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More Disturbing News For The Life Insurance Industry

 MetLife building in New York, October 8, 2008. REUTERS/Lucas Jackson)

MetLife building in New York, October 8, 2008. REUTERS/Lucas Jackson)

Last month, MetLife made the bombshell announcement that it will exit from the life insurance business. The company indicated it will shed its life insurance and annuity business by forming a separate company and then selling stock in the new company via an IPO; in essence selling its life insurance business to stockholders. (Most likely because MetLife knew no other company would buy it.)

For those of us in the insurance industry, this is one of those, “you’ve got to be kidding me” moments. Could you have ever imagined reading that MetLife, the very pillar of the life insurance industry, would announce that it is getting out of the business? This is akin to the New York Yankees announcing they are going to get out of the baseball business.  

MetLife CEO Steven Kandarian justified the decision by blaming federal regulators for imposing the “too big to fail” tag on MetLife. The MetLife grievance is that these federal regulations would require the company to increase – to unreasonably high levels – the reserve capital it holds to support its life insurance business. (Of note, there are those in the financial and regulatory community – including the Insurance Department in New York – who have suggested that MetLife has been “playing games” in reporting its life insurance reserves.)

Blaming federal regulations for MetLife’s decision to exit the life insurance business is at best a half-truth. The new federal regulations for reserves may have been what triggered the decision, but they are being used more as a smokescreen and an excuse for doing what the company has wanted to do for a long time. MetLife acknowledged that even if the company were to prevail in its lawsuit against the federal government over its designation as too big to fail, it would still exit the life insurance business.

There is an unspoken but simple truth underlying MetLife’s decision: Life insurance and annuities are no longer “core” to the future of MetLife. It may surprise some in the insurance industry, but the retail life and annuity business now represent only about 20 percent of MetLife’s operating earnings, and it has been declining. MetLife reported that in the third quarter of 2015, operating earnings from life insurance and annuities declined by 33 percent from the previous year and growth had slowed to just 2 percent, compared to 12 percent the previous year.

Reaction by the Financial Community

When MetLife announced its decision to exit the life and annuity business, the financial community did a happy-dance. MetLife stock jumped 10 percent, right off the bat. The Wall Street Journal suggested that MetLife’s action will put pressure on the industry’s biggest companies such as Prudential and AIG to follow suit and exit from the life and annuity business. The Journal mused that MetLife’s action could trigger “a broader shake-up of the insurance industry’s biggest companies.”

The MetLife Decision in Perspective

It is difficult to argue with the MetLife CEO’s decision to exit the life insurance industry. He should be given credit for recognizing the realities of the industry now and for taking action to meet them. For a number of reasons, there has been, in effect, a “polar reversal” in the fundamentals of the life insurance industry. An industry that operated for 150 years selling products based on guarantees producing long-term value and long-term profits, has become an industry driven by fear of guarantees, short-term profits and commodity pricing. A business model predicated on long-term value and steady returns simply cannot function effectively (if at all) in a frenetic short-term world.

There is a simple factor at work here: It is expensive, in terms of capital required, to guarantee meeting the liabilities for mortality (death benefits) or longevity (income in retirement) that either may not emerge for decades or (even worse) be unpredictable. It is the cost – capital held in reserve – to provide these long-term guarantees that MetLife has decided it is not worth paying.

Driving this dynamic is the reality that many of the larger companies in the industry such as MetLife, Prudential and AIG are now public companies judged on the basis of their performance in the next calendar quarter, not the next quarter century. In this short-term world, the financial community views capital that is held in reserve against future liabilities as “dead capital,” and that is judged to be a liability in and of itself. This modern reality is at the core of MetLife’s decision not to invest its precious capital in new life insurance business.

It is of note that MetLife is not divesting its large block of in force (called a “closed block”) life insurance and annuities. This business has already had capital invested in it and is throwing off consistent profits. What MetLife is saying is, “We don’t want to invest our capital in new, long-term life and annuity policies, because we are being pressured by the financial markets to deliver short-term returns on our invested capital; returns not available from life insurance and annuities.”  

There is a cruel irony in this situation: When the life insurance industry was singularly focused on guaranteed long-term products sold on the basis of value, it was awash in capital. The profits from this type of business created more capital than the industry could invest. In 1987, when I started LifeUSA as a new life insurance company, no less than seven very large companies fought over the right to provide the capital needed to write our new business. These companies literally paid us to take their capital, so they could participate in the long-term life insurance and annuity business LifeUSA was writing.

It was only after the companies began to shift away from guarantees and long-term value, toward a focus on commodity-type products designed to generate short-term profits that their capital base began to evaporate. By looking short-term for its return on capital, the life insurance industry moved from being a capital creator to a capital eater. As a result, the life insurance industry has now become dependent on sources of capital such as the stock market and private equity funds, that demand higher returns than life insurance is designed to produce, and these returns are expected to be delivered over the short-term. Faced with this pressure, MetLife felt its only option was to get out of the life insurance business.

MetLife could take this action because life insurance is no longer a core business of the company; in fact, this action will theoretically allow the company to increase short-term profits. The real question is: What is going to happen to those companies for which the sale of life insurance and annuities is their core business? What options will they have? What cost will they have to pay just to stay in business; if they can?

MetLife’s action is not an outlier, but only the first concrete example of the long-term damage that can be inflicted on the industry when companies abandon long-term thinking for short-term results and returns. Unfortunately, the real losers will be the insurance industry itself and consumers who need, seek and are willing to pay for guaranteed long-term protection and value.  

Keep It Simple, Stupid

When it comes to solving problems or taking advantage of promising opportunities, all too often too many confuse complex and complicated with innovation and creativity.

Do you remember the first time someone explained the “KISS” formula to you? For me, it was probably my first day as an insurance agent in 1965. A grizzled veteran (he was probably 35) sat me down and said, “Kid, I want you to know that the secret to success is the KISS.” Seeing my perplexed look, he leaned forward and said, “Keep it simple stupid.” It was a lesson I took to heart, but over the years I was struck by how often that concept was propagated and then totally ignored.

Even today, I never cease to be taken aback by the extent some business wonks will go to take Kisssomething simple and make it complicated. The life insurance industry is certainly not alone in doing this, but it does set the gold standard when it comes to offering incredibly complex solutions for simple, straight-forward problems. In falling prey to the fallacy that complexity equates to creativity or innovation, the life insurance industry lost touch with the three attributes that were the basis for its past success – simplicity, safety and security. In so doing, the industry has put its success, profitability and even future viability at risk.

You don’t have to be in the life insurance business to learn from its missteps. By understanding the false assumptions, critical mistakes and shortsighted actions taken by the leaders of the life insurance industry, anyone in any industry, can learn that simple is better. Those responsible for the success of an organization can be more effective, efficient and successful when they recognize that byzantine solutions to simple, straightforward problems – such as those adopted by the life insurance industry – often only make the problem worse.

The 20th century was glory-time for the life insurance industry. By offering a simple solution to a vexing problem, the life insurance industry evolved from an obscure group of small companies catering to the elite into a ubiquitous highly-powerful industry meeting the needs of the masses. As the Industrial Revolution drew people from a self-sustaining life on farms to the cities and onto the payrolls of factories, the survival of families became dependent upon a salary earned by the husband, instead of crops raised by the family. Families soon recognized the risk to financial survival should the head of the family die and the cash stopped. For the first time in history, people became concerned about the economic cost of dying young; and during most of the 20th century people did die young.

The life insurance industry perceptively recognized the emerging opportunity and stepped up with a simple solution to the problem. They began to offer an easy to understand, affordable product that made the simple promise that the insurance company would be there to provide cash for the family if the breadwinner died. Using this unpretentious approach to a pressing consumer need, by the 1950’s life insurance was considered a necessity for any young family; so much so that even the government gave the product tax-favored status. And for their effort, life insurance companies became some of the largest and most profitable financial institutions in the world.

But times changed. By the latter stages of the 20th century longevity for men had been extended from 42 to 74 years. (Even longer for women!) Almost overnight consumers became less concerned with the cost of dying too soon and became focused on the cost of living too long. By the end of the 20th century, the pressing – even frightening – financial question changed from: Will I live as long as my family needs income? to “Will my income live as long as I do?

This new financial concern created an even greater opportunity for life insurance companies, because of all financial-type companies, life insurance companies were best structured solve this problem and benefit from the opportunity to do so. Unfortunately – happy with the past – the industry was late to recognize the change and was even more reluctant to respond to it. The life insurance industry paid a high premium for this recalcitrance to change; seeing its products move from the forefront of consumer needs to nothing more than an afterthought. The result was what might be expected: reduced sales, declining profits, consolidation and even failure within the industry.

When the honchos of the life insurance industry finally acknowledged the change in consumer needs and wants, they compounded their tardiness by ignoring the very strengths that initially built the industry – simplicity, safety and security. And even worse, they exacerbated the problem by attempting to replicate the products of banks and investment companies, rather than concentrating on the strengths and advantages of their own industry.

When it comes to an individual’s concern for financial security between the time of retirement and death, the vast majority of consumers have only two questions: Will the money I have be safe? Will the income my money produces last as long as I do? That’s it – nothing more – simple and sweet. All else is extraneous and of declining value that only serves to complicate and confuse the solution; while delaying action.

I know there are those who believe the primary motivating factor for the consumer is the level of income, not the safety or longevity of the income, but they are wrong! Striving for the maximum level of income as the basis for a sale, is only an excuse and invitation to make the solution more complex and complicated. (Just like investment products!) The race to provide the most income leads to layer upon layer of complexity and convoluted “benefits” that only serve to confuse and confound; literally losing sight of the simple problem to be solved.

As the life insurance industry has painfully learned, this mindset can lead to troublesome regulatory Insurance_Stabilityissues, suitability questions and expensive litigation, caused by products so complicated and complex that not even the salesperson can understand them, let alone the consumer. And it is all for naught, because the reality is that not all, but the vast majority of consumers would opt for lower income in exchange for the absolute certainty that their money is safe and the income will continue, no matter how long they live; as opposed to a little higher income, but with less certainty that their money is safe and that the income will live as long as they do. (People can adjust their standard of living to a guaranteed fixed income much easier than they can to one that is variable and uncertain.)

In doing research for this blog, I looked at “product sheets” for two companies selling income products. One company offered 37 different variations of product, while the second company topped its competitor by offering 47 different products; all intended to meet one simple problem. That’s two companies – out of a very large industry – offering 83 different types of income products; just imagine how many there are in total!

Why is it that companies would respond to such a simple need, with so much complexity and befuddling products? Well, believe it or not, one answer is – because they can. Lacking an understanding of the true creativity of simplicity, insurance companies have defined innovation and ingenuity as the number of “new products” that can be put on the street. Another problem is that often insurance executives (most whom have never been face to face with a consumer) believe that the best strategy to increase sales is to be all things to all people. This philosophy requires products that target even the smallest sliver of the market, rather than the largest segment of the market. This approach leads to increasing complexity and confusion, both among consumers and salespeople charged with selling the products.

In fairness to the companies, insurance agents are also at the root of this complexity. Agents tend to believe that if the company will give them “just one more new product,” their sales will significantly increase. This belief is born out of the idea (hope) that a product can sell itself, but that never happens. The value of the agent is to sell the product, not take orders. The more products there are to offer and the increased complexity that comes along with them means the agents spend more time explaining (often what they don’t understand themselves) and less time selling.

Insurance companies and their agents will do better and their future will be brighter if they get back to the same formula that sparked industry success 100 years ago – KISS! The insurance industry should remember its name – insurance – and develop income products based on simplicity, safety and security. The insurance companies should take advantage of the fact that they are the only institutions that can provide a simple solution to financial needs, guarantee the safety of capital and offer the security of providing an income that cannot be outlived.

Sure, these products would not be flashy and sexy, but they would be simple, easy to understand and meet the needs of most consumers to protect their money and security in retirement. Remember, life insurance was never a sexy product, but people bought it in droves because it met their needs for safety and security. The life insurance industry enjoyed its greatest growth and prosperity when its products were simple, easy to understand and based on the inherent value of meeting a financial need and they can again if they just remember KISS.