions in bailout bucks.

There is no more cogent evidence of this state of affairs in the life insurance industry than a recent article in The Wall Street Journal which reported that the New York Department of Financial Services has issued subpoenas to a number of large private equity firms, seeking information about recent investments they have made in the life insurance industry. Regulators may be curious about this activity because the business model of private equity firms – relatively short term high returns – is so contrary to the business model of insurance companies. Just a few weeks later The New York Times reported that the New York Department of Insurance is investigating actions by insurance companies characterized as “shadow reinsurance” that are intended to artificially reduce the amount of capital and reserves needed by insurance companies.

In simple terms, here is the problem: The financial model for the life insurance industry is diametrically opposite to that of most industries. When a typical company makes and sells a product, it reports an immediate profit. When a life insurance company manufactures and sells a policy, it reports an immediate loss; a loss that may not be recovered for several years. As a result, for non-insurance companies, growth creates new capital, while a growing life insurance company consumes increasing amounts of capital. For most companies, a return on invested capital can be measured in a single fiscal year, while for a life insurance company a return on invested capital could take decades.

Capital Requirements Magnify the Issues

When it comes to managing capital needs, life insurance companies face still another financial complication. The nature of life insurance is an uncertain, long-term liability. Actuarial tables notwithstanding, the insurance company never really knows when it will have to pay or how much its future liability to the policyholder may be. With this in mind, state regulators require insurance companies to set aside and maintain a reserve of capital to meet these future liabilities. This requirement ties up capital for decades that further limits capital available for growth.

In the past, there were a number of strategies life insurance companies used to effectively deal with its capital requirements. For one thing, the insurance industry was sheltered from competition because banks and investment firms were prohibited from offering insurance products. This isolation allowed the insurance companies free rein to compete with each other to carve up the available business unfettered from free real competition from outside the industry. This meant that consumers could not comparison-shop for products based on price – as all products were priced on the same basis – and all products produced very high profit margins for the companies. This situation permitted insurance companies to use the profits emerging from existing business as “capital” to invest in new business.

Traditionally, the largest life insurance companies were not publicly traded, but were rather “mutual” companies, LifeInsurancetheoretically “owned” by the policyholders. This structure immunized the insurance company from any real pressure to show a return on invested capital, especially in the short term. In addition, the life insurance industry shared and passed around its capital among companies, in the form of reinsurance. Companies that had capital, but were not growing as quickly as others, would “loan” their capital to another company, in exchange for participating in the future profits of the business. This was facilitated because both companies were willing to accept a long term – maybe over decades – return on this capital.

There’s Trouble Ahead

But then, late in the 20th century, the life insurance industry experienced what was, in effect, a cataclysmic polar shift in its world. The life insurance industry was ravaged by a perfect storm when, in rapid succession, a maelstrom of events dramatically changed the insurance landscape.

First, there was a rush by the largest insurance companies to convert from a mutual to public structure. As a result, the short-term demands of the public market forced the management of these companies to shift, as never before, from long-term strategies to short-term, top-line sales and bottom-line results.

Then, another bomb shell: The restrictions keeping banks and investment firms out of the insurance industry were repealed and this opened the door to stiff new competition for insurance companies. The combination of increased competition and focus on short-term results caused insurance products to be marketed more as commodities – with price being the motivator – a change that significantly squeezed profit margins for insurance companies. On the heels of all this the financial crisis thundered in swamping insurance companies with hundreds of millions of dollars in investment losses at a time when interest rates for new investments dropped to virtually zero.

These were catastrophic events for an industry that always needed to wisely husband its capital and sold products that were “interest sensitive.” The fallout from this chain-reaction of events also triggered a significant reduction in the valuation of insurance companies, making it even more difficult to raise capital.

Just when things couldn’t get worse . . .

In short, just when the insurance industry needed capital the most, it ran out of capital. Companies lacked the cash required to support new business, causing them to scale back on sales. At the same time, reinsurance companies exited the market; they needed to retain all available capital to support existing liabilities.

In response to this confluence of crises, insurance companies began taking one or more of three different actions:

  • Raising capital from private equity investment firms.
  • Engaging in “financial engineering” in an effort to reduce capital requirements.
  • Moving away from the very core of insurance – the guarantee that risk of loss would be covered – by offering investment-type products that transfer the risk to the policyholder.

Any one of these actions – let alone the combination of all three – has the potential to fundamentally change the very nature of the insurance industry and threaten the future of any company that employs them. And here’s why.

It may seem like a match made in heaven: Private equity firms are flush with capital to invest and the insurance Private-Equity-Firmsindustry are desperate for fresh capital. The problem is that the business model for these two groups is not a match, let alone a heavenly one. Private equity firms seek a return on invested capital that is as much as three times higher than the normal return insurance companies can expect to achieve. Even more conflicting for the insurance industry is that private equity firms seek to be in and out of their investments within a five- to seven-year time frame, while insurance products barely break even after five years.

Another challenge for insurance companies that accept private equity capital is that these firms expect to begin receiving dividends on their investment almost immediately. The management of insurance companies that accept private equity capital will soon find they are constrained to meet the requirements of private equity and take actions that are antithetical to sound insurance management. And it could be the policyholder who ends up paying the price for this arrangement.

As mentioned above, reinsurance companies have traditionally been a reliable source of long-term capital for insurance companies, but reinsurance companies are also strapped for cash and have virtually withdrawn from the life and annuity market. In response to this, as the New York Times article pointed out, many of the largest public insurance companies have discovered a “creative” way to overcome the lack of capital available from reinsurance – they have started their own reinsurance companies.

In simple terms, these companies have set up wholly-owned reinsurance companies in states that have lower capital reserve requirements or fewer investment limitations than does the company’s state of domicile. The “parent” company then transfers large blocks of business to this “captive” company; thereby reducing the amount of reserves that have to be maintained to meet future liabilities. Voilà!, with a jurisdictional sleight-of-hand, new capital is magically created out of thin air. This may be all well and good, but should the reserves being held by the “reinsurance” company be insufficient to meet future liabilities (the reserves, after all, may amount to no more than a “conditional letter of credit” from the parent company), then once again the policyholder, or ultimately the taxpayers, could be left holding the bag.

The final action that some companies are taking is, in effect, to get out of the insurance business. Companies are developing products that are more akin to investments than insurance. This is accomplished by transferring the risk for what the future benefits may be from the insurance company to the policyholder. (For example, selling variable annuities and variable life as opposed to guaranteed life or annuities.) In other instances, companies are transferring the longevity risk – how long the benefits will be paid – from the company to the policyholder. Both of these actions have the effect of reducing the amount of capital needed to write new business and the amount of capital needed to be held in reserve. In effect, we are seeing the largest life insurance companies morph into investment companies, right before our eyes.

The Moral of the Story … 

Putting it all together, it is not implausible to foresee a scenario in which the financial services industry contracts into two players – banks and investment companies, with insurance benefits sold as an ancillary benefit on the side. This may be the most logical direction, but is does not portend good things for the life insurance industry as a viable competitor in the financial services industry.